Auditor-General’s Report to Parliament 2001 Volume Four 15 Collapse of HIH Insurance KEY FINDINGS The collapse of HIH Insurance (HIH) in early 2001 will significantly affect NSW Government finances: ¦ A $600 million liability (estimated) has been included in the 2001-02 NSW Budget. This amount relates to a support package set up by the NSW Government for NSW residents who have HIH Compulsory Third Party (CTP) and home-owner warranty insurance claims. NSW public sector agencies have $30. 5 million of outstanding and potential claims with HIH Insurance.

A $28 million liability (relating to the Workers Compensation Act 1926) will now be recognised in WorkCover Authority from the failure of HIH. Some investment losses will be incurred by State agencies holding HIH shares. ¦ ¦ ¦ It is recommended that: ¦ ¦ ¦ The $600 million (estimated) liability for HIH CTP and home-owner warranty insurance claims should be closely monitored as such claims are usually subject to uncertainty and volatility. The regulatory roles of the Motor Accidents Authority and WorkCover Authority should be reviewed once the causes of the HIH collapse are determined.

The current structure of the Treasury Managed Fund should be reviewed to determine whether it is beneficial to include all non-budget dependent agencies under the cover provided. A Royal Commission into the causes of the collapse will report next year. The liquidator of HIH has the responsibility of determining the extent of the losses that arise. Whilst this determination will take some time, early estimates of these losses may exceed $4 billion, making HIH one of the largest corporate collapses in Australia.

FINANCIAL IMPACTS NSW Policyholders Protection Fund In the 2001-02 Budget the Government announced that it would introduce legislation to establish the NSW Policyholders Protection Fund. This Fund will pay the claims against Compulsory Third Party insurance (CTP) policies in force with HIH prior to 31 December 2000 and claims under the Home Warranty Insurance Scheme for policies entered into prior to 15 March 2001. For Budget purposes, the gross liabilities for these claims have been estimated at $600 million, the majority relating to CTP claims.

Up to 2004-05 total claim payments are estimated at $476 million and will be funded by: ¦ ¦ $200 million from the Budget – $50 million in 2001-02 and $150 million over the period to 2004-05 the introduction of the Insurance Protection Tax (IPT) from 1 July 2001. Special Reviews 16 Auditor-General’s Report to Parliament 2001 Volume Four The IPT will raise $69 million per annum from all general insurance companies operating in NSW. It will be apportioned on the basis of each company’s share of the total premium income collected in the previous year from all classes of general insurance and CTP insurance in NSW.

It is common, particularly with these types of insurance claims, for the estimate of outstanding claims liability to be subject to uncertainty and volatility. It is important that the exposure to the State through the Policyholders Fund is monitored closely in order to identify variations to the $600 million estimate, particularly as further claims experience is established. Public Sector Insurance Claims on HIH Soon after the collapse of HIH, NSW Treasury undertook an exercise to ascertain the extent of lodged and potential claims with HIH from NSW public sector agencies.

The latest estimate of these claims is $30. 5 million spread across many entities. A major part of this relates to a claim by Sydney Water Corporation of approximately $18 million for the water quality crisis of 1998. The Treasury Managed Fund (TMF) is a self-insurance scheme, comprising all budget dependent General Government entities, public hospitals and some Government authorities. As indicated above, some authorities had insurance arrangements outside of TMF and with the collapse of HIH, this has resulted in a cost to the State.

Volume Six of the 2000 Auditor-General’s Report to Parliament noted that Government authorities wishing to be considered for TMF coverage must submit a proposal to the Insurance Ministerial Corporation. The criteria used for the admittance to the TMF are not clear. Given the extent of Government authorities currently excluded from the TMF, it is uncertain whether the original outcomes from the establishment of the TMF are still relevant in the current environment. It is recommended that the TMF be reviewed to determine the benefits and risks of including all non-budget dependent agencies under the cover provided.

The Workers Compensation Act Some insurance companies that were part of the former privately underwritten scheme under the (repealed) Workers Compensation Act 1926 still have a tail of claims remaining. Five companies in the HIH group were in this category. WorkCover administers an Insurers Guarantee Fund (IGF) to meet claims arising if any insurers under the former scheme fail. It was initially estimated by WorkCover’s consulting actuaries that $10 million of outstanding claims liability against the five HIH companiees would fall to the IGF to meet.

This amount was advised to Parliament on 27 March 2001. It has now been estimated by the actuaries that this liability is approximately $28 million. The actuaries have advised that the initial estimate had a high degree of uncertainty due to limited HIH data. All IGF’s costs of claims and claims management are met by contributions levied on current licensed insurers. WorkCover envisages that a further contribution is not required to cover claims from the five HIH companies as the IGF already contains sufficient funds to meet their liabilities.

