HSBC 2011 Annual Report Download - page 209

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Overview Operating & Financial Review Corporate Governance Financial Statements Shareholder Information
How market risk is managed
All our insurance manufacturing subsidiaries have market risk mandates which specify the investment instruments in
which they are permitted to invest and the maximum quantum of market risk which they may retain. They manage
market risk by using some or all of the techniques listed below, depending on the nature of the contracts they write.
Techniques for managing market risk
• for products with DPF, adjusting bonus rates to manage the liabilities to policyholders. The effect is that a significant portion of the
market risk is borne by the policyholder;
• as far as possible, matching assets to liability cash flows;
• using derivatives, to a limited extent, to protect against adverse market movements or better match liability cash flows;
• for new products with investment guarantees, considering the cost when determining the level of premiums or the price structure;
• periodically reviewing products identified as higher risk, which contain investment guarantees and embedded optionality features linked
to savings and investment products;
• including features designed to mitigate market risk in new products, such as charging surrender penalties to recoup losses incurred when
policyholders surrender their policies;
• exiting, to the extent possible, investment portfolios whose risk is considered unacceptable; and
• repricing of premiums charged to policyholders.
In the product approval process, the risks embedded in new products are identified and assessed. When, for example,
options and guarantees are embedded in new products, the due diligence process ensures that complete and
appropriate risk management procedures are in place. For all but the simplest of guaranteed benefits the assessment is
undertaken by Group Insurance Head Office. Management reviews certain exposures more frequently when markets
are more volatile to ensure that any matters arising are dealt with in a timely fashion.
How the exposure to market risk is measured
Our insurance manufacturing subsidiaries monitor exposures against mandated limits regularly and report them to
Group Insurance Head Office. Exposures are aggregated and reported on a quarterly basis 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.
Standard measures for quantifying market risks
• for interest rate risk, the sensitivities of the net present values of asset and expected liability cash flows, in total and by currency, to a one
basis point parallel shift in the discount curves used to calculate the net present values;
• for equity price risk, the total market value of equity holdings and the market value of equity holdings by region and country; and
• for foreign exchange risk, the total net short foreign exchange position and the net foreign exchange positions by currency.
The standard measures are relatively straightforward to calculate and aggregate, but they have limitations. The most
significant one is that a parallel shift in yield curves of one basis point does not capture the non-linear relationships
between the values of certain assets and liabilities and interest rates. Non-linearity arises, for example, from
investment guarantees and product features which enable policyholders to surrender their policies. We bear the
shortfall if the yields on investments held to support contracts with guaranteed benefits are less than the investment
returns implied by the guaranteed benefits.
We recognise these limitations and augment our standard measures with stress tests which examine the effect of a
range of market rate scenarios on the aggregate annual profits and total equity of our insurance manufacturing
subsidiaries, after taking into consideration tax and accounting treatments where material and relevant. The results
of these tests are reported to Group Insurance Head Office and risk committees every quarter.
Credit risk
(Audited)
Description of credit risk
We used to sell certain unit-linked life insurance contracts which were reinsured with a third-party counterparty, who
also underwrote market return guarantees. We are exposed to credit risk to the extent that the counterparty is unable
to meet the terms of the guaranteed benefits. The cost to us of market return guarantees increases when interest rates
fall, equity markets fall or market volatility increases. In addition, when determined by reference to a discounted cash