A report into the collapse of HIH insurance
On March 15 March 2001 Australia’s second largest insurer, HIH collapsed with money owed in extra of A$5billion. This report intends to debate some of HIH’s business goals and creative accounting practices that will have attributed to the collapse of the corporate.
HIH began working in Australia in 1968 underneath the name C.E. Heath plc, an English based insurance company whose Australian operations specialised in the underwriting of staff compensation. 1968 was additionally the yr that Ray Williams (future CEO of HIH) and good good friend Michael Payne set up MW Payne Liability Agencies, a small insurance coverage company primarily based in Melbourne that offered staff compensation and public legal responsibility insurance (Main 2003).
In 1974 the two firms merged and undertook the name C.E. Heath Underwriting and Insurance (Australia) Propriety Limited. The company led by Ray Williams was listed on the ASX as C.E. Heath International in 1992 and in 1995 C.E. Heath plc bought its remaining share of the corporate to Winterthur Swiss Insurance Co in a deal that additionally concerned the acquisition of native insurer CIC (Main 2003).
It was right now that the company grew to become generally known as Heath International Holdings or HIH.
HIH was comprised of over 250 companies on the time of liquidation (Main 2003), including HIH Casualty and General Insurance Limited, FAI General Insurance Company Limited (FAI), CIC Insurance Limited (CIC) and World Marine and General Insurances Limited (WMG). They supplied many types of insurance in Australia, the USA, and the UK together with basic insurance coverage underwriting, the operation of insurance coverage underwriting businesses and funding funds administration, while specialist areas of enterprise included general insurance coverage, workers’ compensation, public legal responsibility and skilled indemnity insurance coverage, and property and commercial insurance (Kehl n.
In an organisation corresponding to HIH, various enterprise interests give rise to a myriad of stakeholders. In his report again to the HIH royal commission Justice Neville Owen (2003) defines stakeholders as ‘those who’ve a stake in the company’s success.’ Owen (2003) proceeds too identify HIH’s stakeholders as policyholders, basic creditors, staff, shareholders, the public and the regulators. To elaborate additional Bazely, Hancock, Berry & Jarvis (2001) place stakeholders into two categories; inside stakeholders who include administrators and managers, and external stakeholders who consist of lenders, suppliers, clients, staff, the government and most of the people. At essentially the most primary stage all stakeholders require data relating to an enterprise for the purpose of planning, controlling and determination help (Bazely et al. 2001). (See desk 1).
The Insurance trade operates in a cyclical enterprise surroundings each in Australia and abroad. At the time of HIH’s collapse in 2001 the Australian common insurance business had been in a depression for several years, brought on by a mixture of low interest rates, unlucky claims experiences, and disappointing returns on investments (Owen 2003). The scenario was described succinctly in an trade report by JP Morgan/Deloitte released in (1997) that said ‘the harsh local conditions are best depicted by a horror story’. As a results of these situations competitors turned stiff whereas at the same time the traditional boundaries between banking and insurance had been disappearing, what’s more, advances in expertise had been accounting for giant changes across the monetary companies sector (Owen 2003).
The aggressive takeover of competitors such as FAI and entry into the U.S and U.K markets are examples of HIH’s business aims, which in accordance with Williams (2003) had been based on ‘international growth and diversification’. In his report to the royal fee, Justice Owen (2003) questions the legitimacy of the company’s business aims stating that ‘there was little, if any analysis of the long run technique of the company’. In addition, Owen (2003) claims that any strategy that HIH had seems to have existed within the mind of Ray Williams and that his perspective was by no means clearly expressed to the board. The drawback that arises from the absence of a properly understood technique is that the board does not understand and respect risks (Owen 2003). The failure of operations in the United Kingdom and the United States and the acquisition of FAI present ample proof of this.
In staying true to his objectives of ‘international development and diversification’ (Williams 2003) saw the U.K market as a chance for HIH to broaden its’ international base (McDougall 2002). This resulted in HIH establishing its’ U.K business in 1993 providing public liability and skilled indemnity insurance (Cagan 2001). Operations within the first 12 months proved to be a success and resulted in the enlargement of operations throughout 1997 into areas of business during which the businesses underwriters had little experience or experience (Howard 2003). Furthermore Justice Owen (2003) notably points out that the UK operations had failed to determine suitable underwriting tips and controls.
This combined with the lack of underwriting experience was a method for monetary disaster. In hindsight this has confirmed to be true as the report on the royal commission has estimated that losses in the United Kingdom might attain A$1.7 billion. The majority of those losses may be attributed too the ‘under-writing of entire account excess-of-loss marine reinsurance and film financing,’ whereas different substantial losses could be attributed too the ‘provision of private accident cover to members of the Taiwanese navy and of motorcar bodily injury cover-without terrorism exclusions-to an Israeli insurer.’ (Owen 2003).
In 1997, in scenes reminiscent to those within the U.K again in 1993, HIH introduced that they’d re-purchased their former U.S workers compensation business CareAmerica. In an announcement to shareholders Ray Williams described the situations in the U.S market as favorable and that there was a great basis in place for future development (Main 2003). What he didn’t reveal was that U.S insurance firms did not low cost their liabilities the same method that Australian insurers did, which would lead to extra reserves that HIH may use to govern their very own accounts (Main 2003).
No more than two years later Ray Williams was singing a different tune, asserting within the 1998-99 annual report that HIH could be downsizing its U.S operations because of deterioration of the U.S employees compensation market.
