Case Studies
to accompany
Auditing and Assurance Services in Australia
by Gay and Simnett
Prepared by Renee Radich and Philip Ross
Case studies t/a Auditing and Assurance Services in Australia by Gay & Simnett
1
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Case studies t/a Auditing and Assurance Services in Australia by Gay & Simnett
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Case One & Points for Discussion
HIH Insurance Limited:
Business risk and Inherent Risk Assessment, Legal Liability, Ethics and Audit
Reports
Prepared by Renee Radich
This Case is based on Chapters 1, 3-7 and 13
Learning Objectives
After completing this case, you should be able to:
 Identify key factors that impact on the evaluation of business as well as the
assessment of the inherent risk of a client.(Chapters 5, 6 and 7)
 Understand the degree of legal exposure an auditor faces. (Chapter 4)
 Be aware of the importance of independence in appearance as well as
independence in fact. (Chapter 3)
 Understand the implications of an unqualified audit report. (Chapters 1,7 and 13)
 Identify the appropriate audit report given specific circumstances. (Chapter 13)
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.
The insurance arenas entered into by HIH included the high-risk areas of marine,
aviation, natural disasters and film financing insurance, in addition to the highly
competitive workers' compensation insurance market in California. HIH experienced
considerable losses due to its exposure to these high-risk areas. Such losses included:

$100 million from film losses

Considerable damages claims from the major hailstorm in Sydney (from the
takeover of FAI)

Large losses from the 1999 Florida typhoon

Extensive workers' compensation claims as a result of the industry deregulation
in California. The Californian courts had altered the award scale for benefits,
which resulted in a dramatic increase in the cost of claims to insurance
companies such as HIH.
Case studies t/a Auditing and Assurance Services in Australia by Gay & Simnett
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Board of Directors
Details regarding notable members of the Board of Directors of HIH and changes to
the Board are outlined in the table below.
Name
Ray Williams
(Founder CE
Health in 1968)
Randolf Wein
(replaced Ray
Williams)
Geoffrey Cohen
Position
Deputy Chairman
and Chief
Executive Officer
Deputy Chairman
and Chief
Executive Officer
Chairman
Resigned
Dec, 2000
Rodney Adler
Justin Gardener
Director
Director
Feb 26, 2001
12 Oct, 2000
Dominic Fedora
Finance Director
12 Oct, 2000
Comments
Former partner Arthur
Andersen
Sold FAI to HIH in 1998
Former partner Arthur
Andersen, and auditor of
FAI in 1980s
Former partner Arthur
Andersen
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.
In the two years preceding the cessation of trading, HIH’s share price had fallen
sharply. This was due to a combination of poor financial results and significant asset
sales, which were intended to improve the balance sheet position, as well as fund
insurance claims. It is interesting to note that during 2000 HIH had paid an amount of
$1.7 million to the auditors for auditing services, together with $1.631 million for the
provision of consulting and other services.
The difficulties experienced by HIH were due in part to its policy in regard to
prudential margins. The premiums received by insurance companies are invested for
long periods of time in anticipation of future claims, and companies (including HIH
until 1997) traditionally maintain a prudential margin out of these funds. A prudential
margin means that a proportion of funds received by the company is maintained as a
buffer in the event of unpredictable claims, such as those arising out of natural
disasters such as earthquakes or floods. Some companies have margins such that there
is an 80–90 per cent chance of covering claims. HIH discontinued this practice in
1997, choosing instead to adopt a reinsurance process.
Case studies t/a Auditing and Assurance Services in Australia by Gay & Simnett
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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).
In addition to the Royal Commission, was the preparation of the Ramsay Report
whose purpose was to review existing requirements for the independence of auditors
and to make appropriate recommendations for changes to those requirements. The
Ramsay Report was released in September 2002, prior to the findings of the Royal
Commission.
The Corporate Law and Economic Reform Program (Audit Reform and Corporate
Disclosure) Act 2004 (CLERP 9 ACT) was passed in June 2004.
The
recommendations of the Ramsay Report and the Royal Commission are generally
consistent with the CLERP 9 proposals with respect to audit reform. (See Text Pages
105-109)
For Arthur Andersen the situation deteriorated with the subsequent collapse of Enron
in January 2002. In June the firm was found guilty of obstructing justice for the
destruction of work papers. In May 2003 Andersen Australia was integrated into the
partners and staff of Ernst and Young.
The result has been a major review of the auditing profession.
Case studies t/a Auditing and Assurance Services in Australia by Gay & Simnett
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Appendix:
Australian Securities and Investments Commission (ASIC)
Media and information releases
05-94 Ray Williams sentenced to four-and-a-half years' jail
Friday 15 April 2005
Mr Jeffrey Lucy, Chairman of the Australian Securities and Investments Commission
(ASIC), today announced that Mr Ray Williams, the former Chief Executive Officer
of HIH Insurance Limited (HIH), has been sentenced to four-and-a-half years' jail
with a non-parole period of two years and nine months.
Mr Williams was today convicted and sentenced on three criminal charges arising
from his management of the HIH group of companies in the three-year period 1998 to
2000.
'ASIC welcomes the strong message that today's sentencing sends to corporate
Australia', Mr Lucy said.
'ASIC, the courts and the community will not tolerate company directors who do not
act honestly and in the best interests of shareholders', he said.
Mr Williams was sentenced in relation to offences concerning three substantial
transactions, which significantly distorted the true financial position of HIH. These
matters involved hundreds of millions of dollars and Mr Williams' criminal conduct
occurred over an extensive period.
Mr William's sentencing today on the three criminal charges follows ASIC's
successful civil penalty proceedings (commenced in 2001) that resulted in him being:

