Mutuality in P&I Insurance - an Institutional Approach

This thesis seeks to explain the mutual form of the P&I club system as opposed to a one based on commercial underwriting, using an institutional perspective. Two very basic theoretical notions supply the basic structure, adverse selection in the ex ante phase of the transaction, and moral hazard, ex post. In overcoming the problem of asymmetric information ex ante, no particular advantages can be discerned in a mutual system. On the contrary, it requires more information to be exchanged due to the dual roles of the member, as insured and insurer. However, the present system has capacities and practices of spreading information informally. Significant levels of aggregate uncertainty at the systemic level favour a mutual type of governance. This is particularly true for legal changes in the right to limit maritime liabilities. The presence of counterparty risk, which could develop into an aggregate shock to the insurance system, is another cause of mutuality, while lack of underwriting data is dismissed as motivation thereof. Turning to the ex post section, it is asserted that the mutual form is crucial as it provides legitimacy for loss prevention schemes, but it also brings with it a risk of overexploitation of a common resource, a tragedy of the commons. P&I clubs have the institutional form necessary to shoulder functions of self regulation, bringing advantages in terms of influence. In tackling the problem of weak underwriting discipline inherent in long tail liability insurance, mutuality is found to be a disadvantage, but the mutual system may also have a unique institutional capacity to remedy this problem. Furthermore, the mutual form can legitimize the presence of liability insurance from a societal perspective, and is consistent with the polluter-pays principle. Three agency theoretical hypotheses concerning mutuality are discussed, of which the risk sharing hypothesis has the highest degree of explanatory value, as it makes a correct prediction, and presents a plausible, but not universally prevailing, reason for the dominance of the mutual form. The managerial discretion hypothesis makes a prediction contrary to the actual market structure in P&I, but has the nice feature of shedding some light on the organisational set up of clubs. A limited degree of market segmentation is consistent with the maturity hypothesis.