Liquidating HIH

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Liquidating HIH

• Corporate tales the wins, the losses and the
  challenges

12 May 2006
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Contents

• Background
• Investigation The Royal Commission
• Corporate Governance Lessons

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Background

• Established in 1968 by Ray Williams
• By 1984, the second largest general insurer in
  Australia
• Expansion into the US (1987), UK (1993), New
  Zealand, Asia and Argentina (during 1996 and
  1997)
• Australian Stock Exchange listing in June 1992
• Purchase of FAI announced in September 1998
• Positive Group Net assets of 939m per June 2000
  audited accounts
• Failure 15 March 2001

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Net assets
Source Published accounts
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HIH Revised position at March 2001

• Estimated Deficiency 3.6bn (mid range) 5.3bn
  (75 confidence)
• Differences
• Write off intangibles (principally goodwill and
  capitalised costs)
• Write down of non-insurance asset values
• Trading losses
• Shift to undiscounted claims reserves
• Increases in net claims reserves

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Investigation The Royal Commission Reasons for
failure

• Chronic under reserving
• Not a case of wholesale fraud or embezzlement
• The money was never there
• Past claims on policies that had been underpriced
  had to be met out of present income

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Investigation The Royal Commission Reasons for
failure - continued

• Why was there such serious under reserving?
• HIH was mismanaged!
• Lack of attention to detail
• Lack of accountability
• Lack of integrity

Combined, these factors led to a series of
business decisions that were poorly conceived and
even more poorly executed
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Investigation The Royal Commission Reasons for
failure - continued

• Mismanagement led to some disastrous decisions
• Expansion into the UK market
• Re-entry into the US market
• FAI acquisition and ultimately
• Sales of its most profitable business to Allianz
  which
• Cut off cash flow and
• Hastened the demise

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Investigation The Royal Commission Reasons for
failure - continued

• Corporate culture
• Blind faith in leadership
• Leadership ill equipped for the task
• Risks not properly identified
• Unpleasant information hidden, filtered or
  sanitised
• Lack of sceptical questioning

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Investigation The Royal Commission Reasons for
failure - continued

• Corporate Governance
• Corporate strategy not documented
• Board members had difficulty articulating
  strategy
• Management, rather than board, proposed strategy

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Investigation The Royal Commission Reasons for
failure - continued

• As such the Board was unable to fulfil its
  function
• Understand, test and endorse strategy
• Measure management proposals by reference to
  endorsed strategy
• Challenge and seek explanation for any deviations

A Board that does not understand the strategy
may not appreciate the risks
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Corporate Governance lessons

• A private company approach
• A company which has not yet made a complete
  transition from an entrepreneurially run company
  influenced strongly by senior management to
  that of an ASX listed company run primarily in
  the interests of shareholders
• - Due Diligence Report 1995

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Corporate Governance lessons (contd)

• Dominant personalities
• The hand and influence of Williams was paramount
• Dominance not subject to usual checks and
  balances of
• Close review
• Debate and
• Questioning

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Corporate Governance lessons (contd)

• Role of audit committee
• Audit Committee should operate independently of
  management i.e. where possible the domain of non
  executive directors
• At HIH all directors (including executives) were
  invited to attend Audit Committee meetings
• Non executive directors rarely met auditors in
  the absence of management

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Lack of Independent Directors

• Three of the directors were formerly partners of
  the Audit firm
• Other non-executive directors very shallow on
  insurance knowledge
• Role of chairman questionable

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Information available to Board inadequate - cash

• Lack of information around cash
• How cash flowed around the company not well
  understood
• Cash forecasting poor

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Information available to Board inadequate
cash(cont)

• Consequences
• Lack of understanding about cash led to some
  disastrous decisions like
• The Alliance sale which effectively cut off
  access to cash flow
• Fire sale of property assets
• Fire sale of insurance businesses

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Information available to Board inadequate
cash(cont)

• Underlies the importance of understanding cash in
  any business
• Effective cash tracking shows how a business
  works (or doesnt work)
• Forecast you dont drive using your rear view
  mirrors
• Quantum and timing of cash have to be considered
  when making decisions
• Cash pays bills not profit or financial
  stuctures.