There are a variety of business risks that the insurance business has as identified below (Gay &Simnett, 2012).
- As the investment portfolio tends to fluctuate in value , hence there is market risk present.
- There are chances of human errors in various operational tasks which can potentially lead to losses and hence operational risk is also present.
- The debt investments have underlying default risk giving rise to credit risk.
- The business may lack usage of adequate tools for calculation of risk premium and hedging of risk giving rise to underwriting risk.
The above mentioned risks clearly indicate that insurance business is an inherently risky business and thus competitiveness in the business is contingent on the usage of various prudential norms for risk management. But despite the high inherent risk in business, HIH Insurance used reinsurance which does not manage the business risks in a satisfactory manner. Further, HIH enhanced the overall risk by making an entry into risky insurance segments where the business risk was even higher particularly insurance related to marine and aviation sector. HIH also acquired companies in the absence of the requisite due diligence thus aggravating the financial health further. Additionally, the various internal safeguards for management of risk were lacking and dysfunctional and thus there was acute lack of any contingency planning which implied failure of business was certain. Hence, it may be fair to infer that the HIH business risk will be termed as extremely high.
The noteworthy factors having an impact on the inherent risk are stated below (Arens et.. al., 2013).
- The company was involved in an inherently risky business but still it chose to ignore the prudential norms which were being adhered to even by the market leaders which resulting in higher underwriting risk due to exposure to reinsurance model.
- FAI insurance was acquired by HIH in the absence of proper due diligence which culminated in acquisition at very high valuation thus resulting in further weak position financially.
- The business risk management was severely impacted by the appointed of the previous auditors to the board of directors which effectively compromised the independence of the board. The end result was a continuation of the faulty policies.
- The external auditor’s independence seems to be compromised which leads to the failure of the external reporting mechanism which further led to the continuation of the faulty practices as the independence of the internal and external whistleblowers was severely compromised.
- The company went ahead and bought stake in those companies that were in professional relations with the competitors of HIH which could have adversely impacted HIH’s business interests,
1) One of the cases which highlights the auditor protection from client initiated legal action is the Equitable Life Assurance Society v Hyman .case. As per the relevant case facts, the customers of an insurance policy were provided with two alternate policy choices whereby one extended an annual return which was fixed which the other extended an annual return linked to the market return. The insurance premium associated with both the policies was exactly the same. It was the discretion of the directors to being about change in the returns and thus they utilised the discretion to ensure that the in case of market linked return being lower than the fixed rate, there was a decrease in the terminal bonuses attached with the fixed return policies to the extent that both policies offered the same return. As the holders of the fixed return policy had reduced returns due to the direction discretion, the matter was brought to court where it was ruled that the directors of the partnership would be held responsible for any losses that were suffered by the policyholders (Swarb, 2015).
2) One of the cases where the creditor related liability was borne by the partnership is the Raskov vs. Stapke& Harris  case. Through this case it was demonstrated that when a particular viewpoint is held by the partnership firm, then it is likely that legal determination is possible. Hence, the liability on behalf of the creditors lies on the partnership firm while giving a clean chit to the auditors. In order to escape liabilities, the auditor counsel may cite the above case (Notforlaw, nd).
Tort of negligence is established only if three particular conditions are satisfied. The first condition related to the duty to care being extended to the plaintiff on account of plaintiff being a neighbour of the defendant. It is critical to note that a neighbour is defined as a particular entity that tends to get affected on account of defendant’s choice of indulging in a given course of action or refraining from indulgence. The direct implication of the existence of duty of care is that the defendant on its part needs to take reasonable measures to ensure that the interests of the plaintiff are safeguarded and no harm is suffered (Lindgren, 2011). The level of care that is expected to be extended on part of the defendant would be defined by the given circumstance which in turn defined the underling risk of damage to the plaintiff and the potential impact of any negligence. It is termed that there has been a breach of duty when the defendant does not take those measures which a reasonable person is expected to take in the given situation (Pendleton & Vickery, 2005).
Another aspect which completes the tort of negligence is the presence of damage on the part of the plaintiff which needs to be linked to the breach of the duty bestowed on the defendant. The damage defined under negligence is quite wide in scope and includes emotional and mental stress as well besides physical and financial damages. In order to link the damage to the duty breach, it is critical to establish that the plaintiff would not have suffered any damage had the breach in duty not been observed by the defendant. However, any damage which could not been averted with extension of proper care would not amount to negligence even though the defendant could have breached the duty to care (Harvey, 2009).
The case clearly reflects that HIH Insurance appointed the partners of the ex-auditors without any particular reason to justify the same. Hence, the only valid reasoning seems to be a quid pro quo relationship between HIH management and the external auditors as both the parties seem to hide the wrongdoing of each other while profiteering from this mutual understanding. This is apparent from the conduct of both the parties whereby HIH provided the external auditor with lucrative consulting contracts along with paying a very high audit fees. The external auditor returned the favour by ensuring that the issues with the risk management practices of the company did not come to light. Otherwise, it seems highly unlikely that with the level of skill and experience, the auditors could not even identify the high inherent risk and the gaps in risk management and internal control that existed at HIH. The inclusion in the board was a means to reward the partners for the exemplary services offered and also ensure that the independence of the board remained compromised ensuring that the malpractice continued unabated (Arens et. al., 2013).
