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Lessons from the HIH collapse

It lasted over 16 months, covered 3 volumes and cost over $40m. The HIH Royal Commission into the $5.3 billion collapse of HIH in March 2001 is a very costly case study into how not to run a company, a poor corporate governance culture and risk management gone wrong. Ultimately, the royal commission concluded that the real problem was mismanagement and lack of oversight. So what can corporate leaders learn from Australia’s largest ever corporate collapse?

Using qualified & experienced directors doesn’t guarantee success

  • Between 1997 and 2001, the board included insurance experts, qualified accountants and a QC.
  • With all the expertise, the board was still subservient to the CEO, did not ask enough questions, made poor decisions and were ineffective in managing strategy.

Directors must probe senior management and ask questions

  • Management controlled the agenda for board meetings, vetted the information and concealed information from board members and auditors’.
  • HIH directors didn’t question the key assumptions behind actuarial and auditors’ reports.
  • Board was strongly influenced by senior management, from which senior management benefited significantly, to that of a company run primarily in the interests of shareholders.
  • Directors simply accepted senior management recommendation to enter US market without adequate analysis of management’s assertions. Est. loss $620M.

Directors cannot abdicate responsibility

  • 5 of the 12 directors were not even present when the board voted to pay $300 million for FAI.
  • The HIH chairman exercised an “abdication of responsibility” in relation to ensuring all directors’ conflicts of interests were disclosed.
  • In the last 3 months of HIH’s life, the HIH directors made a decision… to grant themselves fee increases – retrospectively!

Long term strategies need to be developed and questioned

  • There was little analysis of the future strategy. Perhaps the only time that it was discussed was in the context of the annual budget meeting.
  • With the pressure on companies to meet analysts’ short-term expectations, too often the strategy was to achieve the required profits for the next half-year.
  • No broad strategy was ever enunciated, directors had nothing against which to measure its performance.
  • No evidence that the board contributed to a business plan when HIH’s UK branch was established.
  • Responsibility of board members to understand and then provide diligent oversight of the strategies.

Do not do business with a company related to directors/management

  • There was a “flawed understanding of the concept of conflict of interest”. Two non-executive directors were paid significant consultancy arrangements that were not disclosed.
  • Williams approved a $2million investment in a business-coaching company controlled by Adler.
  • HIH lost $38 million on its investment in Home Security plus threw away a further $47 million. When entering new markets and/or new products, do your homework first
  • The company expanded into Britain and Hong Kong, wrote US workers’ compensation, wrote accident cover to Taiwanese army, wrote motor vehicle cover to Israeli army without terrorism exclusion and expanded into marine reinsurance and film financing. Est. loss $1,700M.

Be very diligent during mergers and acquisitions

  • With only minimal information, directors approved a Joint Venture deal where HIH’s main source of premium income (about $1 billion a year) would be diverted into a trust fund. Within 10 weeks of the start of the joint venture, HIH was placed in provisional liquidation.
  • “My estimate of the directly quantifiable loss suffered by HIH due to the acquisition of FAI is … $591 million,” Justice Owen Liabilities need to be understood, analysed, properly valued and disclosed
  • There was a consistent failure of HIH, and FAI before it, to set aside enough money to pay their claims. Under-reserving had arisen because HIH was mismanaged.
  • According to AM Best, 51% of insurance company failures are due to reserve deficiency.
  • Deliberate manipulation of claims estimates by FAI management, contributed to under-reserving. Excessive under-reserving of FAI’s long-tail business. Est. loss $590M.

Accountability and propriety is essential at all levels of the organisation

  • “There was a lack of accountability among senior management…a singular failure to assess performance in the context of deteriorating financial results,” Justice Owen.
  • Mismanaged by the “lack of attention to detail, a lack of accountability for performance”.
  • Unpleasant information was hidden, filtered or sanitised. And there was a lack of sceptical questioning and analysis when and where it mattered.
  • Justice Owen recommended a toughening of the Corporations Law to ensure that employees and advisers can be held accountable for their actions.

Risk Management should go beyond statements, guidelines and policies

  • “HIH had a corporate governance model. The directors said so in the annual reports,” There were guidelines for corporate governance, underwriting practices and investment guidelines. They just weren’t adhered to very often.
  • “Risks were not properly identified and managed” Justice Owen.
  • HIH was mismanaged and out of control rather than brought down by fraud and embezzlement.
  • Mismanaged by the “lack of integrity in the company’s internal processes and systems”.

External regulators need to be more proactive

  • 61 recommendations to tighten the way companies are run, listed and audited. Structural changes to regulatory bodies (ASIC, APRA) & ASX listing rules have been recommended.
  • The “new APRA” will have an aggressive enforcement culture to make sure this does not happen again.
  • ASIC given a further $17.5 million in May 2003 federal budget to deal with the matters referred by the HIH royal commission. Be aware of large and/or unusual transactions
  • “As the company approached collapse, many strange transactions and events occurred” Justice Owen.
  • HIH entered into reinsurance contracts that delayed the date of payment and shifted the risk back to HIH.
  • “side letters” relieved a reinsurer of all risk, which turned it into a disguised loan. This allowed FAI to claim about $27million extra profit shortly before HIH’s bid for FAI.

Culture affects behaviour and behaviour will ultimately affect performance

  • There was a culture of apparent indifference or deliberate disregard on the part of those responsible for the wellbeing of the company.
  • Management failures were the direct consequence of a sick corporate culture.
  • In such an environment, systemic problems became routine.

Source: Based on extracts from The Australian, Australian Financial Review, The Sydney Morning Herald and AM Best.