In the past few years, the collapse in large consumer stated companies has lifted stakeholders matter about corporate and business governance, which really is a leading concern area for business worldwide. While numerous explanations of the word corporate and business governance have been suggested, it is normally defined as the construction of procedures and structures to regulate and deal with a corporation with the aim of improving company and shareholder riches, whereas at the same time, protecting the pursuits of other stakeholders. The inability of many companies resulting from a corporate and business governance problem caused counterproductive effects to shareholders as well as the wider community. One of the most well-known business debacles, specifically in Australia, is HIH Insurance Small (HIH).
As a result of over-optimistic valuations of resources and intensive understatement of liabilities, many of HIH's policyholders and its creditors encountered a considerable reduction. Bailouts can cost Australian taxpayer over the billion-Australian money but it did not cover all. It is the simple fact that not only the scale of the organization failure is so huge but also its result is widely, like the community and regulators.
The paper therefore is developed to discuss the HIH corporate and business governance failure within an facet of risk management. Both a culture failing and mis-governance/mismanagement can be identified as key risk management issues. The mother board of directors (from here it will be referred to as the board) and management were not able to do something as their own roles and basically with respect to shareholders' interests. One of fundamental problems is the fact that HIH offered at too much price for merger and acquisition. Besides, the business had not set aside enough capital to protect its future liabilities. It could be argued that HIH's plank was subservient to senior management resulting to a poor decision making is critical factor of this crisis. Moreover, the newspaper will apply some theories and/or the other company's problems to compare with the HIH turmoil. In the end, several lessons that are to boost performance and also to enhance accountability will be attended to to keep good corporate and business governance.
Introduction and aims
Business risk management is normally a variety of activities undertaken by way of a corporation to control and take care of potential undesireable effects. Alternatively, the corporation might take such advantages by experiencing from opportunities which can be relative to those hazards. It therefore performs an important role in a organization to be continuing growth, increases success as well as sustainability. As a result of its importance, this newspaper will activate all stakeholders especially at the level of older management and table of directors to be aware of risks and also to attempt to deal with uncertain circumstances by learning from a earlier case particularly, the HIH failing.
A decade ago, HIH was put into liquidation representing one of the major company collapses in the history of Australian. Many accusations, specifically business experts, have attributed questionable decision-making processes as one of major factor to this crisis. This paper will take a look at about causes of HIH inability and large unfavorable effects involved with a corporate and business governance subject.
While there are many reasons leading to the HIH turmoil, this newspaper will concentrate solely on the business risk management issue associated with the failure in corporate governance. To consider the determined issues, which are a culture problem (a poor role model), and mis-governance/mismanagement (an under-provision), explicit criteria are that the severity of impact on financial performance and its own scope.
The reason for this newspaper is to analyse the HIH commercial governance concern. The first section will discuss the encompassing facts containing a firm background. The next section will evaluate risk management issues: in aspects of an incompetent role model and a provision deficit, in line with compare with reference point materials and other companies. After that, some consequences of this crisis and its own implications will be tackled. Lastly, the learned lessons and suggestions: paying more attention to risk management, pushing more accountability, restructuring the board as well as appointing proper management, improving risk-based decision and establishing intensive regulations, will be mentioned in a conclusion section.
SURROUNDING COMPANY FACTS
MW Payne Responsibility Companies Pty Ltd. was established in 1968 by including between Ray Williams and Michael Payne to underwrite insurance business in Australia as an agency for Lloyd's of London syndicates (Owen 2003a). The center business was to write numerous kinds of accredited insurance comprising compulsory insurance (such as personnel' compensation) and non-compulsory insurance (such as travel cover) (Owen 2003a).
Over the next two decades, the business expanded and varied its insurance business geographically in both Australia and abroad, and became an Australian posted company in 1992 (Owen 2003a). In those days, the CE Heath plc was a major shareholder with 44 percent of total equity (Owen 2003a). The company merged with the Swiss centered insurer Winterthur Insurance Company established 'HIH-Winterthur' (subsequently HIH Winterthur International Holdings Ltd. ) as the next largest general insurance underwriter in the Australian market (Owen 2003a). However, three years later, Winterthur removed its HIH holding, which then sustained as HIH Insurance Ltd. (HIH) (Owen 2003a). After Winterthur's exit, HIH attained FAI General Insurance Company Limited (FAI) and joined a joint venture romance with Allianz (Owen 2003a).
According to Lipton (2003), there are several factors related to the collapse in the governance of HIH. Those factors are associated with an ineffective decision making and a lack of business view in circumstances of other insurance market conditions. The lack of a well-understood strategy was illustrated by the difficulties in the functions in both the United Kingdom and the United States market. Besides, an inappropriate reinsurance and an incorrect provision level shown the understatement of liabilities. Likewise, the entirely inadequacy information of the board led to overvalue purchased company's resources.
