In 1968, Ray Williams and Michael Payne formed CE Health International. As aresult of a merger in 1995 between CE Heath and the Swiss based insurer WinterthurInsurance Company, the company HIH Winterthur was established. In 1998 the nameof the company was changed again, this time to HIH Insurance Limited. This lastname change had been brought about by the withdrawal of Winterthur from theoperations. Winterthur had become increasingly nervous about the operations of thecompany and consequently had sold its shares. HIH continued to expand its insuranceventures with the purchase of FAI Insurance, World Marine and General Insuranceand Cotesworth, which had direct links with Lloyd's Insurance. However, FAI hadbeen purchased in 1998 at a premium from Rodney Adler (Non-Executive Director ofHIH) and without either board consultation or the completion of a due diligencereport. Accordingly, in September 2000, HIH was forced to write off its investment inFAI 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 highlycompetitive workers' compensation insurance market in California. HIH experiencedconsiderable losses due to its exposure to these high-risk areas. Such losses included:$100 million from film lossesConsiderable damages claims from the major hailstorm in Sydney (from thetakeover of FAI)Large losses from the 1999 Florida typhoonExtensive workers' compensation claims as a result of the industry deregulationin California. The Californian courts had altered the award scale for benefits,which resulted in a dramatic increase in the cost of claims to insurancecompanies such as HIH.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 fewmonths" 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 leveland whether they would have contributed to an increase or decrease in theinherent risk assessment.Question 2— Legal LiabilitySydney solicitor Bruce Dennis will be coordinating a class action for some 600 HIHshareholders against the auditors — Andersens (as the firm is now known). Inaddition, HIH's liquidator, Tony McGrath of KPMG Peat Marwick is also likely toseek to recover funds for HIH creditors.Required:a) Discuss the facts and findings of relevant court cases that Andersens should referto in determining the likelihood of the partnership being held liable to:1) clients2) creditors.b) What conditions need to exist for a negligence action to be upheld?Question 3 — EthicsThe HIH board of directors includes three former partners of the audit firm ArthurAndersen. In the past decade, Andersens has earned more than $8 million fromauditing 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 andconsulting services?c) Indicate whether these circumstances represent a violation of ethical standardsand give reasons for your answer.d) Outline the primary recommendations for audit reform proposed by the RamsayReport and CLERP 9. What impacts do you feel these changes will have on thepractice of auditing?