Quick Death For A Sick Multi-million-dollar Insurer

Sydney Morning Herald

Wednesday May 9, 2001

Elisabeth Sexton

The directors at the helm had little choice but to scuttle HIH Insurance, Elisabeth Sexton reports.

In the end, it took just half an hour to pull the plug on HIH Insurance Ltd.

The directors gathered at 10.30am on Thursday, March 15 in the boardroom at the company's headquarters at 50 Bridge Street in the city.

They had two reports in front of them. One, from consulting actuary Mr David Slee, was scathing. The other, from accountants KPMG, was chilling.

Mr Slee had been retained by HIH to provide regular advice about whether the company was adequately estimating the claims its customers would make under their insurance policies.

HIH used a controversial accounting practice in this area.

In order to cope with the uncertainty that is part and parcel of the insurance business, HIH was in the habit of laying off some of the risk of unexpected claims by buying its own ``reinsurance" with other insurance companies.

The bad news in Mr Slee's report, dated March 9, was that this cover had run out.

``The capital base of HIH is so eroded that quite drastic measures are called for," Mr Slee wrote. ``The [reinsurance] situation now presents a risk that premiums are due in the future whilst the cover has been exhausted."

Most Australian insurance companies gauge what past experience tells them future claims will be, and then increase whatever figure they come up with by 10 per cent or 20 per cent or more, depending how conservative they choose to be.

They then make sure they have enough assets to meet the higher number.

But HIH had not done this since 1997. FAI, which HIH took over in 1999, did not do it either.

Mr Slee pointed out that as far back as March 2000 the company had been vulnerable to unexpected claims.

``Even prior to that date, all my reports have warned of the risk being taken ... Directors should not therefore express surprise when a blow-out does occur."

He had told the company in September 2000 that it was completely exposed to unexpected claims.

The situation by then ``should have suggested that more had to be done than has been done to cover the risk of further uncertainty".

By March Mr Slee said the company ``seems to have overlooked" a large increase in claims.

``Unless the group takes action to reverse its precarious position there is a grave danger of technical insolvency arising out of the very uncertainty that exists and is presently not provided for."

There was a similar message from KPMG, although the accounting firm had been called in only on March 6, and so could not pepper its sober advice with reminders of earlier warnings.

KPMG thought HIH's solvency position - its ability to meet its debts and the claims on its insurance policies - was ``very marginal".

The five directors listened to a presentation from a KPMG partner, Mr Tony McGrath. He had prepared a dozen slides. They were all to the point, but the nitty-gritty appeared under a heading ``Implications if HIH continues to trade with marginal solvency".

The bullet points included that HIH might breach its banking agreements, and that its assets could be eroded.

A third reminded the directors that by law, if the company tipped over into insolvency, the directors would become personally liable for the company's debts.

The conclusion? ``This exposes the group's directors and officers to an unacceptably high risk."

Two more slides gave directors only two options. One was gradually running down the company with the directors at the helm. The second was asking the court to let an outsider do it.

KPMG said handing over to an outsider would, among other things, ``stabilise the environment for asset sales and dealing with creditors" and allow a scheme to be developed to make sure that policyholders with short-term claims did not get better payouts at the expense of those with long-term claims.

It would also remove the risks to directors and officers, and was KPMG's recommended option.

The directors accepted it and by 11.00am it was all over.

The board minutes note that ``each of the directors indicated that he wished to seek the protection of the court for the company and that he was no longer prepared to continue to act as a director of the company".

Seven hours later, after board meetings for 17 of the company's subsidiaries, most of which lasted for five minutes each, the NSW Supreme Court appointed Mr McGrath provisional liquidator of the company.

Nevertheless, the draft balance sheet before the board showed a company in the black.

Even after incurring a loss of $810 million in the second half of 2000, the company's assets still outweighed its liabilities (its debts and the claims it was obliged to meet under the policies it had written) by $134 million on December 31, 2000.

That allowed HIH to release a statement on Friday March 16, the day after the company went into provisional liquidation, saying that ``there are substantial reserves available to meet policyholders' claims".

On April 5 Mr Ray Williams, who had run the company for 32 years until he bowed to shareholder pressure and resigned in October, told a press conference he was ``devastated", ``shattered" and ``totally shocked" about the collapse.

Six days later, Mr McGrath issued a statement saying the HIH group was in much worse condition than KPMG had thought when it advised the board on March 15.

``The financial position of each of the three main licence-holding companies is worse than the stated balance sheet position, by a very significant margin in each case," Mr McGrath said.

``The deficiencies reflect previous optimistic valuation of assets, and extensive underestimation of liabilities."

Although the liquidator has yet to produce an official figure, there is little doubt today that something was badly awry in the company's calculations.

The insurance industry, the Federal and NSW governments all now assume that customers will not be paid in full. Some informed observers estimate they could get as little as a third of what they are owed. Shareholders face little prospect of getting anything at all.

THE FIVE WHO PULLED THE PLUG...

GEOFFREY COHEN

A former senior partner of major accounting firm Arthur Andersen. (Andersen earnt fees from HIH in the year to June 2000 of $1.7 million for auditing the accounts and $1.6 million for other services.) Also a director of Foster's Brewing Group and Diversified United Investment.

RANDOLPH WEIN

HIH chief executive since December 15. A lawyer with 20 years operational experience in the insurance industry, who had been running HIH's Asian arm.

JUSTIN GARDENER

A partner of accounting firm Arthur Andersen since 1972. Also chairman of Ashton Mining and a director of Austar United Communications and Hutchison Communications.

CHARLES ABBOTT

A former partner and now consultant to major law firm Blake dawson Waldron. (BDW earnt $164,000 in legal fees from HIH in the year to June 2000.) Also a director of Flinders Capital and Bass Capital.

ROBERT STITT

Sydney QC best known in recent times for defending Channel 7 in the long running defamation case bought by solicitor John Marsden. A legal adviser to HIH since it began trading in 1968.

THOSE WHO LEFT EARLIER...

RODNEY ALDER

Inherited control of FAI Insurances at the age of 29 when his father Larry died in 1988. Joined the HIH board when HIH took over FAI in 1999. Resigned on February 26,2001.

RAY WILLIAMS

Founded HIH in 1968 and ran it until last October, when he offered his resignation as chief executive to appease shareholders after the share price tumbled. Stayed on the board until December 15, when Randolph Wein Appointed chief executive.

ALSO...

Michael Payne. Joint founder with Ray Williams of HIH. Resigned September 12, 2000.

George Sturesteps. Deputy to Ray Williams since 1969. Resigned September 12, 2000.

Terry Cassidy. HIH executive. Resigned October 12, 2000.

Dominic Fodera. HIH executive. Resigned October 12, 2000.

Alex Gorrie. Former BP Australia executive. Resigned November 19, 2000.

© 2001 Sydney Morning Herald

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