The failures of culture and mis-governance/mismanagement are probably the underlying reasons of the Australia's biggest corporate collapse, HIH. Significantly, there was a substantial fall in share price below an insurance sector average and an insufficiency up to AUD5. 3 billion (Mellahi 2005, p. 266). HIH was located into provisional liquidation on 15 March 2001 and continues to be run-off nowadays (Owen 2003a).
Regarding to associated risk management that is approximately riches creation and cover by assisting a corporation to produce a decision how to approach dangers, HIH therefore should solve material business hazards of its company. However, used, it does neither identify hazards nor implement risk treatments causing a catastrophic event.
A CULTURE Inability: AN UNHEALTHY ROLE MODEL
In general, plank of directors has responsible to comprehend, endorse and keep an eye on company's strategies consistent with a risk management process, that happen to be suggested by management. Conversely, both the plank and management of HIH failed to act on the stewardship. Among the main reasons that the plank failed to accomplish its role as monitor is the culture of the boardroom. Culture identifies the collegiate atmosphere that prevents any member speaking out from the senior management's view (Monks and Minow 2001, p. 189). For example, Chief Executive Officer (CEO) control buttons the board's plan, information and payment with no challenging of board users about his expert and impact. As the lifestyle of the culture, the board thus seems to be accused as "old males' night clubs" (Monks and Minow 2001, p. 189). This paper will discuss the way the culture did not suit with the business statements.
While the surroundings changes overtime, the business strategies acquired never been considered and modified to reveal its carrying on sustainability expansion (Owen 2003a). The mother board was risk-ignorance and did not understand company strategies. Thus, they might haven't any right questions to ensure whether strategies are properly executed in the right way or not (Lipton 2003, p. 275). Furthermore, an independent homework reported that Ray Williams, the HIH's CEO, experienced strongly inspired on the company and might work by himself interests rather than company's benefits (Lipton 2003, p. 274 and Owen 2003a). A culture problem is therefore one of the major risk management issues.
The acquisition of FAI can be considered a good example of the table and management's role problem, caused by and afflicted on a poor corporate governance culture. Basic speaking, a company is preferred to exercise a due diligence in making a conclusion however the FAI's CEO refused to allow the due diligence process (Owen 2003a). More really, the HIH's table and management do nothing to oppose his action, the takeover hence is consistently proceed by only relying on the publicly available information (Owen 2003a). Furthermore, five of 12 directors were not within the meeting due to the lateness of the notice (Lipton 2003). Of the three directors were present in person and the remaining directors, who might possibly not have enough relevant information, just participated by video meeting (Lipton 2003). Significantly, since lack of knowledge about the FAI's budget, the company didn't observe that FAI possessed a problem about an excessive reserve deficit (Owen 2003a). The compounding impact made HIH facing more difficulties because at that time HIH itself possessed a reserving problem as well. The overall costs of the FAI acquisition from overpayment have been estimated at AUD590 million (Owen 2003a). It could be seen that the decision to takeover FAI went ahead with inadequate preparation and inspection resulting from a culture problem.
In terms of risk types, tactical risk is defined as the chance to profits from negative business decisions or incorrect implementation of these decisions. Operational risk refers to exposure to loss leading to insufficient or failed internal processes, people and systems or from exterior events. It is likely to be some overlaps between tactical and operational risks, the risk issue of HIH thus might be classified as both.
A promoting example is the fact though HIH possessed a corporate governance model offered in the twelve-monthly report, there is a little data that the table frequently evaluated the HIH's corporate and business governance rules to ensure that these were suited to the business and persisted practice, Owen (2003a) claimed. Moreover, the panel misunderstood long-term as well as relevant business strategies and also was missed opportunities to achieve them. These could go directly to the heart of corporate governance inability.
Although it can be argue that related-diversification acquisition can create positive outcomes for an acquirer, it is irrelevant in the FAI case. The HIH's CEO insisted that FAI acquisition would pay back the business at reasonable returns, which is aside from improvement of well-known reputation, removal of a competition, expansion of circulation programs and synergy (Owen 2003b). The mother board totally failed to consider the potential risks: under-estimated provision and mispricing posed by proceeding the FAI takeover. It really is probably evident that the problematic decision making technique of HIH should get worried.
MIS-GOVERNANCE AND MISMANAGEMENT: AN UNDER-PROVISON
As a reserve represents future obligations of an insurance organization, it is one of essential tools to assess a corporation's financial health. Exceptional Case Provision (OCP) is a fundamental critical item reported on the responsibility side of a general insurer's financial statements (balance sheet). For HIH, a key business is a general insurance, OCP thus shown about a 1 / 2 of its liabilities (Owen 2003a). The maintaining of OCP level is to ensure a corporation's capabilities to meet every lay claim from the policyholders happened in the future. Improper provision either inadequate or increased can present a false picture of the company's financial conditions and cause serious problems. Thus, the level of a reserve takes on an important role in a price risk regarding an increase in number of underwriting plans as well as the size of insurance deals.
