Business Risks Related to Insurance Companies
Business risk related to insurance companies are defined as risk of loss which are connected closely to the insured of carrying on business which are not to be considered as right element of insurance coverage and these risks are normally covered with the costs incurred through loss as overhead and charged in the price of premium of insurance for the said subject.
The case study of collapse of HIH Insurance Ltd had identified different level of business risks which were not attended properly by the management. The company had gone for acquisition of insurance company by name FAI with direct influence from Mr. Alder, the Director of the company in 1998 without any consultation by the Board or proper assessment through due diligence report. The assessment of the acquisition was not aptly made and the resultant financial losses occurred with the event of acquisition. Moreover the company had gone for different new products like aviation, marine, film financing and natural calamities which are of high risk in nature. The industry attracts high level of compensations packages for the employees too, as per the normal trend of insurance business. In the course of business, the company should have exercised the assessment of different business risk areas which include factors like:
- Proper assessment of risk margin
- Seek assistance from Policy Research and Consulting Division of APRA
- Proper assessment of Industrial Special Risk
- Highest Risk Retention or HRR to cover the risk of investment made by direct insurer
HIH Insurance Ltd had an aggressive attitude towards their business expansion by floating the products like reinsurance, property, marine, travel, professional indemnity, personal accident, contingency, catastrophe and political risk insurance along with the effort to underwrite film financing. Insurance Act has clearly mentioned the solvency requirement through the norms with calculation of tangible assets but at the same time APRA has no such authority to derive the solvency parameter to cover the business risks of the insurers. Lack of professional management to cover the required business risks in the field of operation had made the early demise of HIH Insurance Ltd (Iaisweb, 2006).
Inherent risks are defined as the risks which occur in the financial reports of any organization through containment of material misstatement or omission which is a significant failure of implemented internal control of the organization. Being an insurance company, HIH Insurance Ltd had the scope of inherent audit risks which are normally featured in case of insurance industry. The inherent risks found in case of HIH Insurance Ltd are typical like fixation of enough premium, maintenance of sufficient margin to prove solvent, ensuring liquidity by maintaining positive working capital derived through balance of current assets over current liabilities and determination of risk factors related to individual insurance policies. While determining inherent risks in case of HIH Insurance Ltd, consideration of reinsurance of general policies along with marine and film insurance practices are to be taken into account which is not familiar with other insurance companies in the industry (Irmi, 2015).
Detection of inherent risk of HIH Insurance Ltd with the effort of decrease was not found, instead increment of inherent risks are found in the domain of their choice of different products with high risk applicability by unprofessional management to combat the same in the area of marine, reinsurance, film financing, calculation of proper premiums considering risk factors and other areas of operations (HIH, 2017).
The Collapse of HIH Insurance Ltd and Its Business Risks
Primary liability of auditors is lying with the external stakeholders in the forms of shareholders and creditors. As statutory auditors are engaged in the assignment through the appointment issued by the shareholders, their main liability is to ensure prudence for the external stakeholders out of which creditors are playing a major role. Australian Accounting Standard Board through their standards had clearly and distinctly clarified that with the power of Corporation Act 2001 through their imposed legislation of AASB standard 101. It is mandatorily mentioned that the auditors are independent in nature and has no such liability to the client regarding their execution of job; instead they have to be liable to the creditors in the form of suppliers, investors and lenders to the company. With the objective of performing professionally with due diligence towards the liability dawned upon them by the creditors, they have to maintain prudence through proper application of conceptual framework as fixed by AASB through their implemented standards time to time.
There are three cases of 1990s which should be considered by Andersen, the auditor of HIH Insurance Limited to fix the priority of whom should they discharge their liabilities as professional executor- the client or the creditors (Sinning & Dykxhoorn, 2010).
The first case was R Lowe Lippman Figdor and Franck vs. AGC (advances) Limited of 1992 where the Supreme Court of Victoria had inferred that if any implied effort is absent to introduce third party to any specific course of activity or inactivity, there is no scope of general duty to client to be arisen.
The second case of Columbia Coffee and Tea Pty Ltd and Donyoke Pty Ltd Vs. Churchill t/a Nelson Parkhill of 1993, it was inferred that the auditor is liable to perform his duty to safeguard the interest of the third parties as the own audit manual of the audit firm conforms the statement which acknowledged the authenticity of the audit report if the third parties want to go through it to find their required information (Davies, 2000).
The third case of Esanda Finance vs. KPMG of 1994 also found the verdict that the auditors must execute their duties to the third parties if for any such cases where the plaintiff has to rely upon their report with financial implications.
Basic conditions for upholding negligence actions are subject to establishment of four elements by the plaintiff viz. duty of care, breech of duty, casual connection and actual loss or harm (Inc, 2000).
Reasons for hiring prior members of audit team by HIH Insurance Ltd were multi-folded:
- The auditor, Andersen was deputed since early 1970s.
- Out of six Board members, three were engaged with Andersen. Geoffrey Cohen, the Chairman was former partner of Arthur Andersen firm, Justine Gardener, the non executive director was former partner in Arthur Andersen and auditor of Acquisitioned FAI in 1980s, and Dominic Fedora, the Finance Director was partner of Arthur Andersen.
- It was easy to dictate terms related to audit work of the company with main emphasis to be prioritized for the client, not for the creditors, lenders and the shareholders.