banned from acting as a director of any company for 10 years

ordered to pay compensation jointly with Mr Rodney Adler and Adler
Corporation Pty Limited of approximately $7 million, and

ordered to pay a pecuniary penalty of $250,000.
'Today's sentencing brings to a close ASIC's proceedings against Mr Williams
concerning the collapse of HIH', Mr Lucy said.
ASIC's investigation into the matters surrounding the collapse of the HIH Insurance
group of companies is continuing.
Background
Mr Williams was sentenced after pleading guilty on 15 December 2004 to three
criminal charges:
Case studies t/a Auditing and Assurance Services in Australia by Gay & Simnett
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
that he was reckless and failed to properly exercise his powers and discharge
his duties for a proper purpose as a director of HIH Insurance Limited when,
on 19 October 2000, he signed a letter that was misleading

that he authorised the issue of a prospectus by HIH on 26 October 1998 that
contained a material omission

that he made or authorised a statement in the 1998-99 Annual Report, which
he knew to be misleading, that overstated the operating profit before abnormal
items and income tax by $92.4 million.
ASIC's HIH investigation has already led to criminal prosecutions of 9 former senior
executives, including directors, of FAI, HIH and associated entities on 31
Corporations and Crimes Act charges. These criminal prosecutions include:

On 23 December 2003, Mr William Howard, a former General Manager of
HIH Insurance Limited, was sentenced to three years imprisonment, fully
suspended on the basis of on-going assistance to the HIH investigation. Mr
Howard had pleaded guilty to two counts of criminal misconduct, namely that
he dishonestly received from Mr Brad Cooper approximately $124,000 in
return for facilitating payments by HIH directly or indirectly in favour of Mr
Cooper. Mr Howard also admitted facilitating a payment of $737,000 to a
company associated with Mr Cooper knowing that the payment obligation had
already been discharged.

On 22 October 2004, Mr Bradley Cooper was committed for trial on six
charges of corruptly giving a cash benefit to influence an agent of HIH
Insurance Limited, namely Mr Howard, and seven charges of publishing a
false or misleading statement with intent to obtain financial advantage. The
trial is set down to commence on 1 August 2005.

On 20 April 2004, Mr Charles Abbott, the former Deputy Chairman of HIH
Insurance Limited, was charged with dishonestly using his position as a
company director. The committal hearing is set down to commence on 30 May
2005.

On 19 July 2004, Mr Timothy Maxwell Mainprize was committed for trial on
charges of failing to act honestly in the exercise of his powers and discharge of
his duties as an officer of FAI General Insurance Company Limited. He was
also committed on one count of providing false and misleading information.
His trial is set down to commence on 5 September 2005.

On 19 July 2004, Mr Daniel Wilkie was committed for trial on charges of
failing to act honestly in the exercise of his powers and discharge of his duties
as an officer of FAI General Insurance Company Limited. He was also
committed on one count of providing false and misleading information. His
trial is set down to commence on 5 September 2005.

On 19 July 2004, Mr Stephen Burroughs was committed for trial on charges of
failing to act honestly in the exercise of his powers and discharge of his duties
as an officer of FAI General Insurance Company Limited.

