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Collapse of the HIH Insurance

Discuss about the Causes For the Collapse of Hih And Onetel.

It has been observed that the during the first year of 21st century there were many high profile company that collapsed and mostly these were in U.S. that included WorldCom and Enron and in Australia the companies were HIH Insurance , OneTel, Ansett Airlines and Harris Scarfe. The main aim of the report is to analysis and investigate the failure of the two Australian corporate the HIH insurance and the OneTel and further reviews the inadequate corporate governance that were responsible for their failure. In the August 2001 the HIH company was liquidated with the losses that ranged about AU$ 3.6 billion to about AU$ 5.3 and just before its collapse a very well known company of telecommunication in Australia and one of the fastest growing company listed in ASX posted a operating loss of AU$ 291 million in the year 2000. The failure of both the companies that is the HIH and the OneTel was analyised to be the myriad problem that is the weak corporate governance that was being faced by both the companies along with various other issues that included aggressive financial reporting, unsustainable business strategies, questionable party transactions, ineffective working capital and poor auditing. It was highlighted that the main cause of the failure of the OneTel and the HIH was not having good corporate governance and not paying the “lip service”.

The main problem that was faced by both OneTel and HIH was their passion for chasing low yield business and not thinking or worrying about the covering of the future liabilities hence not saving sufficient capital for meeting the future needs. (Hill, 2007) This problem was due to the failure of the management and the board of directors of the company to monitor and enforce the due diligence in the company. (Barney, 2009)

The collapse of the HIH insurance was considered to be the biggest corporate failure in Australia due to which a Royal Commission was established by the Liberal Federal Government for investigating in to various reasons that lead to the failure of HIH. There were number of recommendations that resulted in to the changes of corporate regulatory. There were various policies and systems that failed in this spectacular fashion. It was concluded by the commissioner Mr. Justice Owen that the collapse of the HIH was due to the inflated egos, lack of monitoring and the poor systems. It was found that there were number of directors who had breached their duties under the corporation act and hence they were banned for any of the involvement in the management of the company.

Causes of Collapse of the HIH Group

It was observed that HIH had a very conservative corporate culture and various deficiencies that resulted in the collapse of the HIH. The CEO of the company was very dominating and charismatic who engaged himself in various high risk practices in the market that was highly competitive. There were no independent directors on board of HIH and some of the directors even alleged that they were not aware of the true financial position of the company. (Owen, 2003)Many of the difficulties that HIH faced was due to its aggressive acquisition strategy, a culture of not giving the bad news and the growth at all cost mentality that often resulted in the conflict between the implantation of the corporate governance procedures and profit maximization. (Commission, 2003) 

From the financial perceptive of the company it can be concluded that the main reason that led to the collapse of the HIH Company was the inability of the company for paying the claims of the debts and the insurance policy holders that fell due.  The poor cash position of the one of the second largest Australian Company led it to the collapse. It is very important for every company to meet its operating cycle to maintain the cash for the long term success of the company. (Monem, 2009)Thus, after examining the causes of the collapse of the HIH then the focus cannot be made on to the cash only rather the analysis needs to be extended in to the financial activities and the operational activities that are the main causes of the insolvent position of the company. (The HIH Royal Commission(a), 2003)

The insurance company deals it self with the high risk position as a going concern issue. The three important vehicles of the insurance company are outstanding claim provision, the risk pricing ability and the investment decision. Firstly, the pricing ability is taken into consideration. Underwriting is very important element in the insurance business for its general operations. According to the reports of the Royal Commission in the year 1997 HIH made a underwriting loss of $73 million against the premium that it earned of about $1550 million.

After analyzing in to the matter it can be found out that the main reason for the bankruptcy of HIH was the agency cost problem that arose from the conflict between the managers, proprietors and the debtors of the organization. (Clarke Frank, 2003) According to the theory of the mainstream it can be analyzed that the equilibrium between the debtors and the stakeholders can be dynamically made because if the interest of the debtor will be impaired it will automatically reduce the value of the company and would cause a damage to the interests of the stakeholders. For maintaining such equilibrium it is important to take in to consideration the main element which is corporate governance. So, it can be concluded here that the main reason for the bankruptcy of the company was the failure of its corporate governance.

Flawed Corporate Governance Practices

But, after going through the corporate governance report it can be found that the company has maintained a decent corporate governance model that is complied with the guidelines of the ASX.

According to the analysis the independence of the non-executive directors needs to be questioned which is not that perfect as it appears to be. This inference can be drawn from the facts below:

  • There are five non executive director of the company out of which two are the former partner of the Arthur Anderson which is the auditor of the HIH Company. (Buchanan Bonnie, 2003)Further, it can be noticed that the Arthur limited has earned $8 million after auditing the HIH business whereas it has earned $7 million from other auditing services. It is very well known fact that the non auditing services are regarded to be the major distracting source that takes the independence of the auditors.
  • During the year 2000 the controlled entity paid the insurance premium for ensuring the officers and the directors of the company
  • One of the auditors of the audit committee Justin Gardener was the auditor of the FAI in the year 1980 and in the year 1998 FAI was sold to HIH. This was the main reason for the collapse of the HIH Company as this takeover transaction highly influenced HIH Company.

