HA 3032:Holmes Institute-Auditing Assignment-Case study

Internal Code:MAS24

Case Study Assignment:

Case Study: HIH Insurance Company History In 1968, Ray Williams and Michael Payne formed CE Health International. As a result of a merger in 1995 between CE Heath and the Swiss based insurer Winterthur Insurance Company, the company HIH Winterthur was established. In 1998 the name of the company was changed again, this time to HIH Insurance Limited. This last name change had been brought about by the withdrawal of Winterthur from the operations. Winterthur had become increasingly nervous about the operations of the company and consequently had sold its shares. HIH continued to expand its insurance ventures with the purchase of FAI Insurance, World Marine and General Insurance and Cotesworth, which had direct links with Lloyd's Insurance. However, FAI had been purchased in 1998 at a premium from Rodney Adler (Non-Executive Director of HIH) and without either board consultation or the completion of a due diligence report. Accordingly, in September 2000, HIH was forced to write off its investment in FAI for $400 million. Background to the Company Failure In September 1999, Rodney Adler wrote to the Chief Executive Officer, Ray Williams, criticising the direction of the company and raising concerns about the company’s financial position. More than a year later, on Tuesday, 27 February 2001,trading in HIH Insurance Limited shares was halted and ASIC commenced a formal investigation into market disclosure by HIH. Provisional liquidators were appointed to the company on March 15, after the company had flagged a provisional loss of $800 million. In May the assets of the company directors, Adler, Fedora and Williams were frozen, pending further investigation. On 21 May, the Prime Minister, Mr John Howard, announced a Royal Commission into the collapse. ASIC began its investigation into the accounting for reinsurance agreements between HIH and Hannover Re and Swiss Re, and between FAI and National Indemnity and General and Cologne Reinsurance Australasia. The investigation by ASIC has raised many questions as to the role of directors, senior management and auditors. The Aftermath of the Collapse In September 2001 the independent Royal Commission commenced investigations into the collapse of HIH. The results were published in April 2003. The Commissioner concluded that “the primary reason for the collapse of HIH was the failure to provide properly for future claims. This failure was essentially due to mismanagement and an inadequate response to pressures emerging in insurance markets internationally.”The Commissioner also concluded that “the Australian Prudential Regulation Authority (APRA) did not cause the collapse of HIH.” However, new legislation for general insurers was enacted in September 2001 and new prudential standards were issued in February 2002 (applicable from 1 July 2002). Question 1— Legal Liability Sydney solicitor Bruce Dennis will be coordinating a class action for some 600 HIH shareholders against the auditors — Andersen’s (as the firm is now known). In addition, HIH's liquidator, Tony McGrath of KPMG is also likely to seek to recover funds for HIH creditors. a) Identify and discuss in detail THREE (3) relevant legal concepts which are related to the collapse of HIH. In your answer, explain why these principles are relevant. b) What conditions need to exist for a negligence action to be upheld? Question 2 — Ethics The HIH board of directors includes three former partners of the audit firm Arthur Andersen. In the past decade, Andersen’s has earned more than $8 million from auditing HIH books and $7 million for other services. a) Why would HIH have wanted to hire prior members of its external audit team? b) What are the advantages of having the same firm provide both the auditing and consulting services? c) Indicate whether these circumstances represent a violation of ethical standards and give reasons for your answer. d) Outline the primary recommendations for audit reform proposed by the introduction of CLERP 9. What impacts do you feel these changes will have on the practice of auditing?