On 16 February 2005, Mr Rodney Adler pleaded guilty to four charges, two of
disseminating false information that was likely to induce people to buy HIH
Case studies t/a Auditing and Assurance Services in Australia by Gay & Simnett
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shares, one of making and publishing false statements and one of being
intentionally dishonest and failing to discharge his duties in good faith. Mr
Adler was sentenced on 14 April 2005 to four-and-half years' jail with a nonparole period of two-and-a-half years.

On 24 March 2005 Mr Terry Cassidy pleaded guilty to two charges of
recklessly making false statements and one charge of recklessly failing to
discharge his duties as a director for a proper purpose. There will be a
sentencing hearing commencing on 19 April 2005.
Case studies t/a Auditing and Assurance Services in Australia by Gay & Simnett
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Question 1 —Business Risk and Inherent Risk Assessments
"It is difficult for an insurance company to go broke in the space of a year, let alone a few
months" Sydney Morning Herald, May 19–20, 2001.
Required:
a)
How would you assess the business risk of HIH Insurance Limited?
b)
List several inherent risk factors effecting HIH at the financial report level
and whether they would have contributed to an increase or decrease in the
inherent risk assessment.
Question 2— Legal Liability
Sydney solicitor Bruce Dennis will be coordinating a class action for some 600 HIH
shareholders against the auditors — Andersens (as the firm is now known). In
addition, HIH's liquidator, Tony McGrath of KPMG Peat Marwick is also likely to
seek to recover funds for HIH creditors.
Required:
a) Discuss the facts and findings of relevant court cases that Andersens should refer
to in determining the likelihood of the partnership being held liable to:
1) clients
2) creditors.
b) What conditions need to exist for a negligence action to be upheld?
Question 3 — Ethics
The HIH board of directors includes three former partners of the audit firm Arthur
Andersen. In the past decade, Andersens has earned more than $8 million from
auditing HIH books and $7 million for other services.
Required:
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 Ramsay
Report and CLERP 9. What impacts do you feel these changes will have on the
practice of auditing?
See Text Pages 105-124
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Question 4 — Audit Reports
For the 30 June 2000 Financial Statements of HIH, the auditors issued an unqualified
audit report. Ten days after their appointment, KPMG reported the solvency of the
company was very marginal and that the problems pre-dated the last audit period.
ASIC has indicated the question of solvency could extend as far back as July 1998.
a) Discuss any mitigating circumstances that may have resulted in the issue of an
unqualified report.
b) What are the implications of issuing an unqualified report?
Case studies t/a Auditing and Assurance Services in Australia by Gay & Simnett
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Case Two & Points for Discussion
HIH Insurance Limited:
Analytical Procedures, Account Balance Assertions and Audit Procedures
Prepared by Renee Radich
This case can be completed in conjunction with Case One or independently.
Learning Objectives
After completing this case, you should be able to:
 Use analytical procedures to identify key accounts at risk.
 Understand the use of analytical procedures in the planning stage of the audit.
 Appreciate the importance of non-financial information when using analytical
procedures.
Background
HIH Insurance Limited was the second largest insurance company in Australia prior
to its collapse in May 2001. A background history of HIH is provided in Case One.
The Financial Statements for the year ended 30 June 2000 showed an $18.4 million
profit and a balance sheet in which assets outweighed liabilities by $939 million.
Accounts to the 6 months to December 2000 indicate a loss of $810 million, with
estimates of liabilities outweighing assets by billions of dollars.
Extracts from the financial statements for HIH Insurance Limited are provided below.
Question 1 — Analytical procedures and the risk of audit assertions
Using analytical procedures, identify four (4) account balances that you believe are
likely to have been at high risk of material misstatements in the audit of HIH's 2000
