The main objective of this paper is to explore the major significance of corporate governance in an organization. In order to explain the central idea of corporate governance, a public listed company of Australia has been selected. In this paper, HIH collapse will be discussed along with its corporate governance framework and failure. This report will clearly explain the significance of effective corporate governance in HIH Insurance.
Executive Summary. 2
Importance of Corporate Governance. 4
Principles of Corporate Governance. 5
Corporate Governance Failure of HIH Insurance. 6
HIH Collapse. 7
Corporate Governance Failure in HIH Insurance Limited. 9
Conclusion and Recommendations. 12
Business risk management includes various activities including corporate governance. Corporate governance basically supports the organization in meeting its objective of maximization of the shareholders’ wealth. Failure of corporate governance has leaded many organizations towards bankruptcy as well as affected the shareholders and concerned community. Global concern regarding corporate governance is increasing due to collapse of gigantic public listed companies. In 21st century, one of the biggest corporate failures in Australian market is collapse of HIH Insurance Limited. It has been identified that the organization has been over-optimistic in evaluating the assets. In contrast, the liabilities of the organization were extensively underestimated. HIH Insurance was liquidated in 2001 which leaded to substantial loss for the shareholders, policy holders and creditors of the organization. The major reason for the collapse of HIH insurance is the corporate governance of failure in terms of managing the risk of the organization. The entire corporate world can learn a lesson from the incident of HIH and focus on improving the corporate governance. In this paper, severity of the corporate governance is discussed in context of HIH Insurance Limited collapse (Hih.com.au, 2014).
Corporate governance is a system of an organization which is responsible for directing and controlling the corporate activities of the organization. Corporate governance distributes the responsibilities and authority among different individual, committee or bodies of the organization. It also designates the rules and process for making decision regarding corporate affairs. According to Fama and Jensen, Corporate governance can be described as the control over the entire operations of an organization. In other words, corporate governance is a framework of the principles and systems which guides, manages and controls the operations of an organization. The objective of corporate governance is to provide a mechanism that assists the stakeholders in exerting control over the management and organization so that their interest is catered. Effective corporate governance aims to achieve the corporate objective by enhancing the performance, improving the financial management and maintaining integrity of an organization.
Over the past few decades corporate governance issues have received extensive attention in the public policy debates. Corporate governance is receiving greater importance as it has significant impact on the economic performance of the organization. An organization having superior quality corporate governance will assist the organization in having easy access to the capital market. The major components of corporate governance in an organization are the Board of Directors, Corporate Governance Committee, Legal framework, Organizational regulations, Business Policy, Ethical codes, Transparency and disclosure, Effective management of risk, Monitoring and Communication. Internal audit is an important tool that helps in carrying out all the corporate governance activities efficiently (Kim and Nofsinger, 2007).
The concept of corporate governance revolves around some basic principles. Corporate governance principles are discussed below:
HIH Insurance Limited was one of the largest publicly listed companies in Australia. It used operate in various countries and was the second largest insurance companies of Australia. The organization was founded in 1968 and it acquired some other insurance companies. The organization has expanded and diversified globally. HIH was listed on Australian Stock Exchange (ASX). In 2001, HIH was liquidated as it failed to pay back its debt obligation. The estimated loss was 5.3 billion dollar (Austlii.edu.au, 2014).
The major cause of HIH collapse is failure in corporate governance. If the case is analyzed from the financial perspective it can be observed that the company encountered liquidation position as HIH Insurance was incapable of paying the claims to the policy holders. Moreover, it also failed to meet other debt obligations. The inefficient financial management of the organization has leaded to the poor cash position of HIH Insurance. This allegation against the second largest insurance of Australia is universally accepted. In order to manage the operational activities of an organization, each company needs to maintain enough cash balance. At the beginning and end of each operating cycle the company can maintain required level of cash by generating more revenue and managing it effectively. The cash position of an organization reflects the operating policy, financial policy and business activities of the organization. Moreover, there are some long term non cash transactions which influence the cash position of an organization. Hence, in order to identify the reason of collapse emphasis must be given on operational as well as financial activities of the organization.
