Hih Accounting Strategy

1 January 2017

I am going to talk about HIH insurance’s Corporate accounting scandals. Background: HIH insurance was formed as a small insurance company in 1968. Its main business was to underwrite workers compensation insurance in Australia. The company expanded its operations into property, commercial and professional liability from the mid 1980s. During this period, it also moved into the UK and the US insurance markets. In the US, the focus was on workers compensation insurance. Public liability and professional indemnity insurance were its main specialisations in the UK.

Corporate governance The HIH Royal Commission Report attributed the failure of the company to two key factors. First, claims arising from insured events in previous years were much greater than the company had provided for in its accounts, thus leading to an overstatement of reported profits. This is known as ‘under-reserving’ or ‘under-provisioning’. The second factor concerns the further mismanagement of HIH through poorly conceived and badly executed acquisitions.

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The insurance risks were not properly identified and managed.

There was an environment where unpleasant information was hidden from the Board or filtered or sanitised to reduce discomfort or undue questioning from the Board. And there was a lack of sceptical questioning and analysis by senior management, by the board and, arguably, by the auditors Accounting issues: Provisions for expected future claims Evidence presented before the HIH Royal Commission indicates that the prudential margin approach is common industry practice due to the inherent uncertainties in predicting claims.

Yet HIH almost always employed the central estimate and did not apply a prudential margin. The consequence was not only to take an overly optimistic view of claims provisions but to continually overstate reported earnings. Accordingly, if one assumes a lower amount of claims is likely to be made on outstanding policies this will generally make profits look more substantial than otherwise would be the case, given an inverse relationship between profits and provisions for future claims (that is, liabilities).

According to Main (2003, p. 107) and Westfield (2003, pp. 38 and 43) the approach to profit determination at FAI and HIH was to chose a targeted profit number and to alter the provisions to effectively arrive at that arbitrary figure. Not only did this approach appear to violate the spirit of the accounting standard but it would eventually result in large losses being reported should actual claims exceed the amounts that were previously provisioned. Earnings management using reinsurance contracts

HIH appears to have obscured its optimistic provisioning by entering into so-called financial reinsurance arrangements with other parties. Reinsurance is a process “whereby a second insurer, in return for a premium, agrees to indemnify a first insurer against a risk insured by the first insurer in favour of an insured” According to AASB1023, for a transaction to be accounted for as insurance or reinsurance, there must be a transfer of risk to the reinsurer.

The standard does not describe, either in qualitative or quantitative terms, what degree of risk transfer is required. Without examining the intricate details of the actual transactions entered into by HIH, these contracts, in effect, “promised that no claim would be made on a specific reinsurance policy” (Main, 2003, p. 115). The overall objective was to use reinsurance to offset any likely increase in claims liabilities on the balance sheet with a corresponding recovery under a reinsurance contract. Accounting for goodwill

In acquiring the shares of FAI, HIH gave consideration which, in total, amounted to $300. 5 million. This acquisition was initially recorded in 1999 in the consolidated financial statements of HIH as comprising $25 million of net tangible assets and $275 million of purchased goodwill. Subsequently, another $163 million of FAI-related “goodwill” was added to this intangible asset account so that by the year 2000 this goodwill account had a balance of $438 million (HIH Royal Commission Report, 2003, Section 7. 1. 4).

Justice Owen contended that the goodwill adjustments (and reinsurance transactions referred to earlier) became techniques for concealing under-reserving problems inherent in FAI’s insurance portfolio. Conclusion: In conclusion, HIH insurance has several factors lead the company collapses- 2 corporate governance problem and 3 accounting issues. ‘under-provisioning’ and mismanagement are two factors of corporate governance. Provisions for expected future claims; Earnings management using reinsurance contracts and Accounting for goodwill are 3 factors of accounting governance.

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