Since 1995 the number of acquisitions increased sharply both local and international business as a result of rapid progress in HIH procedures (Owen 2003a). However, the business appeared consistently to have an under-provision, which is neglected to provide properly operation growing quickly for future commitments. Its plank and management didn't grasp an chance to identify and manage this problem. Findings like this, theoretically, governance consists of monitoring and overseeing a corporate route as strategy-oriented, while management pertains to task-oriented associated with administering a corporate and business operation, both mis-governance and mismanagement hence could be determined as another risk management issue of HIH.
To establish a provision amount, the mother board relied on exterior specialists' reports. They did not notice the critical assumptions; such as special discounts and claims-handling costs which are used as an actuarial-based reserve (Owen 2003a). It might be questionable why such an enormous insurer didn't understand and concern relating to this key issue specifically in its efficient field. Lipton (2003) pointed out the fact that CEO promoted exclusively close person, such as his friends, becoming the table or management of company. It implies that those may do not need enough appropriately actuarial knowledge in their track record. As a consequence, this is instrumental in too little accountability by senior management to the plank and too little self-reliance within the board. Due to an unacceptable business decision, this problem can be determined as the strategic and operational dangers as well as may create some degree of hazards.
On the very best of that Devid Slee of David Slee Consulting Pty Ltd was the HIH's consulting actuary and was also Williams and Payne's former colleague in CE Health plc (almost all shareholder of HIH in later) (Owen 2003b). Definitely, Slee got unusually close relationship with two founders. This possible added to a poor independent report. For example, no prudential margin was accepted in Slee's estimation, too much estimating discount rate and assuming fully recoverable of reinsurance in his statement (Owen 2003b). These are likely to allow HIH to publish healthier its financial position than it will. The reduction in its syndication to a provision can cause to mislead the use of excessive money. Besides, the business would anticipate with its higher expected go back from opportunities. Without skepticism of using information, HIH was run careless of dangers incurred from the under-provision setting.
Another risk type that HIH experienced is regulation risk, which identifies the potential loss due to the uncertainty of legal proceedings impacting the organization change, such as bankruptcy. In 2000, the prudential laws of the Australian Prudential Legislation Authority (APRA), the main regulator, enforced the underwriter to increase capital adequacy requirements of insurers (Owen 2003a). As a result, it resulted in the shortfall of HIH's reserve level. The business had not enough capital to repay insurance risks for quite some time and then might be no more a going matter of its operation. All in all, risk management had not been in progress to resolve the reserve shortfalls in that period.
COMPARE AND CONTRAST
Attempting to explain the routine of HIH culture, it may separate as the 'fiefs'. A fief culture identifies a private company culture, which is the leader specialist is influential in substantive areas such as investment and acquisition (Birkett 1999). In addition, it infers that the chance orientation of company is risk ignorance (Birkett 1999). Williams, the founder and CEO of HIH, is probably no better example in this point. The dominant chief executive had no plainly determined limited of his power in investment, donation, and remuneration (Lipton 2003). More importantly, the plan on reserve concerns also came ahead the personal-based discretion of CEO compounding too positive prospective reports by way of a dependent consultant, Slee (Owen 2003b). Rather than having skeptical review and approve, the mother board just accepted Slee's recommendations of provision level without concerning the inherent hazards of the estimation (Owen 2003b). This might show unawareness of dangers occurred among directors and the impact of William is seemingly paramount. Such an influence needs to deliberately review, controversy and questioning, however the HIH board got done nothing. It might argue that inadequate accountability and unbiased happened within the panel and older managements.
Moreover, discussing Augustine (2000 pp. 7-27) model which is to manage dangers, such participant tasks involved with HIH got done in neither the first two steps of problems management, as elimination and preparation for the turmoil, nor the last mentioned step, recognition. Recognising, consistent with resolving, the problems had come belated to HIH consequently of any catastrophe. The business did not gain any advantageous outcomes (revenue) form this problems as well. In addition, it conducted to a lacking recovery say which helped bring significant reduction to policyholders and made the business's responsibility to be default. The HIH then went personal bankruptcy finally.
Furthermore, the financial magnitude of HIH collapse is most likely the Australian's biggest and hence it can be comparable in in accordance with Enron (the American energy company) scandal. Comparable to Enron, HIH attributed to managerial failures, especially the immediate role of older management. They appeared to experienced an under-involved and under-informed the panel. As opposed to Enron, HIH havent been reported a large-scale scam or insider extractions. HIH still retained characteristics of an exclusive company dominated by its creator and CEO. Williams possessed an overbearing impact on an enlargement decision making, whereas the present board overlooked to question and matter about a interconnection between acquisitions and other strategies of company that is clearly a just to illustrate.
