AUS: Owen Inquiry into collapsed insurer HIH nears end.

Opening the Inquiry in September 2001, Mr Justice Neville Owen said:

"The critical point of the terms of reference is "the reasons for and the circumstances surrounding the failure of HIH". The remainder of the terms of reference flows from this point of the Commission's inquiry.

"The aim of the Commission, in each aspect of its work, will be to help redress the public disquiet to which the failure of HIH has understandably given rise.

"Those associated with the Commission have a firm resolve to inquire diligently and with requisite tenacity into the reasons for and circumstances surrounding the failure of HIH. This will, of necessity, involve an investigation into the conduct of individuals and groups of individuals.

"But of equal importance will be an assessment of transactions into which the group entered and of the practices and cultures that may have developed and which may have had an impact on the way in which individuals conducted themselves."

The report, which is due to be produced by the 4 April 2003, will pass comment on a number of issues: for example no one, in their written submissions, made comment on issues of conduct that might be contrary to the standards of conduct expected of members of a particular profession and whether the conduct should be referred to a relevant tribunal charged with the supervision of that profession.

According to the Inquiry, there have been 194 witnesses and had some 25,000 documents, totalling more than 150,000 pages, submitted in evidence. The transcripts of the hearings amount to more than 18,500 pages to the middle of January 2003.

The estimated deficiency according to the Liquidator, is AUD5.3 milliard. But the liquidation is expected to take another ten years.

The central reason for the failure, according to representations made to the Inquiry were that the company underpriced premiums, the blame being placed on long tail liabilities: this is the reason given for so much trouble amongst underwriters at Lloyds' in the 1970s and 1980s.

Perhaps an astonishing revelation is the idea that insurance companies may operate as a (in the broadest sense) pyramid / Ponzi scheme: according to representations made "if the insurance business grows, so that premium income increases at a greater rate than losses incurred on prior year's business, from a cash flow perspective, the insurer will be able to meet claims arising from unprofitable business written in earlier years from current year's premium income. Even if the current year's business is itself unprofitable, because that fact may not be established, or its consequences felt for many years, the cashflow derived from business growth may be used to mask the fundamentally unprofitable nature of the business."

But the reason it is surprising that the case has not received more international coverage is in this representation: "

In the case of HIH there was another particular factor at work, namely, the use of financial products and accounting treatments to obscure and in some cases conceal the fundamentally unprofitable nature of the business. In other words, financial products and dubious accounting techniques, were used to paper over the large cracks which had appeared in the fundamental structural elements of the group concealing them from the gaze of investors, consumers and the regulators, enabling HIH to trade unprofitably on until the cash simply ran out."

According to evidence given, says further representation, "the evidence establishes four dominant reasons for the collapse of the group. They are, firstly, chronic and recurrent failure to adequately estimate the liabilities arising from the business which had been written, which I have already referred to, and which I will describe as unprovisioning. Secondly, the unprofitably of the group's business in the United Kingdom. Thirdly, the unprofitability of the group's business in the United States and, fourthly, HIH's acquisition of FAI Insurance and in particular the consequence of that acquisition in terms of the assumption of liabilities on business which had been written by FAI prior to its acquisition."

These comments appear to be all to familiar: for example Australian insurer blames market conditions afflicting UK subsidiary Pearl for the group's poor performance; few non-US insurers find significant, or indeed, any profit in the USA; the failure to undertake effective due diligence on an acquisition; being involved in business that they do not understand.

Other causes of failure are said to be the disposal of a majority shareholding by Swiss company Winturther - apparently this meant that there was no single large shareholder that the management could ask to bail them out: an argument that emphasises the risk that large shareholders face - give us money or lose what you have invested. And, when the group was already in a deep hole, it sold a part of its business to Allianz - and failed to realise that the money would have to go straight into filling a gap in its reserves and could not be used to fund cashflow. Although no one is spelling out the obvious, if it is true then the management and some of its advisers were not paying adequate attention. However, from the point of view of policyholders, there was money available that would not have otherwise been there and the failure of the group as a whole is less adversely affected than had the disposal not taken place.

"The simple fact of the matter is that the business outgrew its management, who were just not up to the task of ensuring that proper systems and safeguards were installed in this very complex business to adequately protect the interests of policyholders and shareholders," says one submission citing the fact that the business had grown from a one room office to a massive multinational with the same four people in charge. At the time of collapse, the Group consisted of more than 250 companies.

Regulators all over the world will be both pleased and worried by another submission: "The regulator most responsible for the regulation of HIH, namely, Australian Prudential Regulation Authority, missed every one of the many available opportunities to identify and react decisively to the looming financial problems of the group. It lacked the expertise, the human resources and the requisite culture to undertake any effective form of prudential regulation of HIH and was not well served by its senior officers.

"In hindsight, the deficiencies in APRA, in systems, in personnel and approach, were such that there was never any realistic prospect that it would adequately perform its regulatory responsibilities with respect to HIH."

It will be noticed that at no point in the representations outlined has there been any question of blame on the accountants and auditors. The comments quoted above all come from Mr Wayne Martin, lead Counsel assisting who had previously criticised the auditors for failing to locate and examine documents that would have evidenced the true position: "given the very nature of an auditor's function ... to encourage a company to adopt a desirable process of documentary recording of significant events so there can be an audit trail."

In December 2001 Mr Martin said that the Commission should examine the question of independence of the auditors as three members of the senior management team had been previously associated with the audit firm. The Auditors have claimed that vital information was "hidden" from them.

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