Business risk refers to the possibility that a business entity, such as HIH will report lower than anticipated profits

Business risk refers to the possibility that a business entity, such as HIH will report lower than anticipated profits and that it may report losses rather than taking a profit. In general, the business risk gets influenced by various factors and depending on the perspective of the causative or correlated factors; business risk can either be external or internal (Investopedia). The understanding of business risk as a concept marks the very first stage in the assessment of this type of risk. The following few details will expound on how to assess business risk as it relates to the case of HIH.
From a general perspective, the analysis of business risk requires the understanding of the products and markets served by the business entity. Secondly, the assessment requires the understanding of how the business entity conducts its operations and thirdly, this business risk assessment requires the understanding of the entity’s transactions with related parties (Rose 2).
In the case of HIH Insurance, the expansion of the products and markets served becomes the first point of business risk assessment. When it first started operations in 1968 the company majorly focused on health insurance. However, the company would get into several mergers and acquisitions with FAI Insurance, Cotesworth, and World Marine and General Insurance. The expansion grew the product range, and while it increased the potential of earnings, it also increased the risk of losses. As the case indicates, the marine, aviation, natural disasters and film financing insurance are some of the high-risk products that exposed HIH to considerable losses.
On the assessment of how HIH conducts its operations, the prudential margins, the allowance for losses or claims, and the accounting for reinsurance agreements. According to the case study, the company’s policy on prudential margins left it unprepared for unexpected claims. The implications of this are that the company was not able to raise funds to cover claims when they arose. Secondly, the company’s financial reports included material misstatements and misleading statements on the allowance for losses or claims indicating the company’s focus on the manipulation of the results. On the reinsurance agreements, the report indicates the company’s failure to report according to the accounting principles. Arguably, the strategies were employed by the company to cover up the business risk or the risk on its bottom line. The risks would then be the reason for the company’s failure.
The last approach to the assessment of business risk is the assessment of the transactions with third parties. The first and major transaction includes the questionable acquisition of FAI. According to the facts of the case, the purchase of FAI at a premium and without either board consultation or the completion of the due diligence report ought to have raised a red flag on transaction anomalies. Notably, the transaction would end up in the write-off of about $400 million. Also, there were transactions involving third parties that were found to include corrupt dealings. Some directors in the company received monies to facilitate transactions between the company and third parties. Involvement in such activities is one of the reasons for heightened business risk in the organization.
The above mentioned approaches to the assessment of business risk at HIH help in revealing the business risk from internal factors. However, there is also the aspect of business risk that involves external factors. Consequently, the assessment of business risk also requires the study of the external environment. For instance, the crises in Florida’s typhoon and the hailstorm in Sydney are two external environment factors affecting the business risk levels of HIH. In the assessment of the business risk emanating from external factors, it would be important for the company to consider the industry factors, the economic factors, and the regulatory environment (Van Buuren 107). For instance, the deregulation of the industry resulting in extensive workers’ compensation claims increases the risk of HIH reporting lower and even negative profits.
In conclusion, this response explains how best business risk at HIH insurance would be assessed. The assessment requires the understanding of business risk and the factors that contribute to high business risk. In this particular case, the understanding of transactions, products, and markets, and the entity’s operations and strategy are main assessment approaches in the understanding of business risk. From the external factors perspective, the understanding of the industry, economic factors, and the regulatory environment are key factors. Overall, the application of analytical procedures in business risk assessment would be an important approach (Auditing and Assurance Standards Board).
b) List several inherent risk factors effecting HIH at the financial report level and whether they would have contributed to increase or decrease in the inherent risk assessment. There were several inherent risk factors affecting HIH at the financial report level. Firstly, there is the economic downturn inherent risk factor (Sadgrove 45). At the time of the collapse, there was the technology bubble and the resultant financial crises. This resulted in the increase in the number of claims and as the claims increased the possibility of the firm incurring losses increased considerably. Similarly, the increase resulted in material increases in the inherent risk of the company.
The second major inherent risk factor was the occurrence of natural calamities that were beyond the control of the company and its customers (Sadgrove 45). The 1999 typhoon in Florida and the major hailstorm in Sidney whose exposure at HIH was linked to the FAI stake were two of the most notable inherent risk factors. The company does not have any control over the natural calamities and as a consequence, the two factors increase the inherent risk assessment. Notably, these factors were recorded as key reasons why the company failed and though they may not be solely the reasons for the company’s failure they increased the inherent risk assessment materially.
The third major factor affecting HIH is the availability of financing in an environment where the shares of the company appeared to be dropping considerably (Sadgrove 46). As the analysis observes, the number of policies that HIH sold during the period in consideration reduced drastically.
Considering the pooling of resources to be the major source of financing for the company’s core operations, the company was not able to raise adequate resources to meet the needs of the company.
The amounts of claims were, on the other hand, increasing as the economic downturn, the natural calamities, and changes in the regulatory environment hit the market. The implications of here are that HIH found it more difficult to finance its operations and even in maintaining prudent margins that would be comparable to the industry levels.
Considering that the financing problems arose at a time when the company was on the cause of aggressive expansion, the limited availability of financing considerably increased the inherent risk materially and hence increased the inherent risk assessment.
The last factor which is closely related to limited availability of financing and economic downturns is the concern of rising inflation and the consequential rising in the interest rates (Sadgrove 45). The rising in inflation was necessitated by the building up technology bubble in the markets while the interest rates rose in tandem with the rate of inflation according to the Fischer’s theorem. This worsened the possibility of the firm being able to access financing and in return, it raised the inherent risk assessment.

Author: Barry Holmes