Annual Financial Report - 30 of 48

RNS Number : 3855B

HSBC Holdings PLC

03 April 2013

Risk management of insurance operations

(Audited)

	Page	App¹	Tables	Page

HSBC's bancassurance model ..................	233
Overview of insurance products .....................		273
Nature and extent of risks ..............................		273
Insurance risk ................................................		274

Risk management of insurance operations in 2012 .....................................................	233
Insurance risk ................................................	233		Analysis of life insurance risk - liabilities to policyholders ..........................................................	234
			Analysis of non-life insurance risk - net written insurance premiums ...............................................	234

Balance sheet of insurance manufacturing subsidiaries ..................	235		Balance sheet of insurance manufacturing subsidiaries:
			- by type of contract ..................................................	236
			- by geographical region ..........................................	237

Financial risks ............................................	238	275	Financial assets held by insurance manufacturing subsidiaries .............................................................	238
Market risk ....................................................	239	275	Liabilities to policyholders ..........................................	239
			Sensitivity of HSBC's insurance manufacturing subsidiaries to market risk factors ...........................	240
Credit risk ......................................................	240	277	Treasury bills, other eligible bills and debt securities in HSBC's insurance manufacturing subsidiaries ........	240
			Reinsurers' share of liabilities under insurance contracts ................................................................................	242
Liquidity risk .................................................	242	277	Expected maturity of insurance contract liabilities ......	242
			Remaining contractual maturity of investment contract liabilities .................................................................	243

Present value of in-force long-term insurance business .................................	243		Movements in PVIF and total equity of insurance operations	244
			Key assumptions used in the computation of PVIF for main life insurance operations ................................	244

Economic assumptions ...............................	244		Sensitivity of PVIF to changes in economic assumptions ................................................................................	244

Non-economic assumptions ......................	245		Sensitivity analysis ......................................................	245

1. Appendix to Risk - policies and practices.

The majority of the risk in our Insurance business derives from manufacturing activities and can be categorised as insurance risk and financial risk. Insurance risk is the risk, other than financial risk, of loss transferred from the holder of the insurance contract to the issuer (HSBC). Financial risks include market risk, credit risk and liquidity risk.

There were no material changes to our policies and practices for the management of risks arising in the insurance operations, including the risks relating to different life and non-life products, during 2012.

A summary of our policies and practices regarding the risk management of insurance operations, and the main contracts we manufacture, are provided in the Appendix to Risk on page 273.

HSBC's bancassurance model

We operate an integrated bancassurance model which provides wealth and protection insurance products principally for customers with whom we have a banking relationship. Insurance products are sold through all global businesses, predominantly by RBWM and CMB, through our branches and direct channels worldwide.

The insurance contracts we sell largely relate to the underlying needs of our banking customers, which we can identify from our point-of-sale contacts and customer knowledge. The majority of sales are of savings and investment products and term and credit life contracts. By focusing largely on personal and SME lines of business we are able to optimise volumes and diversify individual insurance risks.

Where we have operational scale and risk appetite, mostly in life insurance, these insurance products are manufactured by HSBC subsidiaries. Manufacturing insurance allows us to retain the risks and rewards associated with writing insurance contracts as part of the underwriting profit, investment income and distribution commission are kept within the Group.

Where we do not have the risk appetite or operational scale to be an effective insurance manufacturer, we engage through a handful of leading external insurance companies in order to provide insurance products to our customers through our banking network and direct channels. These arrangements are generally structured with our exclusive strategic partners and earn the Group a combination of commissions, fees and profit-share.

We distribute insurance products in all of our geographical regions. We have core life insurance manufacturing entities, the majority of which are direct subsidiaries of legal banking entities, in seven countries (Argentina, Brazil, Mexico, France, UK, Hong Kong and Singapore). Our life insurance manufacturing entities in the US are held-for-sale at 31 December 2012.

Risk management of insurance operations in 2012

This section provides disclosures on the risks arising from insurance manufacturing operations, including insurance risk and financial risks such as market risk, credit risk and liquidity risk.

Risks in these operations are managed within the insurance entities using methodologies and processes appropriate to the insurance activities, but remain subject to oversight at Group level.

