Nature of the Insurance Business

Question: Discuss about the Report for Nature of the Insurance Business. Answer: 1. The nature of the insurance business is such that it has immense risk as the potentially liabilities in certain sectors such as aviation would be in millions. These risks may be operational, credit, underwriting or market related. Hence, to excel in such a business adherence to the prudential norms along with effective risk management framework is imperative. However, HIH unlike other insurance companies through its faulty policies and inappropriate acquisition strategies enhanced the overall business risk. It did not have follow the industry norms and standards with regards to prudential norms and any disaster could potentially make the company bankrupt as the ability to settle huge claims was limited. Instead, the company relied on reinsurance which is a comparatively very high risk policy. However, despite the faulty business model, the company ventured into providing insurance to high risk sectors such as marine which was highly unadvisable. Also, the various investment plans offered to customers had dismal returns which enhanced the overall business risks. Cumulatively, the core issue of the company was its reckless internal working which did not involve much planning and prudent risk management thus resulting in high business risk for the business (Arens et. al., 2013). The factors to be considered are highlighted below. Non-adherence to the industry regulation norms for risk management and instead including reinsurance at the heart of the risk management meant that the business risk was increased by manifolds and the company was adversely impacted (Gay Simnett, 2012). Lack of due diligence while acquiring FAI Insurance coupled with limited board meetings for discussion of the proposal. The company ended up paying a premium for the acquisition which was not justified and the led to huge financial burden which increased the underlying inherent risk (Arens et. al., 2013). Quid Pro Quo relationship with the external auditor through the usage of consulting contracts meant that the auditor independence was severely compromised and therefore the various lapses with regards to the company and its business policies were not highlighted. This led to higher inherent risk as the owners could run the business as per their whims in collusion with auditor (Livne, 2015). Appointment of ex-auditors to the Board of Directors led to the compromised decision making which would not be in the best interest of the company and thereby allow the imprudent policies to continue and hence cause increased inherent risk (Livne, 2015). 2.1) The relevant case that the auditors can cite for defence against the clients is the Equitable Life Assurance Society v Hyman [2000] case. As per the relevant fact of this case, the clients were given the choice of going for either market rate of return or fixed rate of return when the insurance policy was issued. Every time the market rate was lower than the fixed rate promised, the directors stating the objective of maintaining parity between the returns of both policyholders reduced the terminal bonuses of the policyholders that had opted for fixed returns. Since the fixed returns customers were at a loss, hence the matter was dragged in the court where the partners of the partnership were held guilty of using their discretion in bad faith and they were made liable for the losses incurred by the policyholders (Swarb, 2015). 2) The useful case that the auditors can cite for defence against the creditors is the Raskov vs. Stapke Harris [2010] case. This case allowed for legal determination under the specific conditions when the partnership actually assumed a specified stance and the same may be forwarded by the counsel of the auditor in this case to ward off any liability arising from the creditors due (Notforlaw, nd). Any situation involving negligence needs that the following three conditions are to be obeyed. The defendant must have a duty to care with regards to the plaintiff. To ascertain this, the defendant must ascertain whether his/her decision to engage in a particular action or to refrain from the same would have any impact on the plaintiff or not. In case, the plaintiff could be impacted by the decision, then the defendant needs to ensure that reasonable care be extended to the plaintiff so that he/she must not be protect against foreseeable damages arising from the choices of the defendant (Donoghue v. Stevenson [1932] AC 562 at 580) (Lindgren, 2011). Once the duty to care is established, it needs to be ascertained that the defendant has indeed breached the duty to care. In this regard, it is imperative that defendant must take reasonable measures that a third party would take so as to ensure the safety of the interests of the plaintiff which may be adversely impacted by the decision by defendant. However, if appropriate level of care is not extended to the plaintiff in according with the foreseeable risk, then breach of duty is seemed to take place (Davenport Parker, 2014). Damages need to be incurred by the plaintiff and these must be on account of breach of duty by the defendant. In order to conclusively prove this, it is imperative to establish that if the breach of duty would not have taken place, the damages to the plaintiff were avoidable. However, any damage which is not related to breach of duty or could not have been avoided in case of duty being adhered to, then such cases would not be constitute as negligence (Taylor Taylor, 2015). 