Mutual insurance companies and stock insurance companies are different forms of organized risk sharing: policyholders and owners are two distinct groups in a stock insurer, while they are one and the same in a mutual. This distinction is relevant to raising capital and selling policies in the presence of frictional cost of capital. Free-rider and commitment problems in a stock insurer limit shareholders’ compensation for the frictional cost and therefore the level of capital that can be raised. By tying sales of policies to the provision of capital, the mutual form can overcome these problems at the cost of less diversified owners.

Insurance contracts are often complex and difficult to verify outside the insurance relation. We show that standard one-period insurance policies with an upper limit and a deductible are the optimal incentive-compatible contracts in a competitive market with repeated interaction. Optimal group insurance policies involve a joint upper limit and individual deductibles; insurance brokers can play a role implementing such contracts for their clients. Our model provides new insights and predictions about the determinants of insurance.