accounts. Which audit assertion(s) would be the most important for each account
identified? Give reasons for your choice.
Account Balance
Assertion
Reason
Question 2 — Use of non- financial information in analytical procedures
What additional non-financial information would be useful when undertaking the
analytical procedures?
Case studies t/a Auditing and Assurance Services in Australia by Gay & Simnett
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HIH Insurance Limited
Extracts from the Financial Report
for the year ended 30 June 2000
PROFIT AND LOSS STATEMENTS
Operating profit before abnormal item and income tax
Abnormal item before income tax
Operating profit before income tax
Income tax attributable profit
Abnormal tax expense
Operating profit after income tax
Loss on extraordinary items
Income tax attributable to loss on extraordinary items
Loss on extraordinary items after income tax
Outside equity interest in operating profit
Operating profit/(loss) after extraordinary items and income tax
attributable to members of the parent entity
Retained profits/(Accumulated losses) at the beginning of the period
Total available for appropriation
Dividends and other distributions provided for or paid
Retained profits/(Accumulated losses) at the end of the period
Parent Entity
1.7.99–
1.1.98–
30.6.00
30.6.99
$m
$m
104.6
54.1
–
–
104.6
54.1
(2.2)
(4.0)
–
–
102.4
50.1
–
–
–
–
–
–
–
–
50.1
19.3
69.4
(33.3)
36.1
Consolidated
1.7.991.1.98–
30.6.00
30.6.99
$m
$m
102.0
61.9
(50.0)
(6.0)
52.0
55.9
(14.7)
(17.9)
–
(18.8)
37.3
19.2
–
(50.1)
–
–
–
(50.1)
(8.4)
(0.8)
102.4
3.1
105.5
(86.2)
19.3
18.4
(26.5)
(8.1)
(49.4)
(57.5)
Comparatives
The economic entity changed its financial year-end from 31 December to 30 June, as
at 30 June 1999. These financial statements have been prepared to provide financial
information and statements for the year to 30 June 2000 with comparatives stated for
the eighteen-month period to 30 June 1999.
Case studies t/a Auditing and Assurance Services in Australia by Gay & Simnett
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(21.2)
89.9
68.7
(95.2)
(26.5)
HIH Insurance Limited
Extracts from the Financial Report
for the year ended 30 June 2000
BALANCE SHEET
Current Assets
Cash
Receivables (Note 11)
Investments
Reinsurance recoveries receivable
Deferred acquisition costs
Other
Total Current Assets
Non Current assets
Receivables
Investments
Plant and Equipment
Reinsurance recoveries receivable
Intangibles
Other
Total Non-Current Assets
New South Wales Workers Compensation Statutory Funds
Total Assets
Current Liabilities
Accounts payable
Borrowings
Provisions
Outstanding claims
Unearned premiums
Other
Total Current Liabilities
Non-Current Liabilities
Accounts payable
Borrowings
Provisions
Outstanding claims
Total Non-Current Liabilities
New South Wales Workers Compensation Statutory Funds
Total Liabilities
Net Assets
Shareholders' Equity
Share capital
Convertible notes
Converting notes
Reserves
Retained profits/ (Accumulated losses)
Total Shareholders' Equity attributable to members of the parent
entity
Outside equity interests in controlled entities
Total Shareholders' Equity
Note 11 — Receivables
Trade debtors
Less provision for doubtful debts
Trade debtors net
Amounts due from reinsurers, other insurers and statutory bodies
Accrued premiums
Accrued interest, commission and other income
Other debtors
Total current receivables
Parent Entity
30.6.00
30.6.99
$m
$m
Consolidated
30.6.00
30.6.99
$m
$m
1.2
4.7
–
–
–
–
5.9
5.3
4.7
–
–
–
–
10.0
461.6
1603.6
624.4
431.6
304.3
25.0
3450.5
638.70
1400.7
803.5
415.5
278.3
33.8
3570.5
286.4
731.8
–
–
–
–
1018.2
–
1024.4
269.4
685.7
–
–
–
–
955.1
–
965.1
0.6
1753.1
164.6
1383.3
494.4
244.4
4045.4
831.2
8327.1
35.0
1908.8
147.8
986.7
346.5
191.7
3616.5
864.1
8051.1
–
–
14.4
–
–
0.2
14.6
–
–
18.5
–
–
2.1
20.6
381.0
19.6
83.7
1423.4
1069.4
49.2
3026.3
563.7
164.5
46.3
1415.5
1038.9
33.9
3262.8
–
55.8
0.9
–
56.7
–
71.3
952.8
–
56.1
–
–
56.1
–
76.7
888.4
14.5
504.4
4.1
3007.5
3530.5
831.2
7388.0
939.1
335.8
6.0
2636.0
2977.8
864.1
7104.7
946.4
697.9
65.3
–
153.5
36.1
952.8
684.2
65.3
–
119.6
19.3
888.4
697.9
65.3
213.1
8.7
(57.5)
927.5
684.2
65.3
213.1
(1.0)
(26.5)
935.1
–
952.8
–
888.4
11.6
939.1
11.3
946.4
613.1
(8.8)
604.3
377.8
526.4
8.4
86.7
1603.6
497.5
(19.8)
477.7
360.7
470.0
5.9
86.4
1400.7
4.7
4.7
4.7
4.7
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