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The March 2001 collapse of HIH Insurance sent shockwaves through the Australian business community. The country’s second-largest employer, HIH was at the tail-end of a major acquisition spree that had seen the company purchase major insurance operations in New Zealand, Argentina, Switzerland and the US since 1997. Most significantly, in 1999 HIH had purchased one of its main competitors, FAI Insurance, taking on that company’s chief executive Rodney Adler as one of its corporate directors. With an estimated $8.1bn asset base at the end of 2000, HIH was widely perceived as an extremely robust and reliable company; however, private internal reports had begun to demonstrate that the company’s debt leverage and insurance liabilities were so high that there was a real risk of insolvency. Ultimately, in early 2001 the company’s precarious financial situation became untenable and HIH endured the largest corporate collapse in Australian history, going down with losses of more than $5bn. With the company continuing to function purely so as to service old claims, with no new business being taken onboard, Australia’s financial regulators set out to determine the precise chain of events that had led to the HIH collapse. (M. Westfield. 2003)
A Royal commission, examined the chain of events that led to the collapse of HIH. Reporting in April 2003, the commission found that there wasn't just a single cause of the company’s collapse. But that there was systematic failure in almost every area of its operation (hihroyalcom.gov.au 2003), and the extent of this failure was so great that criminal charges were brought against key members of the company’s board such as William Howard, Ray Williams, Geoffrey Cohen and Rodney Adler. (ASIC 2005) In particular, Rodney Adler was convicted on four separate charges: one count of obtaining money by deception; one count of dishonesty in the discharge of his duties; and two counts of intentionally disseminating false information. In particular, Adler was found to have falsely claimed, in a number of interviews, that he had personally purchased HIH shares in mid-2000. (D. Elias .2005)Â By making such claims, and specifically by claiming that HIH is undervalued in terms of its share price, Adler was guilty of willfully disseminating financial information that they knew, or had good reason to know, was false. However, there were separate calls for an inquiry into how HIH’s corporate governance systems had failed to prevent Adler abusing his position in such a manner. In a separate claim, Adler was accused of persuading HIH to invest a $2m loan in Business Thinking Systems (BTS), a company in which Adler had an interest.(Karen Percy 2005)
The other major failing identified in the downfall of HIH was a failure to provide properly for future claims, and all other problems essentially stemmed from this issue. Covering future claims is one of the most fundamental aspects of any insurance company’s business, yet by the end of its existence HIH was in a position where a negative shift of as little as 1.7% would be enough to bring the company to the point of insolvency(M Westfield,2003) . The primary reason for this failure was reported to be a mismanagement of changing market conditions, which increased HIH’s liabilities massively and were not covered by strategic planning initiatives that might have been expected to absorb such changes. Changing market conditions can cause serious destabilization for any insurance company, but the risks are well-known and most companies take extra care in order to minimize their exposure to such changes. The fact that HIH dramatically over-exposed itself was for the most part due to the company’s extremely rapid expansion (Brendan Bailey 2003).As noted earlier, HIH acquired a number of companies during its final years and was making a major push for international expansion. Such expansion, while often a strong business move, often brings greater liabilities than would otherwise be the case, and HIH appears to have acted based on the belief that the liabilities would merely be proportional to its expansion. The company appears to have fundamentally misunderstood the degree to which extra provisions need to be made for changes in its market environment. This is a major mistake that could in my opinion, if addressed at the time, have been resolved. The fact that the board of HIH apparently went unchallenged when pursuing this strategy shows that there was a failure of governance at HIH, with no real oversight being applied to check whether the company’s strategy was correct or financial sustainable.
In the aftermath of the HIH collapse, the Australian Securities and Investments Commission (ASIC) made a number of changes to ensure that the same problem could not be repeated. In particular, ASIC inaugurated a strict new set of corporate governance rules designed to ensure that companies stay closer to the regulations in this area. ASIC acted on the belief that the core governance procedures and rules were fundamentally sound during HIH’s final months, but that ultimately the company’s board was able to find ways to achieve technical compliance while still engaging in the kind of activity that the regulations were designed to prevent.(ASIC 2003) In my opinion this can be seen as a failure of the regulations as much as a failure of the company, although clearly it was the decision of individuals such as Adler to deliberately move against these regulations that led to the company’s downfall because there was no proper oversight on the actions of the board. However Adler and other members of the HIH board were in no way induced or encouraged to act in the way that they did. Rather, they chose to go against the spirit of the rules and act in a manner that was clearly against the best interests of the company.
Ultimately, it’s clear that HIH should have been much more cautious when pursuing its expansion, and should have taken greater steps to ensure that its liabilities were covered. By expanding so rapidly, the company was entering markets in which it had little or no experience, yet no provision appears to have been made for the need to leave extra margins while entering these new markets. This is clearly a case of major mismanagement and of over-confidence during a period of major expansion. These problems were increased, by the company’s reaction to its bad financial position, and particularly by Rodney Adler’s decision to attempt to secure investment based on false statements. Even when the company’s enhanced liability was made apparent, in my opinion there still could have been a chance for HIH to recover by introducing a major cost-cutting program and ensuring that future operations would eventually make up for the losses. Adler chose to try to cover up the financial problems in the short-term and hope that his misstatements might ultimately bring the company back onto a strong financial footing that would allow it to cover over his mismanagement so that it would never become public. This approach by Adler was designed to fix the initial over-expansion error, but actually compounded that problem and represented a second serious mistake. The fact that the regulatory authorities were unaware of what was happening in my opinion does not indicate major problems with those authorities, since any company that engages in the level of deception orchestrated at HIH will always have a chance of getting past the rules. Although lessons can be learnt, particularly in terms of the apparently concentration of power in Adler’s hands, there’s clearly a limit to the ability of regulatory groups to cover companies where the directors set out on a determined path to commit fraud and to mislead observers. Although this does not mean that the authorities should not be vigilant, it’s clear that in the case of HIH, ensuring full and proper punishment for Adler and other executives in the aftermath of the collapse, as a warning to others, was in my opinion one of the best options.
Amerta Mardjono (2005). A tale of corporate governance: lessons why firms fail. Managerial Auditing Journal, vol. 20, no. 3 p. 272-283
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