HSBC 2012 Annual Report Download - page 279

277
Overview Operating & Financial Review Corporate Governance Financial Statements Shareholder Information
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.
See also ‘Sensitivity of HSBC’s insurance subsidiaries to market risk factors’ on page 240) which indicates the
sensitivity of insurance manufacturers profit and total equity to market risk factors.
Credit risk
(Audited)
Description of credit risk
Credit risk arises in two main areas for our insurance manufacturers:
i) risk of default by debt security counterparties after investing premiums to generate a return for policyholders
and shareholders; and
ii) risk of default by reinsurance counterparties and non-reimbursement for claims made after ceding insurance
risk.
How credit risk is managed
Our insurance manufacturing subsidiaries are responsible for the credit risk, quality and performance of their
investment portfolios. Our assessment of the creditworthiness of issuers and counterparties is based primarily upon
internationally recognised credit ratings and other publicly available information.
Investment credit exposures are monitored against limits by our local insurance manufacturing subsidiaries, and are
aggregated and reported to Group Credit Risk, the Group Insurance Credit Risk Committee and the Group Insurance
Risk Management Committee. Stress testing is performed by Group Insurance Head Office on the investment credit
exposures using credit spread sensitivities and default probabilities. The stresses are reported to the Group Insurance
Credit Risk Meeting.
We use a number of tools to manage and monitor credit risk. These include a Credit Watch Report which contains a
watch-list of investments with current credit concerns and is circulated fortnightly to senior management in Group
Insurance Head Office and the individual Country Chief Risk Officers to identify investments which may be at risk
of future impairment.
Liquidity risk
(Audited)
Description of liquidity risk
It is an inherent characteristic of almost all insurance contracts that there is uncertainty over the amount of claims
liabilities that may arise and the timing of their settlement, and this creates liquidity risk.
There are three aspects to liquidity risk. The first arises in normal market conditions and is referred to as funding
liquidity risk; specifically, the capacity to raise sufficient cash when needed to meet payment obligations. Secondly,
market liquidity risk arises when the size of a particular holding may be so large that a sale cannot be completed
around the market price. Finally, standby liquidity risk refers to the capacity to meet payment terms in abnormal
conditions.
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