The consolidated Group liquidity and market risk management disclosures exclude insurance operations. The assets of the insurance manufacturing subsidiaries are included within the consolidated Group credit risk disclosures.

Operational and sustainability risks are covered by the Group's overall respective risk management processes and are not included in this section.

Insurance risk

Insurance risk is principally measured in two ways:

· liabilities to policyholders on life insurance contracts; and

· net written insurance premiums for non-life contracts.

The insurance risk profile of our life insurance manufacturing businesses did not change materially during 2012 despite the increase in liabilities to policyholders on these contracts to US$68bn (2011: US$60bn). This growth in liabilities largely resulted from market value gains on underlying financial assets in addition to new business generated during 2012.

The insurance risk profile of our non-life insurance manufacturing businesses changed during the year as net written insurance premiums declined to US$656m (2011: US$993m). This was in line with our strategy to focus on the manufacturing of life insurance products, with non-life manufacturing entities or portfolios in Argentina, Hong Kong, Ireland and Singapore sold during 2012.

A principal risk we continue to face is that, over time, the cost of acquiring and administering a contract, claims and benefits may exceed the aggregate amount of premiums received 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.

In respect of financial risks, subsidiaries manufacturing products with guarantees are usually exposed to falls in market interest rates and equity prices to the extent that the market exposure cannot be managed by utilising any discretionary participation (or bonus) features ('DPF') within the policy contracts they issue.

The following tables analyse our insurance risk exposures by geographical region and by type of business. The insurance risk profile and related exposures remained largely consistent with those observed at 31 December 2011.

Analysis of life insurance risk - liabilities to policyholders⁵⁶

(Audited)

	Europe	Hong Kong	Rest of Asia- Pacific	North America⁵⁷	Latin America	Total
	US$m	US$m	US$m	US$m	US$m	US$m
At 31 December 2012
Life (non-linked) .........................................	1,319	25,615	1,587	-	2,163	30,684
Insurance contracts with DPF⁵⁸ ...............	353	23,685	439	-	-	24,477
Credit life ................................................	160	-	61	-	-	221
Annuities .................................................	586	-	122	-	1,579	2,287
Term assurance and other long-term contracts .............................................	220	1,930	965	-	584	3,699

Life (linked) ................................................	3,249	3,786	594	-	5,427	13,056

Investment contracts with DPF^58,59 .............	24,370	-	4	-	-	24,374

Insurance liabilities to policyholders ............	28,938	29,401	2,185	-	7,590	68,114

At 31 December 2011
Life (non-linked) .........................................	1,163	21,460	1,227	982	2,094	26,926
Insurance contracts with DPF⁵⁸ ...............	335	20,109	338	-	-	20,782
Credit life ................................................	219	-	58	34	-	311
Annuities .................................................	517	-	78	741	1,546	2,882
Term assurance and other long-term contracts .............................................	92	1,351	753	207	548	2,951

Life (linked) ................................................	2,508	3,393	476	-	4,833	11,210

Investment contracts with DPF^58,59 .............	21,477	-	11	-	-	21,488

Insurance liabilities to policyholders ............	25,148	24,853	1,714	982	6,927	59,624

For footnotes, see page 249.

Our most significant life insurance products are investment contracts with DPF issued in France, insurance contracts with DPF issued in Hong Kong and unit-linked contracts issued in Latin America, Hong Kong and the UK. The decline in life insurance liabilities in North America reflects the classification of this business as held for sale at 31 December 2012.

Analysis of non-life insurance risk - net written insurance premiums⁶⁰

(Audited)

	Europe	Hong Kong	Rest of Asia- Pacific	North America	Latin America	Total
	US$m	US$m	US$m	US$m	US$m	US$m
2012
Accident and health .....................................	7	181	7	-	34	229
Motor .........................................................	-	14	20	-	161	195
Fire and other damage .................................	-	20	15	24	20	79
Liability ......................................................	-	15	4	-	1	20
Credit (non-life) ..........................................	-	-	-	36	1	37
Marine, aviation and transport ....................	-	7	4	-	13	24
Other non-life insurance contracts ..............	5	33	1	3	30	72

