Auditing For HIH Insurance Limited: Risks, Mismanagement And Account Manipulations

Risks and Mismanagement at HIH Insurance Limited

Discuss about the Auditing for HIH Insurance Limited.

1. The HIH Insurance Limited was incorporated in the year 1968. There is a lot of facts questionable right from its formation. For instance, despite incorporation, the insurance operations were commenced only from the year 1998 and even in this; the way insurance business was being carried out was much different from the others. As a result of proper policies and procedures and lack of due diligence and statutory compliances, HIH succumbed to a lot of business and operational risks that made its functioning questionable. As its downfall was clearly marked, Winterthur Insurance Company withdrew its stake from HIH.

Insurance business is prone to risk and so risk orientation should be the primary requirement for the same. As public money is held by the insurance company, adequate safeguards have to be taken while dealing with the same and any shortcut or non compliance can lead to destructive results (Vause, 2009).

There were several problems with HIH. The first one was the acquisition of multiple companies and diversification into sectors like marine, aviation, so on and so forth. Knowledge of business, proper market research and study are preliminary before commencing any business, which HIH did not carry out vigorously. There are also pre-merger compliances and analysis into the economic, political and market conditions which HIH had avoided. The lack of proper financial planning and working capital strategies led to a weak capital structure and investment base of HIH. The risks kept getting added on from lot of unexpected areas. The provisions had to be created based on the number of expected claims to be settled but this was also not done due to lack of research into the subject (Hoffelder, 2012). Thus the whole system was susceptible to risks and all these factors contributed to the downfall of HIH.

HIH was already under financial mismanagement when it decided to takeover FAI Insurance. As there were discrepancies, a proper due diligence of FAI was not carried out and as a result FAI was purchased at a premium which was a faulty decision. This was the main fault and this takeover of shares at a premium added the losses of HIH and increased its complications further (Hoffelder, 2012).

The next major threat that hit HIH was its decision to discontinue the compliance with prudential standards. These prudential standards were designed to substantiate the impact of unexpected contingencies but rather than following these, HIH adopted reinsurance policy that increased the risks of the company. When the company faces unexpected risks, it should have a backup plan to encounter them at least o some extent, but HIH was faced with such risks that had gone beyond its control and management (Mock et. al, 2013). This ultimately led to its downfall.

Auditors as Board Members

Apart from this, funds used for auditing and consultancy services were really huge and would attract attention of any common investor. The point to be noted here was also that despite paying such huge amounts, the quality of audit and consultancy services was not up to the required level as the accounting frauds were not reported and there were no noteworthy steps taken to prevent the frauds and negligence. This also made the company risk averse.

The Management and Board of Directors is responsible for the day to day functioning and routine administration but where the independence of the Non Executive Directors is questionable, it is evident that the services provided by them might not be fair and transparent. These factors also increased the risk for the company (Heeler, 2009).

The unhealthy links of HIH’s competitors with a few of its parties also led to the increased business risks for HIH. The actions taken by the competitors also had an impact on the goodwill of HIH.

Thus it can be seen that most of these risks were self created by HIH due to its mismanagement in almost every aspect of insurance business and ultimately the company had to be wound up.

2. The Directors of the company held assured annuity rate policies with an intention of siphoning the public monies and issuing current annuity rate policies to the public. With reference to the case of Equitable Life Assurance Society vs Hyman, the decision passed by the House of Lords led to the closure of the Society due to its false intentions. The policyholders of this society had not become insolvents; still the UK Government had ensured a fair compensation for the policyholders under the Equitable Life (Payments) Act, 2010. Thus this case is a classic example for the treatment of the dishonesty by the insurance company. Anderson can refer to this case law for determination of the liability of the partnership.

A partnership is accountable to its creditors and the case of Raskov vs Stapke & Harris can be used as a reference to encounter the wisdom of the partnership firm. Thus this is a suitable case law for reference.

When it comes to audit or the management of the insurance company, there can be mistakes on both sides. Unintentional mistakes can be forgiven to an extent as there might not have been false intentions behind the same but intentional mistakes which arise due to the intentional negligence of duty or intentional breach of trust are all viewed as bigger crimes in the eyes of law (Heeler, 2009). The government and the society encourage fair business practices. Thus providing inappropriate details, making false claims, levying of surprise charges and having secret clauses signed by the policyholders without their knowledge are all acts of intentional negligence. As all such activities are undertaken to harm the public, it is certainly punishable by law. For all these reasons, due diligence is stressed upon to prevent such cases in future (Baldwin, 2010).

Conclusion

Negligence can be said to exist when a person is bound to perform a duty and when such a person either does not exercise due care and diligence in performance of the duties or does a breach of the duties (Kaplan & Williams, 2013).

When a case is filed in the court, it is between the two parties, the defendant and the plaintiff. Where the defendant fails to exercise due care to the plaintiff, then it is up to the jury to decide the extent of contravention which depends upon the facts of the case. On the other hand, the plaintiff will try to prove that the damage caused to him is due to the negligence of the defendant. The cause for the damage also known as the proximate cause is also considered here as a deciding factor whether the damage caused to the plaintiff is solely due to the defendant or due to the factors supporting the same (Kaplan & Williams, 2013). Based on the proximate cause, the amount of damages will be decided and the process of arriving at the results and conclusions are usually dependent upon the skills of the lawyer who can either turn the case is favor or against.