3. The decision by the company to offer board position to the previous auditors is a highly dubious step which indicates towards a compromised relation between the two entities. The appointment of not one but three partners seems to justify the largesse doled out by the management for the benevolent auditing services provided by the auditors. The glimpses of this relationship are visible in HIHs case earlier also when high fees was paid to auditors for consulting but still the glaring procedural and policy deficiency was never indicated. It is highly unlikely that the auditors never realised these issues but their independence was compromised and actions driven by self-interest (Arens et. al., 2013). There are obvious advantages of appointing the auditor as the consultant to the firm. The most obvious gains is in the form of superior quality with lesser time and lower cost. On the back of the consulting services, the business model and the underlying risks are better understood which helps tremendously for the audit purpose. The auditor could frame a better enhanced strategy taking into consideration the key aspects of the business along with the level of controls. Similarly, during consulting also, the solutions could be customised keeping in mind the tax implications for the client along with inventory and level of cash flow etc. Hence, the services become better and consume lower time and cost due to synergies (Arens et. al., 2013). Even if the law permits the auditor to offer consulting services, it would be ethical not to use the same firm for both audit and non-audit services. This is recommended since in such situation, the auditor may be caught in a conflict of interest which is best avoided specially in the current scenario where the management provides consulting contracts to auditors based on the flexibility displayed by them during auditing. This is not a healthy precedent and needs to be curbed (Gay Simnett, 2012). Similarly, appointment of previous auditors to the board is highly unethical since it raises concerns regarding boards independence of behalf of shareholders and hence leads to higher agency costs. Further, this may be detrimental to the auditing profession whose credibility is on the decline and hence the profession needs to go the extra file to establish the credibility for the users or its relevance would be lost (Livne, 2015). d) The HIH insurance failure fuelled various concerns in regards to the level of disclosures by the corporate and also issues pertaining to auditor independence. The Ramsay report focused on the issue of auditor independence and recommended the following (Parker, 2002). Auditor independence statement needs to be included as part of the annual report. An auditor declaration with regards to the Board independence included as part of the annual report. Constraining of the auditor client relationship to enhance investor confidence. The constitution of an auditor independence supervisory board was called for to probe the matters of auditor independence. Audits committees scope of activities and role require a drastic increase The above steps suggested would enhance the standards of auditing and would ensure that the incidence of auditors caught in compromising situation would reduce tremendously. This is required due to the deteriorating quality of audit services which puts a question on their relevance (Gay Simnett, 2012). The focus of CLERP 9 was on enhancing the general disclosures made by the firms and thereby strengthens the corporate governance framework. The disclosures were to be included in the annual report and included disclosures such as remuneration and directors report. Also, it recommended that periodic auditor rotation must be done so as to prevent quid pro relation between the auditor and client (Clout, Chappelle Gandhi, 2013). Hence, it is expected that these measures would bring about greater independence of auditors through more information dissemination (Arens et. al., 2013). References Arens, A., Best, P., Shailer, G. Fiedler,I. 2013. Auditing, Assurance Services and Ethics in Australia, 2nd edn., Pearson Australia, Sydney Clout, V, Chappelle, E Gandhi, N 2013, The impact of auditor independence regulations on established and emerging firms,Accounting Research JournalVol. 26, No. 2, pp. 88-108 Davenport, S Parker, D 2014, Business and Law in Australia, 2nd eds., LexisNexis Publications, Sydney Fearnotlaw nd, Raskov vs. Stapke Harris, Available online from https://www.fearnotlaw.com/wsnkb/articles/raskov_v_stapke__harris-33634.html (Accessed on August 29, 2016) Gay, G. Simnett, R. 2012. Auditing and Assurance Services in Australia, 5th edn., McGraw-Hill Education, Sydney Lindgren, KE 2011, Vermeesch and Lindgren's Business Law of Australia, 12th eds., LexisNexis Publications, Sydney Livne, G 2015, Threats to Auditor Independence and Possible Remedies, Finance Practitioner Website, Available online from https://www.financepractitioner.com/auditing-best-practice/threats-to-auditor-independence-and-possible-remedies?full. (Accessed on September 1, 2016) Parker, C 2002. Auditing at arms length, CACharter, February, pp. 38-40 Swarb 2015, EQUITABLE LIFE ASSURANCE SOCIETY V HYMAN; HL 20 JUL 2000, Available online from https://swarb.co.uk/equitable-life-assurance-society-v-hyman-hl-20-jul-2000/ (Accessed on September 1, 2016) Taylor, R Taylor, D 2015, Contract Law, 5th eds., Oxford University Press, London