In 1999 the actual extent of the issue was beginning to unfold. The US business regulator informed HIH’s director of worldwide operations George Sturesteps that they believed HIH America to be under-reserved by as much as $US57 million. Reserves are essentially an allocation of after-tax income that are put aside on the steadiness sheet for future insurance coverage claims (Owen 2003). This estimate was on prime of HIH’s own internal estimate that the shortfall was about $US40 million (The Mercury 2002). In an attempt to search out out the true state of reserves as of March 2000, HIH employed Milliman & Robertson to conduct a full report. The report tabled by M&R found a $US55 million shortfall. These numbers had been much higher than HIH’s management had anticipated so that they sacked M&R and employed Towers Perrin Tillinghast to conduct a report utilizing a special methodology. The result revealed a niche closer to $US56 million (Main 2003).
The timing of this news could not have been worse for HIH as they were about to announce their June 2000 results. Somewhere along the line though, it seems that the $US56 million shortfall had didn’t be mentioned. In his statement to the royal fee Mr. Sturesteps stated he did not tell the auditors or his fellow board members about the reports as a end result of ‘Mr. Williams knew’ and he did not pass the data on to the companies auditors because ‘that was not his responsibility’ (Main 2003, p.83).
On September 23, 1998, in a transfer that in hindsight ‘was the straw that broke the camels back’ HIH introduced its takeover bid of FAI insurance coverage with the intention of becoming Australia’s largest listed general insurer. FAI was a direct competitor of HIH and the takeover was part of HIH’s diversification and growth strategy into the Australian market (Williams 2003). Furthermore CEO Ray Williams had identified five main benefits that HIH would obtain from the merger including: placing HIH up one other level within the insurance trade; attaining substantial savings; making HIH the most important gross premium earner in Australian common insurance; taking HIH into the direct car and home insurance coverage market; and making HIH the largest skilled indemnity insurer in Hong Kong (Main 2003).
HIH proceeded with the takeover of FAI based mostly on their assessment of publicly out there info. (Owen 2003). A request put ahead to FAI on the time for further information was denied by Rodney Adler on condition that FAI were negotiating with other potential buyers. Adler (2003) rightly claimed that his company didn’t want its rivals to gain access to ‘sensitive business details’.
What was not apparent from the public info was the excessive underneath reserving of FAI’s long-tail enterprise. (Owen 2003). FAI would have made a lack of around $50 million if it was not for two reinsurance offers carried out with General Cologne that where done because the books had been closing on June 30 1998. Reinsurance essentially entails a bigger insurer helping a smaller insurer to pay out policies throughout a tough interval. The smaller insurer then pays again the cash by the use of a premium within the following years (Main 2003). In regular circumstances a mortgage is often accounted for as a legal responsibility. Through artistic accounting insurance policies FAI’s accountants have been able to take the $57 million in reinsurance insurance policies and guide it as revenue.
Main (2003) makes notice that ‘some of the best auditors in Australia, and no doubt in other countries, have been talked into accepting such measures as legitimate’. These comments came under attack from federal treasurer Peter Costello (2002) who was astonished to find that the auditors were conscious of those entries and accepted them as a outcome of the Australian Accounting Standards allowed it. The two reinsurance deals enabled Rodney Adler to later announce that FAI had made an $8.6 million revenue in 1998, a turnaround of virtually $20 million (Main 2003).
2.four HIH accounts.
Justice Owen (2003) comments on the significance of the accounting process stating that ‘accounts are prepared so that those with an interest within the monetary affairs and situation of the entity–whether that interest be proprietorial, regulatory or transactional–are truly and fairly informed as to the entity’s monetary state’.
Richard White SC, Counsel for the royal commission brings attention to two entries that were of main significance in the 2000 financial statements of HIH that will have been made advanced intentionally ‘in order to befuddle the reader and disguise the true substance of the transactions’ (White 2003).
The first concern issues the writing off of any lack of value referring to the acquisition of FAI as a constructive addition to the goodwill account in the steadiness sheet. This resulted in over A$400 million being booked on the asset aspect of the balance sheet from the acquisition that had value HIH A$300 million.
Bazely et al. (2001, p.568) outline goodwill as ‘the future benefits from unidentifiable assets’. Wayne Martin QC, within the royal commission elaborates further on the idea stating ‘a firm can solely carry goodwill in its balance sheet if it is rather confident of earning that cash again within the future’ (Main 2003, p.181). When requested by Wayne Martin QC in the royal fee about how HIH would earn the cash again, Williams (2003) acknowledged that ‘it was a problem that involved the financial department’ and he furthermore pointed out that the auditors had signed off on the entry.
The second issue was the decision to enter into two reinsurance contracts during 1999 in what appears to be an try and lift the companies operating earnings for the yr. The deals have been just like those seen at FAI one year earlier in the sense that a larger insurance coverage firm, on this case Hannover Re, was to lend HIH close to A$400 million in reinsurance (Main 2003). As a result of the reinsurance contracts HIH was in a position to raise its profits for 1999 from A$10 million to A$102 million and for 2000 were in a place to flip a A$45 million loss into an A$61.9 million revenue.
List of references.
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Tasker, B 2002, HIH `inflated’ earnings – Deception alleged on complex contracts:[1 Edition] The Courier Mail, [online], p.27, available: http://80-proquest.umi.com.ezproxy.usc.edu.au:2048/pqdweb?index=12&did=000000397114211&SrchMode=1&sid=8&Fmt=3&VInst=PROD&VType=PQD&RQT=309&VName=PQD&TS=106