Hih; What Went Wrong

Corporate Governance

HIH; What Went Wrong?

During 2000 at the Institute of Actuaries annual seminar on general insurance, two senior actuaries, Peter McCarthy and Geoff Trahair, presented a paper that rang alarm bells for HIH Insurance. Even though HIH was not mentioned in the paper [entitled “Lack of industry profitability and other stories”] the insurance industry was accused of under pricing policies, pressuring actuaries to reduce the projected level of outstanding claims liabilities and of having poor quality staff and senior management. This was a forewarning of what seems to have gone wrong at Australia’s second largest insurance company.

According to McCarthy and Trahair the main problem was bad management. They outlined “poorly trained and low-skilled staff, with inadequate or non-existent pricing models, combined with poor underwriting controls.” They also suggested that poor claims management, careless data management and imprecise monitoring led to incomplete analysis of portfolio performance, if done at all. Senior management did not escape criticism either. “The management progression path seems dominated by those who have risen through the ranks, starting out either as underwriters or case officers. Whilst this gave a good grasp of the micro picture, it fails to deliver the broader macro picture that is required to make the transition from managing individual policies and claims to managing whole portfolios or companies.”

Former HIH director, Rodney Adler, confirmed these views when he wrote to the managing director of HIH, Ray Williams, in September 1999. He claimed the long serving management team had fallen into a rut. Another HIH insider described the culture of the organisation as macho in which senior management knew about their own area only and nothing about the rest of the business.

In their paper, McCarthy and Trahair recommended greater actuarial influence on the pricing of policies and argued that any actuarial “suggestions” need to have some authority. Their paper included a light-hearted supplement - the top ten tips for running a general insurer. The ninth tip was “when the actuary says the rates need to go up by 50% ignore them. After all, those actuaries are so uncommercial they just don’t live in the real world.”

Insolvency specialist David Lombe, prepared a report showing HIH continued to lose millions even though a revival package showed they were making a profit. They failed to take into account future insurance claims and they also declared they had net assets of $939 million which was not a true picture.

The collapse of HIH forced a NSW judge to freeze the assets of the three key figures – Ray Williams [CEO], Domenic Fodera [CFO] and Rodney Adler [former director.] The mismanagement of investments and acquisitions by these management executives had a downward-spiral effect on many people’s lives. The Australian Securities and Investments Commission [ASIC] claimed that the three men “breached their duties by showing lack of good faith, care and diligence for HIH assets.”

ASIC cited that an HIH payment of $10 million was made to a company wholly owned by Adler, without following policies and procedures of the company. Adler’s lawyer stated this transaction was not a matter of public interest. “This is a discrete little dispute about a particular investment that involved a modest sum of money.” Evidence given in court also showed Williams owned real estate worth $6.5 million in addition to “a lot of boats.”

The lack of understanding of company policies and procedures added to the downfall of HIH Insurance. ASIC believes that the three men had breached the Corporations Law and “asked the court to order them to pay compensation, fines of $200,000 and that they be banned from management positions.” The impact of these monetary decisions at director level forced federal Government to announce a Royal Commission into the downfall of HIH.

The influence of the collapse of HIH casts a shadow over other issues such as the recovery of the housing industry which in turn can affect the Australian economy. Katie Lahey, chief executive of the Business Council of Australia has said “a leader today has to be well read and know about what is going on in the environment as a whole. You can’t imagine a leader of any significant company not knowing the fundamentals of the economy, or what is happening to the economies of our trading partners. Big issues for the whole country. A leader has to be tuned to those.”

The collapse of such a large insurance organisation also had a major impact on the existence of smaller companies, as well as individuals in terms of their ability to absorb levies for future insurance services. A leading management consultant said that “an organisation can be using the latest technologies and be highly people-focused, but if the methods and approaches used to structure and organize the work are weak, performance will suffer badly.” This seems to sum up what happened at HIH Insurance.

Subsequently, criminal proceedings were brought against Rodney Adler and Ray Williams who were subsequently sentenced to up to four years in prison with a non-parole period of 2 ½ years for Adler and two years and nine months for Williams. Adler was also disqualified from holding the position of Director for twenty years and fined $900,000 and Williams for ten years and fined $250,000. Domenic Fodera was sentenced to three years in prison with a non-parole period of two years. However, he was subsequently sentenced to another year in prison for further misdemeanours in HIH..

Discussion Point

Discuss issues of corporate governance in the context of the above case