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Three directors of Independent Insurance were sentenced to jail for up to seven years on Wednesday, after auditing frauds led to the collapse of the UK's ninth largest insurer.

At Southwark Crown Court, Michael Bright, Philip Condon and Dennis Lomas, the firm's former chief executive officer, deputy managing director and director of finance, were found guilty of conspiracy to defraud and imprisoned for seven, three and four years respectively.

The Serious Fraud Office called the collapse of Independent Insurance "one of the worst commercial disasters to occur in recent years in the UK", with over 1,000 employees losing their jobs. Thousands of shareholders lost the value of their investments. By September 2007 the Financial Services Compensation Scheme, which pays claims by holders of compulsory insurance policies in situations where insurance companies fail, had paid out over £366 million to people who had insurance policies with IIC.

The company that became Independent Insurance Company Limited (“IIC”) was incorporated in 1986. Shortly afterwards it acquired the UK business of a US insurance company, Allstate International Inc, a company that was originally founded in 1904. Independent Insurance Group Limited (“IIG”) was listed on the London Stock Exchange in November 1993. It grew its market share during the 1990's becoming the ninth largest insurance company in the UK.

In June 2001 both IIC and IIG went into provisional liquidation. Hundreds of jobs were lost, thousands of shareholders lost investments and over £366 million has since been paid out under the statutory compensation scheme.

This disastrous turn of events was in stark contrast to the picture of the company given in the annual accounts for year 2000, published in March 2001. During the 1990s the business had grown rapidly.

In 2000 the market value of the company had reached £900 million. The published report and accounts stated profits of £22 million, indicated net assets of over £300 million and expressed a positive outlook for the company. But in fact, in 2001 the company was in difficulties and it started to come to light that in two specific aspects of the company's business, actions had been taken which created a more positive financial picture than was the case.

Incomplete disclosure

In June 2001 the Serious Fraud Office (SFO) with the City of London Police opened a criminal investigation after it came to light that  the company had withheld claims data from the company's actuaries Watson Wyatt and had provided incomplete disclosure of agreements between the company and its re-insurers.

The SFO said that the actions that constituted the offences were not in themselves the cause of the demise of the business, but  that they were an attempt to disguise the true financial position of the company. The net effect was that the annual accounts for the year 2000, rather than showing a £22 million profit, should have recorded a loss of at least £180 million.

There were many reasons for the collapse of IIC, the majority of which were not the subject of an investigation by the SFO. While IIG may have been doomed before these alleged lies, the SFO said that the directors' lies about the company's true financial situation were important for two reasons.

Firstly they prevented the truth about the financial state of the company coming out earlier meaning unprofitable trading continued. Secondly when the lies emerged they destroyed the credibility of the company making it impossible to rescue the situation.

Insurance companies must make provision in their accounts for the payment of claims; it is one of the responsibilities of directors of insurance companies to ensure that sufficient funds are held in the company's reserves to pay valid claims made on issued insurance policies.

Reserves

Insurance company reserves are made up of different components. One element is case estimates. These are based on the calculations that the insurance company makes of the amount it may need to settle claims already notified by the year end. Another component is something known as IBNR “incurred but not reported”. There is an additional component called IBNER which means “incurred but not enough reported”.

IBNR is an estimate of the remaining claims that are anticipated in addition to those already notified that relate to business already written and earned prior to the accounting date.