HSBC 2015 Annual Report Download - page 225

HSBC HOLDINGS PLC
223
Strategic Report Financial Review Corporate Governance Financial Statements Shareholder Information
How liquidity risk is managed
Our insurance manufacturing subsidiaries primarily fund cash outflows arising from claim liabilities from the following sources
of cash inflows:
• premiums from new business, policy renewals and recurring premium products;
• interest and dividends on investments and principal repayments of maturing debt investments;
• cash resources; and
• the sale of investments.
They manage liquidity risk by utilising some or all of the following techniques:
• matching cash inflows with expected cash outflows using specific cash flow projections or more general asset and liability
matching techniques such as duration matching;
• maintaining sufficient cash resources;
• investing in good credit-quality investments with deep and liquid markets to the degree to which they exist;
• monitoring investment concentrations and restricting them where appropriate, for example, by debt issues or issuers; and
• establishing committed contingency borrowing facilities.
Each of these techniques contributes to mitigating the three types of liquidity risk described above.
Every quarter, our insurance manufacturing subsidiaries are required to complete and submit liquidity risk reports to Group
Insurance for collation and review. Liquidity risk is assessed in these reports by measuring changes in expected cumulative net
cash flows under a series of stress scenarios designed to determine the effect of reducing expected available liquidity and
accelerating cash outflows. This is achieved, for example, by assuming new business or renewals are lower, and surrenders or
lapses are greater, than expected.
Insurance risk
(Audited)
Insurance risk is the risk, other than financial risk, of loss transferred from the holder of the insurance contract to the issuer
(i.e. HSBC). The principal risk we face is that, over time, the cost of the contract, including claims and benefits may exceed the
total amount of premiums and investment income received.
The cost of claims and benefits can be influenced by many factors, including mortality and morbidity experience, lapse and
surrender rates.
Insurance risks are controlled by high-level policies and procedures set both centrally and locally, taking into account where
appropriate local market conditions and regulatory requirements. Formal underwriting, reinsurance and claims-handling
procedures designed to ensure compliance with regulations are applied, supplemented with stress testing.
As well as exercising underwriting controls, we use reinsurance as a means of mitigating exposure to insurance risk. Where we
manage our exposure to insurance risk through the use of third-party reinsurers, the associated revenue and manufacturing
profit is ceded to the reinsurers. Although reinsurance provides a means of managing insurance risk, such contracts expose us
to credit risk, the risk of default by the reinsurer.
The principal drivers of our insurance risk are described below. The liabilities for long-term contracts are set by reference to a
range of assumptions around these drivers. These typically reflect the issuers’ own experiences. The type and quantum of
insurance risk arising from life insurance depends on the type of business, and varies considerably.
• mortality and morbidity: the main contracts which generate exposure to these risks are term assurance, whole life
products, critical illness and income protection contracts and annuities. The risks are monitored on a regular basis, and are
primarily mitigated by underwriting controls and reinsurance and by retaining the ability in certain cases to amend
premiums in the light of experience;
• lapses and surrenders: the risks associated with this are generally mitigated by product design, the application of surrender
charges and management actions, for example, managing the level of bonus payments to policyholders. A detailed
persistency analysis at a product level is carried out at least on an annual basis; and
• expense risk is mitigated by pricing, for example, retaining the ability in certain cases to amend premiums and/or
policyholder charges based on experience, and cost management discipline.
Liabilities are affected by changes in assumptions (see ‘Sensitivity analysis’ on page 188).