The key advantages of ensuring the auditing and consulting services are offered by a particular firm are outlined below.
- Audit service improvement
In the capacity of a business consultant, it is essential that the business model is understood. This understanding is potentially useful for auditing also as the various key business risks could also be understood better. This enhanced business model and risk understanding is helpful in the overall audit strategy along with audit planning. Besides, this would also allow the auditor to focus selectively on areas of higher risk. This would lead to reduced audit risk and enhance the utility of financial reporting (Gay &Simnett, 2012).
- Consulting Services Improvement
An auditor is well aware of the key inherent risks in the business which the business consultant needs to focus on. This leads to solutions for business problems that are customised and aligned with the consumer needs. This is particularly helpful in relation to analysing the liabilities arising on account of tax and related considerations so that consultant can provide solutions that are feasible but effective at the same time (Arens et. al., 2013). Thus, it would be fair to assume that the same person offering both the services would result in cost savings for the underlying client along with improved services provided adequate safeguards are maintained.
The profession of auditing would be able to continue the relevance for users if auditor independence is safeguarded. But, this is increasing becoming more difficult as the auditors are venturing out into providing other services that leads to a conflict of interest leading to compromised auditing services resulting in higher audit risk. Even though the current law does not prohibit the audit firms from venturing out into the sphere of related services but it is in the best interest of the profession that auditors must be careful about the same and should refrain from extending these services to the audit client (Livne, 2015). This is quite apparent from the HIH case where the management provided the auditor with contracts involving consulting work as a compensation to compromises made during auditing. Besides, there is familiarity threat to auditor independence and therefore presence of auditor on the board of a present or past client is outrightly unethical especially from the perspective of perceived independence of the auditor. As a result, the agency costs in the recent times have increased and investors are demanding for greater transparency and disclosures (Kaplan & Williams, 2013).
- d) The main focus area of CLERP 9 is to improve the corporate governance framework in order to allow for better governance and upholding the interest of the shareholders. Some of the significant suggestions are as outlined below (Clout, Chappelle & Gandhi, 2013).
- The annual report of the company must make incremental disclosures which include the directors report along with the remuneration report.
- In order to prevent development of quid pro quo relation between the management and the external auditor, the rotation of the auditor after a fixed term has been made mandatory.
With the increased focus on corporate governance framework, it can be expected that the overall disclosures are bound to lead to higher levels of transparency thus leading to an increase in the confidence of investors (Arens et. al., 2013).
The auditor independence was the central focus of the Ramsay Report which put forward the following recommendations (Parker, 2002).
- Increased mandate with regards to the internal audit committee
- Putting constrains on the relationship between auditor and client
- Auditor declaration with regards to self independence being introduced in the annual report.
- Auditor declaration with regards to board independence must be contained in the annual report.
It is widely expected that the various measures outlined above would result in increased independence of auditor which is key to maintaining the auditor relevance in a corporate world where incidence of fraud is on the rise (Gay &Simnett, 2012).
Arens, A., Best, P., Shailer, G. and Fiedler,I. 2013. Auditing, Assurance Services and Ethics in Australia, 2ndedn., Sydney: Pearson Australia
Clout, V, Chappelle, E and Gandhi, N 2013, ‘The impact of auditor independence regulations on established and emerging firms’, Accounting Research Journal Vol. 26, No. 2, pp. 88-108
Fearnotlaw nd, Raskov vs. Stapke & Harris, Available online from https://www.fearnotlaw.com/wsnkb/articles/raskov_v_stapke__harris-33634.html [Accessed May 2, 2017]
Gay, G. and Simnett, R. 2012, Auditing and Assurance Services in Australia, 5thedn., Sydney: McGraw-Hill Education
Harvey, C. 2009, Foundations of Australian law. 3rd eds., Prahran: Tilde University Press
Kaplan, S. and Williams, D 2013, ‘Do going concern audit reports protect auditors from litigation?’A simultaneous equations approach.The Accounting Review, vol. 88, no. 1, pp. 199-232.
Lindgren, KE 2011,Vermeesch and Lindgren's Business Law of Australia, 12th eds., Sydney: LexisNexis Publications
Livne, G 2015, Threats to Auditor Independence and Possible Remedies, Finance Practitioner Website, Available online from https://www.financepractitioner.com/auditing-best-practice/threats-to-auditor-independence-and-possible-remedies?full. [Accessed May 2, 2017]
Parker, C 2002. ‘Auditing at arm’s length’, CA Charter, February, pp. 38-40
Pendleton, W & Vickery, N 2005.Australian business law: principles and applications, 5th eds., Sydney: Pearson Publications
Swarb 2015, EQUITABLE LIFE ASSURANCE SOCIETY V HYMAN; HL 20 JUL 2000, Available online from https://swarb.co.uk/equitable-life-assurance-society-v-hyman-hl-20-jul-2000/ [Accessed May 2, 2017]