Risk management is considered to be very important for the operation of the insurance company. The above three issues evidence very well that the company did not shaped its risk management in a good way. The directors of the company were negligent regarding the decisions of the analyses of the strategy. 

There were various deficiencies in the corporate governance practices of OneTel that were responsible for its demise. At the time of the collapse of the OneTel the company already had operations in seven countries and annual sales of AU$653 million. Though the financial position of the company was very much secure but it has an inadequate corporate governance structure. The CEO of the company had an excessive influence on the board of directors to the extent that there was no chairman who had the designation at the place even. Rather the CEO of the company acted on ad hoc basis on the board of directors’ chair. The monitoring of the non executive directors was also inadequate and the oversight of the management that was very well reflected in the composition of the audit, remuneration committee all was dominated by the executive directors and CEOs. (The Corporate Law Economic Reform Program, 2004)

There were various corporate governance failures that led to the collapse of the OneTel Company.  The various factors were: Firstly, the CEO had the excessive influence on the Board of directors that led to the board of directors to be ineffective and further reduced the capacity for providing oversight and control. Secondly, the investors who were misled by the financial position of the company though being aware of being misled took least interest in the management of the company and relied more on the direction of the executive directors and the CEO. (ASX Corporate Governance Council, 2003)Thirdly, there was not much effect on the non executive directors as they were closely associated with the CEO. Fourthly, there was a conflict of interest with the auditor that was compromised due to the non audit services of the company. Lastly, the Board of directors was not independent and hence they were not able to monitor the behavior of the management properly and were not able to control the agenda of the board of directors.

Lack of Independence of the Non-Executive Director

There were various governance related recommendations made by the HIH Royal commission to the regulators, ASX and the legislature in the development of the CLERP 9 and the release of the principles of ASX in the year 2003. There was various substantial guidance provided by the ASX corporate and the CLERP 9 to the companies to explain and comply the basis that were stringent than the various Australian disclosure requirements.

One of the most important Australian legislative reforms that responded towards the failure of the HIH was the CLERP 9 that had a major impact on the corporate governance of the Australia that even continues to the present day. The proposals of the CLERP 9 had a direct impact on the corporate governance practices that increased in the mandatory auditor independence that further required that the top 500 listed companies on the Australian stock exchange shall have the audit committees. Hence, the listed companies external auditors were required to attend the annual general meetings and answer the questions of the shareholders of the company, there shall be whistle blower policy for recognizing the various wrong doers in the organization and the participation of the shareholders shall be improved in the meetings of the company.

Conclusion

For facilitating good financial performance and maximizing the returns of the shareholders it is very important to have good corporate governance practice. From the cases of the OneTel and HIH it can be analyzed that corporate governance id much more than just ticking the boxes. The monitoring model of the HIH was award winning but it was ineffective while the OneTel disregarded the guidelines of the corporate governance all together. Both the companies were unable to periodically access the corporate governance practices. Due to the collapse of the HIH and OneTel various codes and reforms were introduced according to which the board was allowed to review the manner of its operation. The above report has analyzed the various corporate excesses and the corporate governance. In the case of HIH though it has a very well developed corporate model but the actual corporate governance practices have been flawed. Due to the inadequacy of the practices of the corporate governance there is a high inherent risk on the company.

ASX Corporate Governance Council, 2003. ‘Principles of Good Corporate Governance and Best Practice Recommendations’. Australian Stock Exchange Ltd. , pp.1-79.

Barney, J., 2009. Corporate Scandals, Executive Compensation, andInternational Corporate Governance Convergence: A U.S.-Australia Case Study’.

Buchanan Bonnie, A.T.N.L., 2003. “Beware the Ides of March: The Collapse ofHIH Insurance”, in Batten J, A and Fetherston T. A. Social Responsibility: CorporateGovernance Issues, pp.199-221.

Clarke Frank, D.G.a.O.K., 2003. Corporate Collapse: Accounting, Regulatoryand Ethical Failure. Sydney: Cambridge University Press..

Commission, T.H.R., 2003. The Failure of HIH Insurance. A corporate collapse and its lessons, 1-3.

Hill, J., 2007. Evolving Rules of the Game in Corporate Governance Reform’. Canberra: ANU, ESRC/GOVNET Workshop.

Monem, R., 2009. ‘The Life and Death of OneTel’, Griffith University. presented at the American Accounting Association Annual Meeting.

Owen, N., 2003. HIH Royal Commission Final Report.

The Corporate Law Economic Reform Program, 2004. Audit Reform andCorporate Disclosure. [Online] Available at: https://www.comlaw.gov.au/comlaw/Legislation/Act1.nsf/0/66B0C93ECDA86C21CA256F [Accessed 8 September 2016].

The HIH Royal Commission(a), 2003. The failure of HIH: a critical assessment”, in The Failure of HIH Insurance. A corporate collapse and its lessons, 1.

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