- Inherent risks could be overlooked by auditors, Arthur Andersen.
Basic advantages of appointing same firm as auditor and consulting services are:
- Awareness of basic knowledge of company operation
- Can find out the loopholes of the system
- Can trace the audit risk factors efficiently including inherent, control and detection risks
- Can have the solution for identification of the risks with proper steps recommended for mitigating the risk factors
- Consulting services, whenever necessary can be asked for with logical charges
- External audit work can be done with more efficiency and perfection
- Liability to the creditors, lenders and shareholders can be easily defined and executed by the same firm which takes care of both audit and consultancy services.
Auditing ethics are specified through the standards set by APESB or Accounting Professional and Ethical Standard Board. Through their legislation fixed by the authority, the board has set APES 110 Code of Ethics for Professional Accountants which is revised from time to time. The latest version is enforced in 2011 and superseded earlier version of APES 110 of 2008.
This standard is specifying audit engagement which ensure logical assurance engagement which can provide the situation where the professional can have the liberty to express his opinion regarding the correctness and authenticity of the financial reports which are based on preliminary financial instruments with the objective of projecting true and fair view of the presentation of financial statement in perspective of material aspects. This basic objective is threatened when the same firm is deployed with multi level engagements like audit assignment and consultancy assignment and this may have direct impact on the independence of the auditors so far their views are concerned.
Independence of auditor can assure prudence and transparency to the stakeholders of the company. Independence is derived through independence of mind and independence through appearance. Independence of mind is such state of mind which can enable the professional to express his inference without any sort of interference by external sources and this needs the virtues of integrity with clear vision of objectivity and professional attitude to encourage skepticism. Independence by appearance can make the professional well equipped of managing situation where significant facts or situations are to be communicated to third parties with proper judgment of all facts and situations to conclude by his own way as per the norms of the profession and mental satisfaction to justify to conclusion. Both these independence can be harmed if the firm is deployed in both audit and consultancy services as the significant information can be leaked to the third parties or the absence of professional skepticism can lead the professional to casual decision which may be vital for the stakeholders of the company.
Lastly the issue of confidentiality can be ignored as the respective significant financial information may be leaked to the third parties of interest and this disclosure may lead to confusion in later stage. This situation may arise resulting to individual advantages by exploiting the financial information for personal interest (Apesb, 2010).
Primary recommendations made by Ramsay Report for Audit Reforms:
- Emphasize on independence of auditors
- Insertion of Auditors’ independence in Corporation Act of Australia, 2001
- Declaration of fees related to assignment of non audit services by the firm
- Enhance the scope of work for independent audit committee(Treasury, 2002).
Primary recommendations of The Corporate Law and Economic Reform Program or CLERP 9:
- Appointment, resignation and removal of auditors
- Attendance of auditor in AGM
- Auditors’ liability
- Incorporation of auditors
- Liability of auditors with the nature of joint, several and proportionate status(Treasury, 2002).
The above recommendations of Ramsay Report and CLERP 9 had strict implications on the audit practice in Australia. The business entities with or without listing in ASX has to follow these legislation as violation of these can make the Board liable for penalties by affecting public and stakeholders’ interest in broader aspect.
References:
Apesb, 2010. APES 110 Code of Ethics for Professional Accountants. [Online] Available at: https://www.apesb.org.au/uploads/standards/apesb_standards/standard1.pdf [Accessed 03 May 2017].
Davies, M., 2000. The Liability of Auditors to third parties in Negligence. The Liability of Auditors to third parties in Negligence, 14(1), pp.171-96. Available at: https://www.austlii.edu.au/au/journals/UNSWLawJl/1991/7.pdf.
HIH, 2017. The Collapse of HIH – Solvency and Audit Risk. [Online] Available at: https://www.123helpme.com/collapse-of-hih-solvency-and-audit-risk-view.asp?id=167702 [Accessed 03 May 2017].
Iaisweb, 2006. Case Studies on the HIH Insurance Group. [Online] Available at: https://www.iaisweb.org/modules/cciais/assets/files/pdf/061004_BGN-0_hih_background_note.pdf [Accessed 03 May 2017].
Inc, 2000. What Is Negligence and How Do I Defend against a Negligence Claim? [Online] Available at: https://www.inc.com/articles/1999/11/15373.html [Accessed 03 May 2017].
Irmi, 2015. business risk. [Online] Available at: https://www.irmi.com/online/insurance-glossary/terms/b/business-risk.aspx [Accessed 03 May 2017].
Sinning, E. & Dykxhoorn, J., 2010. Auditor liability to third parties after Sarbanes-Oxley: An international comparison of regulatory and legal reforms. Journal of International Accounting Auditing and Taxation, 19(1), pp.1-14. Available at: https://www.academia.edu/4596489/Auditor_liability_to_third_parties_after_Sarbanes-Oxley_An_international_comparison_of_regulatory_and_legal_reforms.
Treasury, 2002. Corporate disclosure. [Online] Available at: https://archive.treasury.gov.au/documents/403/PDF/Clerp9.pdf [Accessed 03 May 2017].
Treasury, 2002. Corporate Governance and Accounting. [Online] Available at: https://archive.treasury.gov.au/documents/297/PDF/nia_large.pdf [Accessed 03 May 2017].
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