HIH INSURANCE

HIH INSURANCE COLLAPSE

Smeeta, Vera, Nada, Summer, Wendy and Loraine

Background of the company

• Thousands of investors lost millions and many companies suddenly found they were uninsured.

• The Australian Common wealth government announced a Royal Commission into HIH collapse in response to public outrage and entered into an arrangement to identify HIH policy holders who were able to demostrate genuine hardship.

• State governments also took action to mitigate the effects of the collapse and undertook many outstanding HIH builders' warranties and third-party obligations

The causes of collapse​

• Business​

-Over-priced corporate​

-Corporate extravagance​

-Corporate culture: not operate according to minimum solvency requirements set by prudential regulator

• Accounting​

-Inadequate provision for insurance claim​

-Improperly-priced past claim​

-Under-estimate present and future insurance premiums

BUT corporate audit committee failed to assess the risk​

-Aggressive accounting policies​

-No negligence​

-Management fraud​

-Poor audit practice

Who is responsible for the failure?

• Senior managers

• Auditors and regulators of HIH failed to detect the warning signs

• Information systems lagged business expansion and were unreliable & inadequate​

• HIH’s account overstated profits and understated liabilities.

• The management ignored or concealed the steadily deteriorating financial position

Auditors Dilemmas

• Audit Integrity

• Audit Profession

• Audit and Audit or Independence

• Failure of corporate governance

Auditor Integrity​

• HIH is claimed to mislead investors by providing incorrect financial reports to the market. ​

-Where middle managers had taken steps that resulted in the falsification of the corporation’s accounts or returns lodged with statutory authorities. In some instances, he observed, the existing law did not reach the intermediate conduct . For example, where someone prepared a report knowing it to be false but did not sign it. The more senior officer who then signed the document would assert as “reasonable” his or her reliance on the more junior employee who prepared the report, to argue that the senior officer’s conduct did not constitute a breach of the law.

Auditor Profession​

• Solvency​

- Auditor is responsible to express a true and fair view on a going concern basis of a company’s financial statements. Going concern with net assets of $939 million and 9 months later HIH collapse with debts of 5.3 billion, they did not gain the sufficient evidence to draw the conclusion

• Ethical consideration​

-Provision of non-audit services by Arthur Anderson​

-Aggressive accounting practices utilized at HIH​

• Understate $18 millions liability, under-reserved by $41 million​
• Disagree with prudential margin​
• Use $288 millions in government securities in solvency calculation to hide APRA

• The fact for HIH, lack of profession or integrity?

• ​Examining samples of company “expenditure” may have revealed the questionable appropriations carried out in the company’s name.

• ​Or, the major takeover of FAI Insurance, with obvious and overt related party implications, should have been a red flag to auditors.

Auditor Independence

• Objective—a fair and impartial attitude must be maintained

• Strength of character—ability to withstand pressure and maintain integrity and objectivity

​

The Corporation Act 2001 and Part B section 290 of the Code of Ethics stipulate principles, rules and guidelines that emphasize the need for the appearance of independence.

HIH directors as a group tended to rely on Ray Williams and HIH management to consider and resolve issues.

For the most part the HIH Board, and perhaps the auditors, accepted much that Ray Williams put to them.

Failure of auditors ​

Modern Approach to External Auditors’ Role in Corporate Governance

What auditors should have done?​

• Increase the independence of the auditors​
• Should be a mandatory rotation of the audit partners​
• No remuneration paid to officers of clients​
• Call for legislation to prohibit audit partners from resigning and becoming an officer of their previous clients within a period of two years

• The importance of the audit function for the capital market as a whole and the reliance placed on the audit function by users of financial statements should be emphasised. ​

• The external auditor’s role in corporate governance is a fundamental complement to achieve the desired objective of corporate governance.

The fact for HIH, lack of profession or integrity?

Auditor Profession​

Fodera

Cohen

Familiarity Threats!

Andersen was not independent of HIH

• Failure of auditors

Threats to Auditors Independence: Familiarity​

• 1990 -1993, Junior Andersen partner on the HIH audit team
• 1994, Engagement partner
• 1997 - 2000, Executive director (HIH)
• note: Pye (Andersen) had a very strong relationship with Fodera

• Acquisitions were made and organic expansion pursued without due diligence​

Gardener

• 1965 - 1990

partner of Andersen

• from 1992

Chairman of HIH audit committee

From 12/1998 the HIH board contained three former partners of Andersen

• 1972 - 1998, partner of Andersen
• from 1998 non-executive director of HIH & member of audit committee
• 2001 Chairman of audit committee
• relationship with Williams

• The Companies Act has set the stipulation on appointment, eligibility, qualification, disqualification and removal of external auditors. ​
• The intention is to ensure that auditors are able to carry out audit in an impersonal, objective and professional way. It is also to ensure that auditors are independent of the company. The reason for such emphasis is to ensure the external auditors are not in a position of conflict of interests.​

((When there is conflict of interest, disclosure must be made to shareholders and stakeholders))

Davies’ replacement

Message: Andersen personnel who displeased HIH management might be removed from the audit.

Safeguards to the Threat of Independence

Conclusion

• the absence of further meetings between Andersen and non-executive directors
• affect the independence of the continuing members of the audit team

• Safeguards created by the profession, by legislation or by regulation, such as education and training requirements.​
• Safeguards within the assurance client, including:​

-a corporate governance structure.​

• Safeguards within the audit firm’s own system, either firm-wide or specific to the engagement

intimidation threats!

Threats to Auditors

Independence: Advocacy ​

• Auditors may be unfairly or harshly judged for not foreseeing the collapse and warning the market and shareholders.

• Found in 1968 by Ray Williams & Michael Payne
• HIH was the second largest insurance company in Australia 2000
• It also expanded globally into the NZ, US and UK markets
• HIH comprised three separate government-licensed insurance companies.
• HIH business was initially success writing of worker compensation insurance, but the expand in other insurance class like property, commercial and professional liability subsequently led the demise.
• 2001 the federal government announced HIH collapse because failure in corporate governance, regulation and auditing along with poor management decisions.

The Consequences of HIH Collapse

The audit opinion reported that the accounts a true and fair view of the company financial performance , complied with the accounting standards. Therefore, the auditors has provided an unqualified opinion in respect of the financial accounts showing a net profit of $939 million.

The auditor's should add credibility to the financial reports prepared and signed off by the company's directors and to provide a high level of assurance that the financial reports are free from material misstatement.