3. The Board of Directors of HIH included three former partners of the audit firm, Arthur Andersen. The reason behind this appointment could be the familiarity aspect as the audit firm is well aware of the nature of the business of HIH due to the audit done from many years. The systems, employees, vendors and parties, taxation authorities are all familiar with the external auditor and so the comfort level with the company is already built. As the same members act as auditors and directors, the strengths and weaknesses of the business are known to them, the risk prone areas can also be assessed with greater efficiency (Gilbert et. al, 2005).

Another reason could be due to the fact that the audit firm had earned massive revenues from HIH and at the same time the audit firm was unable to locate the irregularities and fraudulent practices carried out by HIH. So it can be deemed that the auditors had joined hands with the directors of HIH in the falsification of accounts. Thus if the same auditors are appointed on the Board of Directors, it might become easy to cover up such manipulations when compared to any new person coming in and taking up the audit from the scratch (Gilbert et. al, 2005).

The question of whether the same audit firm can provide both auditing and consulting services has been extensively debated. On one hand it has been felt that when the same audit firm provides consulting services, it can lead to a conflict of interest as the management information systems would have been established by the audit firm and also the verification of the same systems and controls is done by the same audit firm. On the other hand it is believed that the services offered in the form of consultancy are a by-product to the information that is already acquired by the auditors during the course of audit (Christensen, 2011). Auditors are potentially trained for understanding the business from an external perspective and so it would be more feasible for them to provide consultancy services. As markets are becoming more competitive day by day, it is essential that auditors look for other opportunities like consultancy services. The deeper knowledge an auditor obtains about the client’s business, the better will be the understanding towards providing consultancy services. This will serve many purposes and will help to drive the business in the correct path. Moreover, the involvement of outside parties will be less in this regard. There are a few services like tax consultancy, tender process, human resource consultancy, so on and so forth that could be otherwise provided by a number of audit firms but the fact of selecting the same audit firm is because it is incidental to the audit process (Wood, 2011). Thus these are the few distinct advantages of having the same audit firm provide consultancy services.

As per the Code of Ethics laid down by the Institute of Chartered Accountants, the auditor is permitted to provide management consultancy services to the extent that it does not hinder the independence of the auditor. In cases where the auditor is also writing the books of accounts of the company, it is clearly unethical. An auditor must have an independent status and should not have any area of profit in the company. Once a material interest is present, it leads to unethical practice and hence destroys the decision. But consultancy services are permitted and so payroll services, taxation consultancy and such services can be provided by the statutory auditors or external auditors (Cappelleto, 2010). The appointment of prior auditors to look into the frauds becomes an unethical decision as the same auditors were present when the frauds had taken place and they were unable to report the same. Hence this area of appointment is unethical.

HIH Insurance Limited’s case is seen to be a significant one in the insurance industry as there was lack of proper management and also the compliance with the legal and ethical standards. Hence the CLERP and Ramsay Report laid down several rules and regulations that have to be mandatorily followed by insurance companies. A few of the regulations were also placed to cover the loopholes of the existing regulations due to which companies were taking advantage. The purpose of an audit is to comment on the true and fair nature of the financial statements whether it is prepared in compliance with the standards and law. These standards aim at proper due diligence and carrying out efficient audits that were unbiased and independent (Cappelleto, 2010). The public faith could be restored in audit as the better performance of the company is seen. When the audit process is done with precision, it leads to better performance of the company because the stakeholders are able to have a transparent view. This enhances the goodwill of the company.

References

Baldwin, S. (2010). Doing a content audit or inventory. Pearson Press.

Cappelleto, G. (2010).  Challenges Facing Accounting Education in Australia. AFAANZ, Melbourne

Christensen, J. (2011). Good analytical research.  European Accounting Review, 20(1), 41-51

Gilbert, W. Joseph J and Terry J. E. (2005). The Use of Control Self-Assessment by Independent Auditors. The CPA Journal, 3, 66-92

Heeler, D. (2009).  Audit Principles, Risk Assessment & Effective Reporting. Pearson Press

Hoffelder, K. (2012).  New Audit Standard Encourages More Talking. Harvard Press.

Kaplan, S. & Williams, D. (2013). Do going concern audit reports protect auditors from litigation? A simultaneous equations approach. The Accounting Review 88(1), 199-232.

Mock, T. J., Bédard, J., Coram, P., Davis, S., Espahbodi, R. & Warne, R. (2013). The audit reporting model: Current research synthesis and implications. Auditing: A Journal of Practice and Theory, 32, 323-351.

Vause, B. (2009). Guide to Analysing Companies, Bloomberg Press

Wood, D A. (2011). The Effect of Using the Internal Audit Function as a Management Training Ground on the External Auditor's Reliance Decision. The Accounting Review, 86(6), 39-56