AFTER THE CRISIS
Meanwhile, APRA (2001) revised a new version of prudential requirements for general insurance companies in Australia. There have been six specifications have been released, including 'Liability Valuation' - to promote the provision of actuarial advice to the board and management, 'Capital Adequacy' - to keep a minimum degree of capital with the chance profile and 'Risk Management' - to promote strong corporate governance by accessing to appropriate 3rd party know-how and systems for determining, controlling and monitoring dangers.
In a season later, 2002, the Australian Securities Exchange (ASX) Corporate Governance Council was developed to build up a corporate and business governance practical guideline for the Australian outlined companies. Elizabeth (2003) also advocated that a corporation's risk management strategy is required to include in a written report as an important part of corporate and business governance. Relating to ASX (2007, p. 32), the recent commercial governance ideas and recommendations claim that corporations should set up policies to control material business risks as well as disclose those guidelines. Likewise, the table should oversight a management team to effectively deal with corporate risks by making and implementing the risk management system (ASX 2007, p. 33).
Conclusion
Many of HIH's issues are related to various factors. Due to huge effects, in terms of range and scope, failing of culture and mis-governance/mismanagement can be dealt with as the primary risk issues. There was no apparently described statement of tasks or limited on expert for management. The mother board had inability to understand and keep an eye on HIH's strategies and a risk management process, whereas mature management possessed too influence on directors. Therefore, too little preparation leading to overestimating FAI's value put pressure on its operation. At that time, reserve strategies itself got recently been staged HIH an issue. Such ineffective risk identification subsequently led the business to disregard a dimension of risk that is in particular essential within an insurance industry. It also neglected to take into account the associated counterproductive effects under on-going assumption. HIH experienced subsequently large size of negative benefits and then collapsed finally.
LESSONS THROUGH THE CRISIS
During times of corporate failing, tendencies of reformative corporate and business governance and increased regulations and recommendations arise. The HIH turmoil is one of an advantageous circumstance to be learned all about commercial governance and risk management issues as pursuing lessons:
Risk management is highly recommended as the top priority of the corporate procedures. The culture problem and mis-governance/mismanagement; like the HIH corporate and business governance guidelines being not adhere frequently, the bad decision making into growth, and limited of business judgments, are failure in the risk id and management. The actual fact that hazards are never-ending and critical concern for all organizations, the business therefore should add its value through having risk management goal.
Accountability is essential at all degrees of a corporation. With no focus on unfavorable information, the plank did not use their skepticism to question older professionals when or where risk issues. This caused a lack of accountability for performance among senior management and the table. Owen (2003a) suggested that the amendment of Organization Laws and establishment of ASX commercial governance ideas and recommendation could ensure that responsibility can be performed for any employees and experts' activities.
Beware the qualified and experienced boards, it generally does not guarantee the success. Between 1997 and 2001, HIH panel comprised insurance experts, experienced accountants and auditors. With a number of expertise, the mother board was still ineptitude and under the control of CEO. They did not question the key issues and also waived rules and guidelines. Due to the board improperly carrying out its functions, it was struggling to monitor management performance and proposal by referencing from approved strategies. Conclusions like this, it can be suggested that the company should restructure panel of directors by changing the percentage of inside/outside directors on board in order to increase freedom of the table and to ensure so it can add value to the company by governing the business primarily on behalf of shareholders' hobbies.
A company must exercise homework before making a decision (Owen 2003a) and also corporate and business liabilities need to be properly valued and disclosed. Due to inadequate preparatory and investigative works, the table decided to acquire FAI. They entirely failed to consider the potential risks posed by the takeover. Besides deliberate manipulation of say estimation by FAI management and HIH itself added to understated liabilities which acquired arisen because HIH was misgoverned as well as mismanaged. Due to excessive under-reserving, HIH had deficiency up to AUD5. 3 billion no longer survive at the present time.
Regulators need to be more proactive. As talk about above, the new rules set up by APRA as well as ASX corporate governance guide and concept probably provide an ambitious enforcement culture to ensure that crisis will not reoccur.
In summary, good commercial governance includes in company value enlargement and risk management. Risk prevails in the centre of any business used the search for rewards. Firms therefore should become aware of risks and attempt to deal with them. Failing to do this, such as with the HIH case, it could cause such multi-billion deficits. This problems also contributes a number of lessons and implications to all stakeholders. To avoid a catastrophe, extended work to make corporate and business governance both improve commercial performance and enhance corporate accountability as well as to move forward risk management are vital and ongoing to be able to mitigate the most detrimental outcomes whilst stimulating the most positive.
