HSBC 2011 Annual Report Download - page 207

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Overview Operating & Financial Review Corporate Governance Financial Statements Shareholder Information
and investment income.
The cost of claims and benefits can be influenced by many factors, including mortality and morbidity experience,
lapse and surrender rates and, if the policy has a savings element, the performance of the assets held to support the
liabilities.
Life and non-life business insurance risks are controlled by high-level policies and procedures set centrally, 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,
in particular to aggregations of catastrophe risk. When we manage our exposure to insurance risk through the use of
third-party reinsurers, the associated revenue and manufacturing profit is ceded to them. 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.
Economic assumptions, such as investment returns and interest rates, are usually based on observable market data.
Clearly, liabilities are affected by changes in assumptions (see ‘Sensitivity of HSBC’s insurance subsidiaries to risk
factors’ on page 177 and ‘Sensitivity analysis’ on page 183).
The main risks associated with non-life business are:
• underwriting: the risk that premiums are not appropriate for the cover provided; and
• claims experience: the risk that claims exceed expectations.
We manage these risks through pricing (for example, imposing restrictions and deductibles in the policy terms and
conditions), product design, risk selection, claims handling, investment strategy and reinsurance policy. The majority
of our non-life insurance contracts are renewable annually, providing added flexibility to the underwriting terms and
conditions.
Financial risks
(Audited)
Our insurance businesses are exposed to a range of financial risks, including market risk, credit risk and liquidity
risk. Market risk includes interest rate risk, equity risk and foreign exchange risk. The nature and management of
these risks is described below.
Manufacturing subsidiaries are exposed to financial risks when, for example, the proceeds from financial assets
are not sufficient to fund the obligations arising from non-linked insurance and investment contracts. In many
jurisdictions, local regulatory requirements prescribe the type, quality and concentration of assets that these
subsidiaries must maintain to meet insurance liabilities. These requirements complement Group-wide policies.