INDIANAPOLIS (Oct. 1, 2008) – A recent opinion from the California Court of Appeals is a significant victory for mutual insurance company boards in their efforts to successfully and flexibly oversee the management of their enterprises for the benefit of policyholders in an increasingly uncertain market, according to the National Association of Mutual Insurance Companies (NAMIC).

The appellate court decision in Hill v. State Farm Mutual Automobile Insurance Company, reaffirms the ability of boards to set appropriate direction and make critical decisions respecting the practice of declaring dividends, and the role and function of policyholder surplus, NAMIC said.

Unlike stock insurance companies, mutual companies are not owned by shareholders. Rather, policyholders are members of the insurance company and retain rights in the mutual company that amount closely to that of “ownership.” Mutual company bylaws and policies often contain provisions outlining the right of policyholders to receive dividends. This right, however, is often contingent on the discretion of the board in declaring such dividends. The Hill case centered on when and how such discretional decisions about issuing dividends are made.

“This decision is important for all insurance companies, but particularly for mutual companies,” said Marsha Brown, NAMIC’s regulatory affairs counsel. “Boards can’t operate effectively if such fundamental decisions, such as dividend declarations, can be second guessed. Mutual company policyholders have an opportunity to influence board decisions when they vote for or against board member candidates.”

The case arose from a complaint filed in 1998 challenging State Farm’s dividend practices between 1983 and 1998. Among other things, the plaintiffs sought to force State Farm to make payment of policyholder dividends from what the plaintiffs considered to be “excess” surplus. The case was certified as a nationwide class action suit, and the recent opinion results from the case’s third trip to the Court of Appeals.

NAMIC, which represents more than 1,400 mostly mutual member companies, participated in prior appeals and filed an amicus curiae brief in the most recent appeal.

In 2006, the trial court granted State Farm’s motion for summary judgment on the basis of applying the “business judgment rule” to the board’s decisions on dividends during those years. The latest Court of Appeals ruling affirms the trial court decision, holding that:

• The policyholders did not have a right to any specific amount of dividend at any specific time.
• It was sufficient that the board of directors was informed of the financial condition of the company and considered dividends from time to time.
• The board could rely on management decisions and recommendations in reaching its decisions about dividends.
• The business judgment rule may be a defense to a claim that the board breached a duty of care.
• It is a valid business purpose to use surplus funds to offset underwriting losses when setting premiums.

“This decision is significant in that it protects a distinctive feature of mutual insurance companies – to issue dividends to policyholders at appropriate times,” Brown said. “As owners of these companies, policyholders can feel confident knowing that decisions about whether, when, and how to issue dividends are carefully balanced with protecting the solvency and financial health of the companies.”

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© Copyright 2007, National Association of Mutual Insurance Companies (NAMIC).