Investments in HIH No exercise has been undertaken to determine the extent of any losses form HIH shares held by the NSW public sector. Losses would be limited to those entities with powers to acquire and hold equities. For example within the WorkCover Scheme Statutory Funds, approximately 230,000 HIH shares were held at the time of the collapse. These shares had an historical cost of $365,000 and a market value at 30 June 2000 of $248,000. This represented 0. 02 per cent of the Funds’ equity investments of $1,134 million at 30 June 2000. Special Reviews

Auditor-General’s Report to Parliament 2001 Volume Four 17 First State Super, the accumulation superannuation scheme for NSW public servants, held approximately 119,000 shares at the time of the collapse. Approximately 1,130,000 shares were held by the defined benefit superannuation schemes. Based on 30 June 2000 market values, these holdings would have represented 0. 01 per cent respectively of total equity investments. The Hour-Glass investment facility provided to public sector investors by the NSW Treasury Corporation held approximately 610,000 shares at the time of the collapse.

These shares were held though a fund manager handling an ASX200 index replication portfolio which required an investment in HIH. This represented 0. 02 per cent of Hour-Glass investments of $3,297 million at 30 June 2000. Local Government Councils A number of local government councils had insurance policies with HIH. It is understood that a total exposure of approximately $60 million may exist with the local government councils although the full extent will not be known for several years. The impact on individual councils will vary greatly.

There is no financial responsibility by the State government for the local government exposures, however individual councils may request rate pegging increases significantly over the maximum allowed in order to fund uninsured payouts. If their requests do occur then the State government will need to consider their policy on this matter. THE ROLE OF THE STATE’S REGULATORS Motor Accidents Authority The Motor Accidents Authority of NSW (MAA) administers and regulates the Compulsory Third Party (CTP) personal injury insurance scheme for motor vehicles registered in NSW.

One of MAA’s principal functions is to license and oversee the operations of insurance companies that provide CTP insurance. The MAA has the power to impose special conditions on licences, including conditions to ensure that insurance premiums for CTP are available to meet claims. In addition the Authority has the power to suspend a licence if it is found that the insurer has contravened its licence. The Motor Accidents Compensation Act 1999 does not provide for the monitoring of other business activities of the insurance companies.

Earlier this year, the Special Minister of State advised the Legislative Council that he had been advised by the MAA in October 2000 about concerns regarding sufficient reserves existing to meet the claims on CTP policies with FAI and CIC (subsidiaries of HIH). The MAA had considered appointing an inspector to examine the positions of both FAI and CIC and this had been discussed with the Australian Prudential Regulatory Authority. On 27 February 2001 the MAA finally appointed an inspector to examine the financial position of FAI and CIC.

However, HIH sought provisional liquidation prior to the inspector reporting to the MAA. The licences of FAI and CIC were suspended at the time of their provisional liquidation. Some special conditions had been imposed on the licences of FAI and CIC by the MAA prior to their provisional liquidation. These conditions related to the joint venture arrangements with Allianz. In respect of CTP with the NSW Policyholders Protection Fund the Government has appointed the MAA as the Nominal Defendant.

The Nominal Defendant is the agent and attorney of persons insured by expired policies and has the duty of discharging liabilities of those persons. The Nominal Defendant is a creditor of HIH and will present a log of payments to the liquidator. The regulatory role of the MAA in respect of CTP insurance should be reviewed once a clearer understanding of the causes of the HIH collapse is available, to ensure that the outcomes intended by the relevant legislation are being met. Special Reviews 18 WorkCover Authority of NSW Auditor-General’s Report to Parliament 2001 Volume Four

The WorkCover Authority of NSW (WorkCover) is constituted under the Workplace Injury Management and Workers Compensation Act 1998. WorkCover manages NSW workplace safety, injury management and workers compensation systems. WorkCover licenses insurance companies that provide workers compensation insurance to NSW employers. Licensed insurers are required to keep the assets of the WorkCover Scheme Statutory Funds separate from all other assets of the licensed insurers. Both HIH Workers Compensation (NSW) Pty Limited and FAI Workers Compensation (NSW) Limited were licensed insurers for WorkCover.

NRMA has now acquired these two companies and they form part of the NRMA Insurance group. These two NRMA companies have taken over premium administration and the management of claims made on WorkCover Scheme policies with HIH or FAI. One of the principal functions of WorkCover is to licence and oversee the operations of insurance companies that provide workers compensation insurance. In accordance with the Workplace Injury Management and Workers Compensation Act 1998, WorkCover can require a licensed insurer to provide information (audited) about its financial position.

WorkCover has the power to impose conditions upon a licensed insurer. No special conditions had been imposed on the licences of FAI or HIH by WorkCover. In addition the Authority has the power to suspend the licence of an insurer if it is found that the insurer has contravened its licence. The regulatory role of WorkCover in respect of workers compensation insurance should be reviewed once a clearer understanding of the causes of the HIH collapse is available, to ensure that the outcomes intended by the relevant legislation are being met. Special Reviews