The Background of HIH Insurance

The report will demonstrate the case study of HIH Insurance Company regarding its liquidation during the year 2001. This will be done for developing an insight into the approaches, concepts and standards of auditing that needs to be complied by an organization for eliminating the risks related to auditing. In this context, the report provides an evaluation of the case of HIH Insurance, an Australian insurance company that was 2^nd largest general insurer from Australia before its liquidation and was operating over various countries. The company was listed on the ASX and attained a position of a world leader in its field before it went into liquidation on 15^th March 2001. The major reason of the collapse was breaches of various criminal as well as civil laws by the managers of the company which in turn forced the company’s liquidation. The report has examined the facts of the case study to gain an understanding of the auditing issues and the significant changes occurred in relation to the auditing approaches after the occurrence of the corporate scandal (Hih.com.au 2018).

The investigation of the case study of HIH Insurance has been carried out with respect of auditing approaches and standards to identify the major reason for the occurrence of scandal and to suggest some measures for overcoming their occurrence in future. The relevant facts and issues have been gathered through exploring the relevant information from the online sources containing sufficient information related to the case study.

Background of the case

HIH insurance was established in the year 1968 by Michael Payne and Ray Williams when it was known as M W Payne Underwriting Agency Pty Ltd. it was acquired by CE Health PLC and Ray Williams was the appointed in the board of the company. However, it changed its name to HIH Winterthur. In 1999, the company sold its 51% share to public and changed the name to HIH Insurance Ltd. In March 2001 at the time of the company’s collapse it sent shockwaves to the business community of Australia. Now various findings will be identified that has led to the failure of HIH Insurance Ltd (Gaber and Lusk 2015).

While any entity is close to its insolvency the associated risk with regard to auditing for that entity is significantly higher as compared to the one that is solvent. The report will identify the various risks associated with the roles of auditors and directors and the level of audit risk related to HIH before its collapse. The general agreement regarding the solvency concept is related to have the capability of meeting the company’s debt when they become due. Any insurance company is considered as solvent if it can fulfil its obligation as per all the contracts irrespective of time (Meidl 2016). However, solvency assessment may be challenging at times as the estimation for liabilities are not easy to determine. Along with the support of profitability structure and insolvency risk the company was required to concentrate more on the business that involves limited numbers of consumers for for launching the sector. Control risk that was associated with the company was that it failed to recognise the internal control approaches. It was identified from the case study of HIH Insurance that completeness and accuracy of general ledger for bank account and ledger account those were not yet performed by the company (Glover, Taylor and Wu 2016). Further, the organizational performance was dependent on substantial differential procedures that were offering huge dependence dependence on external documentation procedure. Detection of risk includes different auditing techniques of the auditing that is based on performance and was not intending for detecting managerial inaccuracies. This indicated that HIH was required to focus on the timely planning and reducing of the instances of not detecting the material misstatement efficiently. It is identified from the company’s internal documents that it gathered that the entity was not capable for conducting the appropriate substantive procedure that was intended to identify the issues associated with the superior performance regarding goodwill and inadequate planning for future tax advantages. Inherent risk is the uncertainties associated with the financial statement of the company under which the company accepts the maintenance of solvency margin, charging sufficient premiums with the liquidity factors of the company (Smith 2015). This involves reinsuring of various policies in addition to offer the practice of marine insurance that largely belongs to the insurance professionals. Further, among the appropriate approaches to evaluate the business risk of the company for analysing competitive environment of various other sectors regarding increase in the competition with enhancement of price range. For evaluating the risk, handling of insurance within Australian industry became comparatively simpler for the fresh regulations of the industry. The ‘Insurance and the Superannuation Commission’ works as Australian regulatory body that holds the ‘Australian Prudential Regulatory Authority’ (AUASB 2018).  

The Risks Associated with Auditing Approaches and Standards

Collapse of HIH Insurance in 2001 significantly influenced the profession of audit, particularly with regard to the activities related to audit committee’s legal liabilities, audit independence that led to various lessons those were required to be learned under audit profession and auditor’s responsibilities. The major reason for the failure of HIH Insurance can be regarded as lack of adequate corporate governance policies that lead to the failure of auditors to identify and control the financial risk presents in the financial reports of the company. There was lack of corporate governance committee such as executive, operating and investment group committee. The lack of an audit risk committee in the company can be regarded as responsible for not identifying and reporting the financial risks present within the company in advance (Arens 2013). The financial discrepancies present within the company were misrepresented by its auditors. The auditor depicted a positive image of the financial and has successfully concealed the materialistic financial facts and figures from the public eye negatively impacting their trust and confidence. The company has placed emphasis only on its growth and development and neglected the importance of presence of an effective governing mechanism that leads to the occurrence of issues of financial mismanagement. The failure of the auditor to correctly value the worth of an entity leads to its corresponding downfall. Thus, it can be said that absence of an adequate internal control mechanism within the company is responsible for its downfall (Damiani, Bourne and Foo 2015).

