HSBC 2008 Annual Report Download - page 267

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DPF, may attempt to reduce exposure to its local
market by investing in assets in countries other than
that in which it is based. These assets may be
denominated in currencies other than the
subsidiary’s local currency. It is often not cost
effective for the subsidiary to hedge the foreign
exchange exposure associated with these assets, and
this exposes it to the risk that its local currency will
strengthen against the currency of the related assets.
For unit-linked contracts, market risk is
substantially borne by the policyholder, but HSBC
typically remains exposed to market risk as the
market value of the linked assets influences the fees
HSBC earns for managing them.
How the risks are managed
(Audited)
HSBC’s insurance manufacturing subsidiaries
manage market risk by using some or all of the
following techniques, depending on the nature of the
contracts they write:
• for products with DPF, adjusting bonus rates to
manage the liabilities to policyholders. Bonus
rates are managed by regularly evaluating their
sustainability. The effect is that a portion of the
market risk is borne by the policyholder;
• as far as possible, matching assets to liabilities.
For example, for products with annual return or
capital guarantees, HSBC invests in bonds
which produce returns at least equal to the
investment returns implied by the guarantees;
• using derivatives in a limited number of
instances;
• when designing new products with investment
guarantees, evaluating the cost of the guarantee
and considering this cost when determining the
level of premiums or the price structure;
• periodically reviewing products identified as
higher risk, which contain guarantees and
embedded optionality features linked to savings
and investment products. The scope of the
review would include pricing, risk management
and profitability (a control introduced during
2008). Guaranteed products which expose the
Group to risk beyond the levels deemed
acceptable in any of these categories are either
altered or are no longer offered to customers;
• including features designed to mitigate market
risk in new products, such as charging surrender
penalties to recoup losses incurred when
policyholders surrender their policies; and
• exiting, to the extent possible, investment
portfolios whose risk is considered unacceptable
– for example, by implementing asset
reallocation strategies in order to manage risk
exposures.
During 2008, the credit, market and liquidity
risk functions in Group Insurance Head Office were
strengthened by the creation of two new positions,
Chief Credit Officer and Chief Market and Liquidity
Risk Officer, both reporting to the Chief Risk
Officer. Also, due diligence procedures were
enhanced during the current lower yield environment
to more critically assess embedded risk in respect of
new products, for example, those including options
and guarantees within the contract. When such
product features are identified, the product proposal
is reviewed by Group Insurance Head Office to
ensure that the key risks are identified and that the
related risk management procedures are adequate.
The frequency with which management reviews
certain exposures is increased in markets
demonstrating increasing volatility to ensure that any
matters arising are dealt with in a timely fashion.
Each insurance manufacturing subsidiary is
required to have a market risk mandate which
specifies the investment instruments in which it is
permitted to invest and the maximum quantum of
market risk which it is permitted to retain. It is the
responsibility of the subsidiary’s ALCO and the
Market and Liquidity Risk Committee (sub-
committee to the Group Insurance Risk Committee)
to ensure that each mandate is consistent with local
regulations. All mandates are reviewed and agreed
annually by Group Insurance Head Office, and
aggregate limits are approved by the Risk
Management Meeting of GMB. During 2008, market
risk mandates were enhanced in some of the major
insurance subsidiaries by introducing stop loss limits
and management action limits designed to control
risk in certain portfolios.
How the exposures to risks are measured
(Audited)
HSBC’s insurance manufacturing subsidiaries
monitor exposures against mandated limits regularly
and report these quarterly to Group Insurance Head
Office. Exposures are aggregated and reported to
senior risk management forums in the Group,
including the Group Insurance Market and Liquidity
Risk Committee, Group Insurance Risk Committee
and the Group Stress Test Review Group.
The standard measures used to quantify the
market risks are as follows: