HIH Insurance Collapse - Case Study Example

IН Insurance Collapse By Student’s name Course code+name Professor’s name University name City, State Date of submission 1. Introduction In Australia, HIH Insurance Limited was publicly listed. HIH Group was the second largest insurance limited in Australia before it collapsed in 2001 and also operated in many other countries. Some subsidiaries and HIH Group were put in a provisional liquidation. Following that, the firms that were in provision liquidation were put in liquidation. For the eight companies, schemes of arrangement are now in place. Owing to that, initial payments have been made by the scheme administrators to various creditors and over the following years it will make further payments. Adding to that, an application to the Insolvency of the HIH group has to be made by the Australian priorities as peer the decision handed down by The House of Lords (Dagwell & Lambert, 2007).  The HIH case was as a result of manifest highest risk areas, financial depression and questionable practices and model setting of corporate governance as from the audit’s perspective. These are big challenges and very desirable to analysis of an audit. The interested party did not get a warning about the HIH financial strength deterioration before liquidation was announced since the process had to take more than a year which did not happen so. Due to the inconveniences, the Anderson Accounting Firm must take the blame for its failure to observe fully the functions on behave of the interests of the stakeholders. As per the remarks in the HIH failure investigation report by Hon Justice Owen who is the royal commissioner, Anderson did not get enough audit evidence to use in support of his conclusion (Insurance Journal 2003). In this paper the challenges and issues of the HIH Group are going to be discussed. The corporate theories too will be discussed in accordance to the company. 1. What Caused HIH Collapse The inability of the company to pay debts and the insurance policy holder’s claims as they due fell is the main cause of what led to the liquidation of HIH, this is from the financial view point. Sincerely, this statement is universally acknowledged as it brings out the concept right. As per our knowledge, the main agenda of any firm in operation is to make more profit and thus the cash is the beginning and ending point of its cycle of operation. Regarding to that, the money position of a given firm is actually the cash effect summary of financial and operation policies & activities, and hence in the long-run there will be a reflection in the cash condition of the non-cash effect of transaction. Using this explanation, we do not need to focus on cash positioning alone while examining the collapse of HIH but also financial and operational activities that are the real causes of the HIH insolvent position (Haines, 2007).  Pertaining the HIH issue, what comes out is that the insurance firms gets themselves into commitments of dealing with the risks which later place them in even more high risk positions. The important factors that the insurance companies have to use against risks that are high and squeezing the profit are; the investment decision, outstanding claims provision reserving policy and risk pricing ability. Firstly looking at the investment decision, which is a very important part of the insurance firms that involves the use and management of cash got from creditors, the shareholders and policy holders. Mostly, the returns from the investments can show the existing loss. A disaster can occur to the insurance company as a consequence of the long term entailment and commitment in large scale funding and hence production of negative return flows by the investments. The HIH gives a typical illustration as per this concern. The HIH suffered three major investments failures as it was brought out in the royal investigation reports. The UK operation was the first failure followed by the US operation. In the UK, the losses summed up to $1.7 billion, and the expected profits never emerged concerning the US operation and they ended up being placed in a run-off costing HIH $620 million. The FAI acquisition is the third failure (Vinten, 2005).  Regarding the three factors, the provision for claims outstanding has a very big role to play. It was revealed that the CEO of HIH, Ray Williams does not concur with the need for prudential margin, this led to implementation of under-reserve policy in connection with the expected future claims by the HIH. However, if the HIH did not follow the regulations of the Australian Prudential Regulatory Authority of setting up the prudential margin, a worst scenario would have been reached regarding the underwriting performance. It is normal for a general insurer to get a loss in a given period of time on underwritings, but for continuous losses were made by the HIH for many successive periods on underwriting, thus will rather be considered as an operational deterioration pattern which was started from the inferior ability of risk pricing (Du Plessis et al, 2005). The third factor is the risk pricing ability. The general insurer’s operations core aspect is underwriting that its performance centrally stands for the risk pricing ability in regards to the insurance business. A statement in the investigation report of HIH by the Royal Commission shows that HIH made an underwriting loss of $33.8 million on net premium earned of $1233.5 million in the year ending on 31st December 1997. If a comparison is made between different years, the underwriting loss increased yet earned premium increased by 61 percent. These major differences between the net premium earned and the core underwriting loss are provision for claims outstanding, reinsurance recoveries and underwriting expenses (Du Plessis etal, 2005). 2. Weaknesses in the HIH Corporation Governance Practice By using the agency theory, we can say that the main reason for the bankruptcy of a corporation mainly is found in the agency cost issues that comes from the conflict among the debtors, managers and proprietors within the organization. The equilibrium between the debtors and the stockholders can be maintained on dynamic basis, this is as per the mainstream financial theory, and this is because the company’s value will also be reduced by the impairment of the debtor’s interest and thus causes damage to the interest of the stockholder. Therefore, the key element of critical importance is the corporate governance for maintaining this equilibrium, a meaning of this to certain extend is the corporate governance failure that cause bankruptcy of the corporation. There is prove on certain well-known corporation like WorldCom and Enron in U.S. and HIH too cannot be an exception (Allan, 2006). The HIH had established a corporate governance model that is decent if we only look at the report of corporate governance that is included in annual report, that fully comply with the ASX guidelines thus has to be acknowledged. The below information can be obtained in relation to the corporate governance model of HIH in accordance to the public yearly financial report that ended on 30th June 2000: 1. The board composition 2. Committees of the Board Table 1: The board composition Name Position Responsibility Geoffrey Cohen Non- executive chairman He is the chairman of investment committee, audit and Human resource. Ray Williams (is the founder of CE Health in 1968) He is the Chief Executive He is the Chief Executive officer and the Deputy Chairman. Justin Gardener A Non-executive director A member of human resource and audit committee. Charles Abbott A Non-executive director Charles is a member of the audit committee. Rodney Stephen Alder A Non-executive director Investment committee member Randolph Wein Executive directors Asia Member of reinsurance committee Chief executive. Robert Stitt He is a Non-executive director He is a member of audit and human resources committee. At the board level, there are four major committees: 1) Reinsurance committee: it reviews the nature and scope of group reinsurance programs. 2) Audit committee: Does a consideration to any matters of significance in relation to the company’s financial affairs with an inclusion of standards of performance in relation to financial managements and systems, audit issues and accounting policies. 3) Investment committee: does a consideration and formulation of Groups asset allocation ranges, performance reviewing of internal and external managers of funds against benchmarks that are approved and setting guidelines of investments on property dealings and currency. 4) Human resource committee: it develops plans for senior managers and constitution of the board related issues, structuring the organization, review of total remuneration for senior executives and succession. Using the above information we can therefore say HIH’s board of directors has a composition of 5 non-executive directors, and 2 executive directors, and by taking the position in relevant committees non-executive directors got actively involved into the function of the board of directors. The corporate governance of HIH have a gloss as its structure of BOD parallels with the ASX best practice recommendation (Insurance Journal 2003). 3.1 Dominance of the CEO of HIH, Ray Williams Among founders of the HIH is Ray Williams, and he has won a great respect for his loyalty and excellent capability to the firm. Though for a long time HIH has become a listed corporation, Ray Williams historical development predominant position still has an illusion that the company belongs to him and not the shareholders and has a big say to the board. What is saddening is that the board of directors does not use their powers to stop this and hence making him run the company the way he wants. Citing an example, there were no limits that are clearly defined on the CEO’s authority in some very important sectors within HIH; Ray got the favor of controlling the board and the company by manipulating the board meeting agendas and other senior executives’ performance evaluation. He made HIH become an entrepreneurially run company controlled by senior manager and rather than running in the interests of the stakeholders, it started running primarily in the interest of senior managers. This posed a big threat to the model of corporate governance function and the risk of the company departing from stakeholder’s interests and going into corporate excess is duly increased (Jiangbo, 2010 3.2 Independence lack for non-executive directors from the management The independence of non-executive directors have to be questioned as it is not as perfect as it appears to be in the personal information given. The facts below leads to this questioning: 1) In 1980’s, the member of the audit committee, Justin Gardener used to be the auditor of FAI which HIH bought in 1998. This transaction is the one seen to have caused the failure of HIH as it had to pay huge amounts for acquisition of FAI. However, Justin has to be placed somewhere that his independence was doubted due to his conflict of interest. The member of investment committee Rodney Stephen Adler in charge of transaction too is a suspect regarding the independence as the situation will not have been bad if he had duly paid diligence 2) To insure officers and directors of parent entity and the entities it controls against liabilities, in 2000, a controlled entity paid an insurance premium. Including non-executive directors, the contract covered the above listed directors. Moreover, the company did not disclose a summary of the nature of liabilities and the sum of insurance premiums payable under the insurance contract; this is as per the cover of confidentiality clauses specified in the contract. This lack of independence affects the ability of the non-executive members to fulfill their functions in the system of corporate governance and hence tend to allow the managers to run the firm at their own interests. Of the five non-executive directors, two are Arthur Andersen accounting firm former directors, which happens to be the core advisor and auditor of HIH. More noticeably, $7 million has been earned to Arthur Anderson for auditing services and $8 million has been earned by him from auditing HIH. Adding on that, $1.7 million were paid by HIH to Anderson for his auditing service, in addition to it $1.631 million for other non-auditing services provision. Non-auditing services are taken as great detracting source from the related directors and auditor independence (Insurance Journal 2003). 3.3 Lack of information resources that are independent for NEDs to work on their responsibilities In a corporate governance system, accounting system plays a major role in its function. Thus a big firm as the HIH, it is not economical and realistic for collection and processing of information to be done by the non-executive directors in order to fulfill their responsibilities, hence they have to depend on the accounting system that is directed and organized by the management. This point represents unquestionably intrinsic risk of the system of the corporate governance. The company has to seek the compensation from such mentioned below institutional arrangements in order to solve potential effects brought by the defect: i. For the non-executive directors to have faith in the accounting information that is edited, the company has to ensure the audit committee functions effectively and independently. ii. To properly inform non-executive members directly and properly on the accounting information, the company has to include into the board a finance director (Commonwealth of Australia 2003). As seen from the given information, HIH does not adhere to the above requirements: firstly, Ray Williams dominated the accounting and management information and no finance director included. Secondly, regarding the defect in non-executive director’s independence that is a composition of the audit committee, a doubt is deserved for the function effect of the audit team. In accordance, it is hard for the non-executive directors to execute well their responsibility with independent data resources (Caliyurt & Crowther ,2006).  3.4 Risk management inadequacy Management of risk plays a major role in the company operation given the nature of insurance company. Though an investment committee is set up by the board to set guidelines of investment on property and currency dealings and appreciation of the risk of investment, ample evidence is provided by the three major investment failures mention in the paper earlier that the HIH risk management has not been well performed and shaped yet. In terms of analyzing the investment strategy and in relation to the investment with enough needed information sources, the directors are neglected, this is pointed out by Justice Neville Owen. However, the failure of risk management was a big part of a management style that is unusual thus led to the collapse of the HIH (Feetham & Amos, 2012).  4. Conclusion What led to HIH collapse is actually their unethical behaviors like letting their CEO Ray William run the company as he owns it. As we all know the interests of all the parties that have a share in a company have to be equally fulfilled of which the HIH did not hence leading to the collapse. The organizational structure was exemplary and rightfully certified the ASX but several board members reputations were questionable hence used their positions to their advantage. The risk management of the HIH is not well shaped and positioned as it did not consider the risk factors that lead to insurance company failure; this too led to its downfall as it was not readily prepared. The worst of this all, HIH board of directors i.e. non-executive members were denied a chance to work independently, this made their fulfillment of their duties hard and had to get orders from seniors hence the company run as a private entity. For an insurance company to run smoothly, the discussed issues must be deeply considered and correctly executed. References Allan, G 2006,'The HIH collapse: A costly catalyst for reform', Deakin low review, vol.11, no.2, retrieved 17 September2013, < http://www.deakin.edu.au/buslaw/law/dlr/docs/vol11-iss2/vol11-2-6.pdf>. Caliyurt, K. T., & Crowther, D. (2006). Globalization and Social Responsibility. Newcastle upon Tyne, Cambridge Scholars Publishing. http://www.UCM.eblib.com/patron/FullRecord.aspx?p=1080903. Commonwealth of Australia 2003,the failure of HIH insurance, reasons, circumstances and responsibilities, vol. lll, retrieved 11 September2013, < http://www.publicaccountants.org.au/media/76456/a00009282.pdf>. Dagwell, R., Wines, G. L., & Lambert, C. (2007). Corporate accounting in Australia. Sydney, N.S.W., University of New South Wales Press. Du Plessis, Jean Jacques, Mcconvill, James, & Bagaric, Mirko. (2005).Principles of contemporary corporate governance. Cambridge University Press. http://hdl.handle.net/10536/DRO/DU:30000408. Feetham, N., & Amos, R. (2012). A guide to insurance: combining governance, compliance and regulation. London, Spiramus Press. Haines, F. (2007). The Paradox of Regulation What Regulation Can Achieve and What it Cannot. Cheltenham, Edward Elgar Pub. http://public.eblib.com/choice/publicfullrecord.aspx?p=730824. Insurance Journal 2003, 'HIH Report Cites Mismanagement as Cause of Collapse', Insurance Journal, international news, vol.21, no.4, retrieved 10 September2013, . Jiangbo, XU 2010,HIH Insurance Limited: Corporate Governance and Corporate Excesses, Capital University ofEconomics and business, p. 259-246, retrieved 10 September2013, . Vinten, G. (2005). Financial regulation. Bradford, England, Emerald Group Publishing. http://proxy2.hec.ca/login?url=http://site.ebrary.com/lib/hecm/Doc?id=10085657. Read More