The Judiciary: the cause of the HIH insurance company insolvency

HIH wrote over fifty percent of Australia’s liability business and accepted liability insurance inwards from a number of countries including the USA.

Two books, written by highly experienced financial reporters, have been published about the whole saga. In my opinion, the authors have missed the point that the collapse of the HIH was caused by the judiciary.

HIH collapsed because it was insolvent; that is it did not have funds to match its liability claims. When Tony McGrath of KPMG was appointed as its provisional liquidator, he estimated the liabilities of HIH to be around A$5,3 bn, making it the largest corporate failure in Australian history. When, however, it came to settling these liabilities, the amount was much less. Asked to explain why his initial estimates were so far out, McGrath explained that the money was never lost or stolen, it was never there. The problem with HIH was not the claims but the income. HIH never charged premiums adequate to pay the mounting claims.

The problems faced by HIH were caused by legal liability claims against it. HIH was not the first insurer to face a crisis because of liability claims. In the 1980s American insurers faced a severe liability crisis, which went beyond mere insolvency of insurers. It disrupted the American economy, prompting President Reagan to appoint a commission of inquiry.

Mounting insurer and corporate failures
Lloyd’s faced its most testing time in its 300-year history, as a result of the LMX Spiral and liability claims from asbestos and environmental cases. In order to solve the severe financial crisis caused by the liability claims, it split its operations into two. It reversed its long-term liability risks into a new Special Purpose Vehicle (SPV) called Equitas and kept the rest.  In this manner it could ring-fence the long-term liabilities, freeing it to carry on with its usual business.

HIH did much the same, but the other way round. It reversed the good business into a new structure and kept the long tail liability business, allowing the existing company to go into insolvency. This solution was a much swifter method of finalising a problem not all of its own making. The correlation between the problems which America, Lloyd’s and the HIH faced, was missed.

Not only insurers, but also companies in general, have been driven into insolvency by liability claims. Over fifty well-established companies have now filed for insolvency as a result of asbestos claims.

What did the judiciary do?
During the liability crisis of the 1980s, President Reagan appointed an interdepartmental committee to investigate the causes of the insurance and economic crises. The committee, under the chairmanship of Richard K Willard, concluded that the crises had been caused by the American judiciary who had distorted, beyond all recognition, the common-law principles upon which liability rests.  So we can accept that today, the principles upon which judges make awards bear no relation to the original common-law principles, despite the fact that the exact same words are used. In the courts today, words no longer mean what they mean, they mean what the courts want them to mean.

Willard’s findings were anticipated in England by its greatest judge - Lord Denning. In 1979 he published a book, The Discipline of Law, pointing out that the law of negligence had changed completely over a fifty-year period, because the courts had adopted a policy ‘that when severe loss is suffered by any one singly, it should borne, not by him alone, but spread [by the courts] through the community at large’. This was to be achieved by holding insurance and other large organisations liable.

The possible economic consequences of what the courts were doing were not lost to him. ‘I wonder’, he said, ‘whether the time has not come when the courts should cry halt!’ Of course that was a vainglorious observation. The main beneficiaries of the system are lawyers. The last thing they will do is cry halt. In America, as the Economist has recently shown, this is a source of $200 bn per annum income. Lord Action, the great historian, distilled centuries of history when he pointed out in his inaugural lecture, ‘A power continues to expand, until stopped by a more superior power.’ No one voluntarily gives up $200 bn per annum.

The Denning dictum is known today as the Deep Pocket phenomenon. Defendants are held liable not because of their deeds but because they are perceived to have money. As a result, liability risks have expanded both in cause and quantum on the assumption that the defendants have limitless funds. There is no such thing as limitless funds; certainly neither Lloyd’s nor HIH had access to such limitless funds.

Judicially imposed socialism
Over 20 years ago, I carried out research to establish if South Africa was following America in its liability madness.  South Africa has a fund dedicated to liability risks, the road accident fund.  Thus, an insight to liability developments in South Africa could be gauged by examining the performance of this fund.  As I examined claims against the fund and its financial performance, it became clear that South Africa was indeed following America (in fact, leading America on cause of liability). In terms of the Denning philosophy, judges were in the position of the ideal socialist. They could impose enormous obligations on others without any regard whatsoever to the economic consequences of their actions. Not even the most socialist government in the world could do what courts did. These governments were economically accountable for their policies and faced with that sobering reality, communism collapsed. With judicially imposed socialism, it is companies which collapse, not governments.

In the next part, I will begin to examine the economic issues about which the judiciary are ignorant which lead to the insolvency of liability insurers.