Lies and a sham, or just ordinary insurance practice? That’s the question which has been hovering over the HIH Royal Commission over the past week as it investigates FAI’s now notorious reinsurance arrangements with General and Cologne Re.

Former FAI Chief Executive and HIH director Rodney Adler hasn’t yet been called to front Royal Commissioner Justice Neville Owen to explain his attitude to the contracts. In the meantime, the methods allegedly used by FAI in May and June 1998 to transform a book loss into a small profit have been educational.

According to evidence at the Royal Commission over the past week, the solution used by FAI to cover its losses was to negotiate an aggregate excess of loss agreement that provided $65 million cover. The premium was $55 million, with additional reinsurance premiums of $10 million – and fees of $2.5 million – applying over the next two years.

Andrew Smith, an underwriter at GCR who handled the deals, agreed that GCR carried no real risk from the contracts, and that they couldn’t therefore be regarded as genuine reinsurance arrangements. They did, however, allow FAI to treat the cover as an asset for accounting purposes, and allegedly turn a book loss of $20 million into a profit of $8 million.

FAI even provided GCR with a letter promising to make no claims, and the arrangements were backdated to March 16. It was, said Mr Smith, “silly and unnecessary” to agree to that. The contracts to cover the $65 million reinsurance were to cost FAI $67.5 million. Mr Smith said he had no way of knowing that FAI’s auditors weren’t aware of the arrangement.

It’s not hard to see where the trail is heading, but the route chosen by counsel assisting the Royal Commissioner is proving fascinating, if discomfiting. The Royal Commission has already been told that this type of reinsurance arrangement was also practised at HIH shortly after it took over FAI. A contract with Hannover Re allowed HIH to boost the insurer’s 1999 results from a $10 million profit to a $100 million profit, and in the followng year from a $45 million loss to a $61.9 million profit.

Meanwhile, the Royal Commission has had its mandate extended by the Federal Government to look at the wider picture. Although Commissioner Owen played down the significance of the extension, it will allow him to investigate whether the actions and decisions of individuals contributed to the HIH collapse. It will also extend the Royal Commission’s ability to investigate associated companies.

It’s complicated stuff, but the HIH Royal Commission is certainly the most interesting show in town at present.