Australian Case Study In Corporate Governance — Hih Insurance
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INTRODUCTION
“The collapse of the HIH Insurance group (“HIH”) resulted in a deficiency of up to A$5.3 billion, making it Australia’s largest corporate failure. The ensuing Royal Commission report released in April 2003 provides a rare detailed dissection of a spectacular corporate implosion and a very useful case study from which corporate governance lessons may be learned. This is particular so because HIH was not unusual case of major fraud or embezzlement. The failures identified by Commissioner Owen were by and large failures stemming from mismanagement. Most breaches of the law were designed to cover up the consequential increasing financial difficulties which were engulfing HIH” (Lipton, P., 2003, p.273, Retrieved 19th December 2007).
CORPORATE DEVELOPMENT HIGHLIGHTS OF HIH
The origins of HIH can be traced back to 1968 when it was incorporated as MW Payne Liability Agencies Pty Ltd, changing its name to CE Heath International Holdings Limited in 1989. The company’s main business was the writing of workers compensation insurance in the Victorian market. In 1970 it expanded into Tasmania and subsequently into other States. The company’s sole business remained in workers compensation insurance until the mid-1980s when the company decided to diversify its underwriting into other classes, among them property, commercial and personal liability.
The board also decided to expand offshore where it concentrated on workers compensation. In 1992 the company listed on the ASX as a public listed general insurer. After listing, the public held about 45% of the issued capital, 44% was held by UK-based CE Heath plc, and local directors held 11%. Until 1995 the company’s core business was in so-called long-tail classes of insurance where the financial outcome of some claims may be delayed or not known for more than 12 months.
After 1995 the board embarked on a period of rapid growth primarily through acquisitions of other companies that changed the company’s investment and business strategies. Asset growth ballooned out from $1,201 million in 1994 to $8,237 million by June 2000. The ambitious growth strategy had a serious impact on the company’s financial position as premium revenue as a contribution before tax was $18.8 million in 1994 and was reported to be $55.9 million in June 2000. In the year 1998-99 the company reported a financial year loss for the first time in its history, brought about by weak premium rate returns, volatile investments, and a series of significant losses in overseas businesses.
On 15 March 2001 the HIH was placed into provisional liquidation. Formal winding up orders were made on 27 August 2001 with the deficiency of the group estimated to be in the range of $3.6 billion to $5.3 billion. This was the largest corporate failure in Australia’s history, prompting the Federal Government to establish a Royal Commission on 29 August 2001. To-date several HIH directors have been prosecuted for numerous offences under the Corporations Act 2001, the Insurance Act 1973 and the New South Wales (NSW) Crimes Act 1990.
KEY CORPORATE GOVERNANCE ISSUES
Based on the analysis of the case, several key corporate governance issues identified in HIH case includes but not limited to the following:-
Discipline
There was substantial degree of dishonesty, lack of integrity and failure in the senior management and the board of directors in discharging their duties. For example, Rodney Stephen Adler (former director) disseminated information that he knew was false in order to induce people to purchase shares in HIH (criminal offences under the Corporations Act 2001). He also manipulated the HIH share price (criminal offences under the Crimes Act, NSW).
Transparency
HIH employed accounting techniques to disguise serious decline in its financial position and performance. For example, the report presented by HIH’s auditor on 12 September 2000 indicates how core underwriting loss was reduced by use of one-off entries such as increments to goodwill and recoveries under reinsurance contracts. The reports indicated that in the 12 months to December 1999, one-off adjustments reduced the underwriting loss by $157 million whilst in the year ending 30 June 2000 they reduced the loss by $360 million. In summary, without those one-off adjustment entries, the underwriting loss would have been worse and thus the financial position and performance of HIH was in fact deteriorating.
(iii)
Independence
The HIH directors failed to exercise sufficient oversight over the management of HIH. The board failed to adopt a generally questioning and independent approach to all the material presented by management. The board’s independence was compromised by the influence of management in relation to its deliberations. This has lead to the existence of several conflicts of interests. For example, Robert Reginald Stitt, one of the lawyers on the board was a significant supplier of legal consulting services to HIH, and was also a consultant to the firm hired by the company as its legal adviser.
Accountability
The chief executive was able to exercise unchallenged influence and authority over the other senior executives and board directors. Even as his business judgment faltered in the second half of the 1990s he remained unchallenged. Business proposals, once duly approved him before going to the board were never changed or rejected by the board. There was also a lack of accountability among senior management and the board of directors. In the acquisition of FAI Insurance (“FAI”), it has emerged that HIH did not conduct due diligence on FAI, and instead relied on FAI’s recently completed accounts.
Responsibility
There was insufficient ability in those at the top of HIH to see what had to be done and what had to be stopped or avoided. Thus, by their own poor example and failure to uphold high ethical standards, allowed a culture to flourish in which secrecy, rule-breaking and fraudulent behaviour became acceptable or, at best, ignored. For instances, Chairman Geoffrey Cohen seemed reluctant to act on matters if he knew that he would not get the support from the chief executive such as he did not bring Raymond William into account when the later bypassed the board in distributing information memorandum about Allianz transaction.