Another major reason of the company’s downfall was faulty conducts of company’s corporate governance. There were agency costs issues generated from the agency conflict among the managers, debtors and proprietors.  Huge fractions of issues were based on changes those were reinforced with government’s direct liability structure. Start point of the legislative changes were associated with public obligations and inefficient management of risks led to ineffective operation by the management (Finney 2017). Various facts accumulated from the case study indicated that the inadequate management of risk as they were failed to develop efficient strategy for management policies and practices. Further, the directors did not conduct the analysis for the strategies for the purpose of investment in addition to risk appreciation associated with various information sources. Further, the case study indicated that the accounting system had considerable role for functioning the commercial system supremely. For an entity like HIH, it is not practicable for non-executive directors to accumulate vital data to accomplish their responsibilities (Carnegie and O’Connell 2014). Owing to this, non-executive director’s responsibilities were compromised as there were no alternatives except relying on the generated accounting systems and management’s direction. Further, it was found that among 5 executive directors, 2 directors were the partners in Arthur Anderson Secretarial Company. It is found that HIH spent an expense amounting to $ 1.7 million to Anderson for providing auditing services in addition to an amount of $ 1.631 million for providing non-audit services. It is found that the auditing services are considered as the major extraction source from various associated directors and independent auditors. Either directly or indirectly the practices for corporate governance by HIH were answerable for negligence in conducting the operation effectively. It led to lack of the independent valuation for the management. Further, the Board members of the company have failed to adopt and implement the ASX Corporate Governance policies and guidelines. As per the ASX corporate governance policies, it is essential for a company operating within Australia to develop and disclose the roles and responsibilities of the executive’s, remuneration, audit and risk committee to prevent the occurrence of any type of corporate governance issue. It is the responsibility of the board members to comply with the ASX Listing rules and to disclose the accurate and fair view of its financial performance for protecting the stakeholder’s’ interests. It has also non-complied with Corporations Act 2001 as per which care and diligences is the main responsibility of a company’s directors within Australia. It is the responsibility of directors to ensure that the financial statements of the company are presented as per the standard accounting rule and practices and depict a true view of its financial performance (Chancharat, Chancharat And Theinthong 2013)

The Corporate Governance Issues Leading to HIH’s Downfall

Apart from the above issues, Royal Commission revealed the evidence regarding questionable and complex reinsurance arrangements. It further used aggressive accounting approach for disguising the true financial status of the company. It was further uncovered the evidence that some of the senior personnel from the company contravened the corporation laws. Eventual investigations by the authorities revealed that charges laid against various director, associates and senior managers of the company. Followed by convictions, it led to custodial sentences and various severe sanctions. The collapse of HIH also encouraged changes in various associated issues including the tort law and preamble of the support schemes for the insurance related to medical indemnity. At the time of the company’s collapse, changes in the legislative framework were already in the way. Further, in view of APRA the most continuing contribution with regard to resilience of the Australian financial institution through global financial crisis came from the close touch efforts for promoting the financial health before the crisis and dealing conclusively with the struggling institutions (Federal Court of Australia 2017).

As per the Royal Commissioner Neville Owen, head of the investigation team, characterized the HIH collapse as ‘shambling journey towards oblivion’ that led to its liquidation. However, the management of the company proclaimed that the insurer could have been saved. Once, the company lost huge amounts under London market along with the loss of considerable amount under US business. It was focussed mainly on coverage of employee’s compensation (Caliskan, Akbas and Esen 2014). It sold the renewal right to California operations to Alaska National in 2000 and balance to US to Argonaut. However the sales could not help and the company’s liability amounted to A$ 5.3 billion. Although number of shareholders and policyholders were there who filed suits against the entity, Owen stated that the outright fraud was not the sole reason for its collapse (Power 2018). He also blamed the Australian regulators for not identifying the issues and taking necessary actions as soon as possible and he further blamed Arthur Anderson, the accountants of the company for not examining entire accounts supposed to be checked for the purpose of auditing. It led to series of the disaster that forced the company to liquidation. Further, the analysis of any company’s solvency can be estimated from 2 indications – non – financial indications and financial indications. The financial indications are applied for assessing the commercial insolvency. If the company is not able to pay its debt it will be considered as insolvent (Crockett and Ali 2015). On the other hand, non-financial indications are used for assessing regulatory insolvency that takes place when the company does not comply with the requirement of supervising regulations, legislations and any other applicable laws. Financial ratios like debt to asset ratio and current ratios are calculated for determining the commercial solvency. It is found from the financial report of the company that the debt to asset ratio for HIH was 0.89. However, the ratio came to 1.01 if PPE, intangibles, deferred costs for acquisitions and the future tax benefits were not considered. It indicates the warning situation for insolvency and major long-run under – provisioning circumstances (Chancharat and Chancharat 2013).