The insurance industry has to deal with enormous risk and every organization has high risk in terms of going concern issue. Risk in insurance industry can be mitigated by adopting appropriate strategies regarding risk pricing, investment decision and provision for outstanding claim. The risk pricing ability of an insurer can be represented by the underwriting performance of the organization. According to the investigation report presented by Royal Commission, in 1997 HIH Insurance Company had incurred underwriting loss of 33.8 million dollar. The net earnings of the company in 1997 were 1233.5 million dollars. Again the underwriting loss was estimated for 1999 and 2000. In 2000, the underwriting loss of HIH Insurance was estimated to be 103.5 million dollar for the net revenue of 1995.4 million dollar. It was observed than within the two years period (from 1997 to 1990), the estimated underwriting loss was doubled with the rise in earnings by 25%. The major reasons behind the incurred loss are outstanding provision fro claim, recovery of reinsurance and underwriting expenditures.
According to the investigation report presented by the Royal Commission, CEO of HIH Insurance Limited did not acknowledge the requirement for prudential margin. Consequently, the company had adopted as well as implemented an under-reserve policy with respect to the expected future claims. If the organization followed the regulatory Australian Prudential Regulation Authority (APRA) for setting the prudential margin, the underwriting performance of HIH Insurance would have decline which would reflect the real situation of the organization. It is frequently observed that a general insurer makes loss on the underwriting in a certain period of time. But, in case of HIH Insurance it is observed that the company is continuously encountering losses on underwriting for successive periods. Hence, it can be concluded that HIH experienced this situation due to continuous deterioration in operational activities (Findlaw.com.au, 2014).
One of the most significant activities of an insurance company is managing investment activities. Money collected from the shareholders, policy holders and creditors need be invested in suitable funds so that the return is maximized. Thus the underwriting loss can be recovered by the high return achieved from investment. If the organization fails to manage its investment activities effectively it will generate negative return from investment. HIH Insurance had encountered significant loss in terms of investment. These are the major reasons for collapse of HIH Insurance apart from corporate governance issue.
One of the principle reasons for bankruptcy of HIH Insurance Limited is flawed corporate governance practice. According to Agency theory, agency cost can lead to bankruptcy of an organization. Hence, financial theories suggest that equilibrium must be maintained between the debtors and stockholders of the organization. In order to maintain the equilibrium effective corporate governance practice is considered to be an effective tool. In contrast, failure in corporate governance will lead to agency problem which is the major reason for collapse of an organization. In the annual report of HIH Insurance it had established a model for corporate governance which apparently seems to be effective for an organization. The corporate governance model outlined in the annual report of 2000 complies with the guidelines mentioned by Australian Securities Exchange (ASX). In the board level of HIH Insurance there are four major committees.
Audit Committee: Audit Committee of HIH Insurance is responsible for considering the significant issues regarding the financial affairs through monitoring compliance of accounting policy, internal audit issues etc.
Human Resource Committee: The Human Resource Committee of HIH Insurance was developed for reviewing the remunerations of senior executives, issues regarding the formation of board, issues related to organizational structures, development plans for employees etc.
Reinsurance Committee: The responsibility of the reinsurance committee is to review the scope as well as character of the Group reinsurance policies.
Investment Committee: The major responsibilities of the investment committee are consideration as well as formulation of Group asset allocation. Moreover, it determines the guidelines of investments and responsible for and reviewing the internal as well as external fund performance.
According to the investigation report disclosed by Royal Commission, HIH Insurance had lot of flawed practice in Corporate Governance which leaded to major financial break down of the organization. The identified flaws regarding corporate governance are discussed below:
The above stated reasons are considered as the principle reason for corporate governance failure in HIH Insurance Limited.
From the above discussions it can be concluded that corporate governance plays a significant role in achieving the organizational goals. The failure in corporate governance had leaded to HIH collapse. Few recommendations can be made for building effective corporate governance model in Australian organizations:
Austlii.edu.au, (2014). Adams, Michael --- "Australian Corporate Governance: Lessons from HIH Insurance"
Findlaw.com.au, (2014). The HIH legacy: Corporate governance and shareholder value.
Hih.com.au, (2014). HIH Insurance - Home Page.
Jiangbo, X. (2005). HIH Insurance Limited: Corporate Governance and Corporate Excesses.
Kim, K. and Nofsinger, J. (2007). Corporate governance. 1st ed. Upper Saddle River, N.J.: Pearson/Prentice Hall.
Mallin, C. (2004). Corporate governance. 1st ed. Oxford: Oxford University Press.
Monks, R. and Minow, N. (2004). Corporate governance. 1st ed. Malden, Mass.: Blackwell Pub.
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