HIH Scandal

HIH Insurance

Company Background
HIH was originally found in 1968 by Ray Williams, then was acquired by British company CE Health PLC in 1971, and renamed as "HIH" in 1995. Before its collapse, HIH was the second largest insurance company in Australia, and covered several insurance segments, including worker's compensation, public and private liability, property, industrial and commercial insurance. It also expanded globally into the US and UK markets.

On March 15, 2001, HIH insurance was placed into provisional liquidation. The liquidator estimated that the total loss of HIH are up to $A5.3 billion as the results of over-optimistic valuations of assets and extensive under-estimation of liability, which represented as the biggest corporate collapse in Australian history.

Event leading to failure

1993-1994
CE Health Commences operated in UK and entered workers compensation underwriting market in California, USA.
1995- 1997
HIH expanded their business rapidly through several merge and acquisition, including CIC insurance, Utilities Insurance. It became to the Australia's largest underwriter of bancassurance business after acquiring Colonial Mutual General Insurance at January 8, 1997.
1998
HIH blacklisted stockbroking analyst who disputed it assessment of the company at Sep. 2008
In January, HIH won a $A300 million takeover bid for FAI Insurance; later HIH admitted it paid more than it expected for FAI, which is estimated to be only worth $A100 million
In March, HIH posts a 39 per cent fall in 1998 net profit at $37.6 million, blaming damage claims.
In July, a routine external audit by Arthur Andersen fails to raise the alarm. The regulators and others accept the company's declaration with $939 million in asset. Two months later, HIH sells part of its domestic personal lines business to German Insurance giant Allianz for about $A 500 million. A day after the deal, HIH shares tumble to an all-time low after lower-than -expected profit results announcement and criticism of the Allianz deal.
2000
December, Ray Williams resigns as managing director with a $A5 million severance agreement. Rodney Adler, former FAI chief, is called for resignation.
February, HIH's December financial statement overdue at Australian Prudential Regulation Authority (APRA). The Australian Securities& Investments Commission ( ASIC) concerns that company might no longer be solvent
2001
March 15, 2001 HIH is forced into provisional liquidation by ASIC with losses of $800 million. ASIC launches its biggest ever investigation, seizing HIH documents. The liquidator revises deficiency between $A 3.6 billion and $A 5.3 billion, which becomes called Australia's largest corporate collapse
2005
April 14, 2005 Former HIH director Rodney Adler was sentenced for four and half year jail for four criminal charges, which included:
Two counts of disseminating information knowing it was false
One counts of obtaining money by false or misleading statement
One count of being intentionally dishonest and failing to discharge his duties as a director in good faith and in the best interest of the company.

HIH insurance is now in run-off, which may take over 10 year to complete. Shareholders may lose their entire capital.

The Falling of HIH Insurance
According to an American report, the HIH insurance company’s failures are attributed to rapid expansion business strategy, unsupervised delegation of authority, underpricing, reserve problems, false reports, reckless management, fraud, greed and self-dealing.

Many of HIH's business difficulties can be primarily due to its aggressive expanded business strategies. Over a decade, HIH created more than 200 subsidiaries, and the business covers almost all insurance business segments, domestically and globally. It either entered the insurance market that is already overcrowded and competitive by offering lower insurance premium (California, US), or chose a sector that it did not fully understand which lead to business issues and legal risks (London, UK). On the other hand, the due diligence failure exacerbated the situation. HIH acquire some troubled insurance business with too high price during its rapid growth period in 1990s. The most controversial acquisition is that pays $A 300 million to buy FAI from Rodney Adler, who later became a member of HIH's board of director. FAI was revealed only to be worth $A 100 millions later.

HIH also has many fundamental problems, such as underpricing and reserve problem. It offers insurance with very low price, but failure to set aside enough capital to cover it future liability. According to press reports, HIH's actuarial adviser had warned HIH's risk management concern a year before company collapse. However, instead of adding extra capital, HIH chose to buy reinsurance to lay off its risk. It was proved as wrong decision on June 2000 since all reinsurance cover was run out.

Further more, the HIH's failure is not only attributed to the business strategy and fundamental problem, but also includes additional issues in conjunction with risk reporting, corporate governance, fraud, external auditing and regulation. Along with company's collapse, it was found that three of HIH's board members in 2000 are previously employed by Arthur Andersen, who is the external auditor of HIH. It has raised huge issues for the reliance of the information provided by company and their auditors.

ERM Lesson Learned from HIH failure
It is not surprising to hear of insurance companies failure in entering new market, in overpaying in mergers and acquisitions, in mispricing and in being undercapitalized, but it may be rarely found in such a large scandal of HIH. It is a typical case of lack of ERM practice, which leads HIH primarily exposure on systematic risk and operational risk. If possible, we believer two key component of ERM practice can largely help company to reduce those risk exposure, corporate governance and line management.

From the ERM perspective, setting corporate governance can ensure senior management establishing appropriate organizational process and executing risk management across the company. The Sarbanes-Oxley Act also provides both specific requirement and severe penalties for noncompliance with newly established governance and disclosure standards. If there is corporate governance setting up for HIH, it will reduce the potential operational risk, such as unsupervised delegation of authority, reckless management, fraud, greed and self-dealing.

Add paragraph on strong compliance and internal audit.

ERM suggests setting up line management aligning business strategy with corporate risk policy, measuring capital required to execute business strategies such as when pursuing new business and growth opportunities or in acquisitions. Specifically in HIH case, if line management is set up to evaluate risk acceptance criteria when considering new product and market opportunities, and to develop formal transaction and business review processes during due diligence, it will allow company to better understanding those risk at initial stage, and further reduce underpricing risk and due diligence risk.