The Impact of HIH’s Collapse on Auditing Profession

Criminal charges were brought against managers, specifically the founder and the ex – CEO, Ray Williams who were charged with withholding of various bad news from the board of the company and from the regulators of stock market. However, as per the report from AFP, Mr Owen stated that maximum instances regarding the possible malfeasance were created due to misconceived desire to conceal the widening cracks appearing in the structure of HIH (Morgan 2014).  

The fall of HIH Insurance Ltd cannot be attributed to any one cause as there were series of issues that can causes the same. As per the information gathered on this case it has been found the downfall of the entity was not due to rise in the competition but it was due to major financial discrepancies that led to its fall in year 2001. Some of major financial mismanagements that have been reported are high debt capital. The debt equity ratio of the company was 0.89 that indicated higher portion of debt as compared to the investor’s fund (Christensen, Glover and Wood 2013).  Apart from this it has been found that management was committed towards the fraud through not providing material information to their auditors and has not presented the same in financial report. Further, various frauds related to financial statement committed by Ray Williams are as follows –

• William authorise issuance of conversion of note prospectus through HIH Holding (NZ) Ltd. It is stated in the prospectus that the Societe Generale Australia (SGA) Ltd the co-underwriter of conversion of note prospectus will take up as the priority allocation. The allocation was less than 30% of total amount to be underwritten that is A$ 35 million. However, the prospectus did not disclose that the company and SGA entered into total return swap transaction (Kumar 2017).
• The operating profit for the year ended 1999 was overstated by $ 92.4 million and under the section of Chief Executive’s Review William stated, that they have taken the decisive actions through purchasing entire reinsurance protection account for protecting the businesses from claims developed from uncertainties. It included the potential exposure for underwriting for the loss of the year 2000 (Betta 2016).

The major reason for the failure of HIH Insurance can be regarded as lack of adequate corporate governance policies that lead to the failure of auditors to identify and control the financial risk presents in the financial reports of the company. The lack of an audit risk committee in the company can be regarded as responsible for not identifying and reporting the financial risks present within the company in advance. Major findings from the HIH case study were the insufficient evidences before the release of auditor’s report along with the changes that were possible to be made (Bebbington, Unerman and O’Dwyer 2014). Development of the close relationship with the non-auditing services led to refusal of improvement of the paid services for the audit. The entity wished to hire before the members of external audit group due to the following reasons –

• Auditors were accustomed with the company
• The auditors were deemed to have high level of experience regarding distinct fiscal as well as monetary matters
• Management were relied upon holding the audit work to develop efficient relationship with the external auditors. Further, the auditors should have been trusted the consumer executive up to the particular level that will not hamper the independence of external auditors (Abbas and Iqbal 2013).

The auditors were further required to apply the professional scepticism that may have implemented managerial conducts for the company as the management and auditors were not capable for managing the financial statements.

Conclusion 

It has been summarized from the overall report that there is need for developing adequate auditing risk-based approaches and standard to prevent the occurrence of downfall of business corporations due to auditing issues. The major reason for the downfall of HIH Insurance Ltd can be cited as the failure of auditors to identify the financial and non-financial risks presented within the financial and corporate governance report of the company. The failures of the relevant accounting policies and rules have also resulted in its downfall. ASIC in this context is emphasizing on developing additional auditing rules and approaches to overcome the occurrence of such issues in future. As such, it is recommended that the business corporations need to comply with all the auditing rules and approaches to ensure for adequate financial management and overcome the issues related to misstatement of financial information.

On the basis of information on the failure of HIH Insurance Ltd it can be said that primarily auditor and managers are responsible for the failure of this company. Auditors have failed to comply with most important auditing standards and management has failed to provide all the material information to their shareholders. Auditors have failed to review the internal control system of the company that was the most important part of the audit process.

References

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