Total net written insurance premiums .........	12	270	51	63	260	656

Net insurance claims incurred and movement in liabilities to policyholders ....................	(5)	(117)	(22)	(24)	(116)	(284)

	Europe	Hong Kong	Rest of Asia- Pacific	North America	Latin America	Total
	US$m	US$m	US$m	US$m	US$m	US$m
2011
Accident and health .....................................	23	186	8	-	39	256
Motor .........................................................	-	17	25	-	328	370
Fire and other damage .................................	5	29	13	30	29	106
Liability ......................................................	1	16	5	-	1	23
Credit (non-life) ..........................................	6	-	-	48	1	55
Marine, aviation and transport ....................	-	10	3	-	25	38
Other non-life insurance contracts ..............	7	39	1	7	91	145

Total net written insurance premiums .........	42	297	55	85	514	993

Net insurance claims incurred and movement in liabilities to policyholders ....................	56	(127)	(26)	(22)	(231)	(350)

2010
Accident and health .....................................	78	174	8	3	37	300
Motor .........................................................	-	15	28	-	267	310
Fire and other damage .................................	38	29	11	16	22	116
Liability ......................................................	-	20	4	-	2	26
Credit (non-life) ..........................................	25	-	-	53	2	80
Marine, aviation and transport ....................	3	10	4	-	18	35
Other non-life insurance contracts ..............	20	39	1	9	84	153

Total net written insurance premiums .........	164	287	56	81	432	1,020

Net insurance claims incurred and movement in liabilities to policyholders ....................	(169)	(117)	(25)	(13)	(201)	(525)

For footnotes, see page 249.

Our motor business was written predominantly in Argentina; this business was sold in May 2012.

Our accident and health and fire and other damage to property contracts was written in all regions but mainly in Hong Kong; this business was sold in November 2012.

Credit non-life insurance, which was historically originated in conjunction with the provision of loans but now in run-off, was concentrated in the US.

Balance sheet of insurance manufacturing subsidiaries

(Audited)

A principal tool used to manage exposures to both financial and insurance risk, in particular for life insurance contracts, is asset and liability matching. In many markets in which we operate it is neither possible nor appropriate to follow a perfect asset and liability matching strategy. For long-dated non‑linked contracts in particular, this results in a duration mismatch between assets and liabilities. We therefore structure portfolios to support projected liabilities from non-linked contracts.

In the absence of insurable events occurring, unit-linked contracts match assets more directly with liabilities. This results in the policyholder bearing the majority of the financial risk exposure.

The tables below show the composition of assets and liabilities by contract and by geographical region and demonstrate that there were sufficient assets to cover the liabilities to policyholders in each case at the end of 2012.

Balance sheet of insurance manufacturing subsidiaries by type of contract

(Audited)

	Insurance contracts						Investment contracts
	With DPF	Unit- linked	Annu- ities	Term assur- ance⁶¹	Non-life	With	With DPF⁵⁹	Unit- linked	Other	Other assets⁶²	Total
	US$m	US$m	US$m	US$m	US$m		US$m	US$m	US$m	US$m	US$m
At 31 December 2012
Financial assets ...	24,288	12,619	1,785	4,350	356		23,620	8,780	4,315	4,692	84,805
- trading assets	-	-	4	-	-		-	-	-	-	4
- financial assets designated at fair value........	2,333	12,440	571	756	196		6,043	8,206	1,486	987	33,018
- derivatives ....	40	4	-	6	-		117	13	86	69	335
- financial investments ...	18,283	-	932	3,315	73		16,022	-	1,853	2,928	43,406
- other financial assets .............	3,632	175	278	273	87		1,438	561	890	708	8,042
		-
Reinsurance assets ........................	124	593	494	320	14		-	-	-	22	1,567
PVIF⁶³ ................	-	-	-	-	-		-	-	-	4,847	4,847
Other assets and investment properties ........	448	7	34	110	11		754	24	28	2,420	3,836
	-	-
Total assets ........	24,860	13,219	2,313	4,780	381		24,374	8,804	4,343	11,981	95,055

Liabilities under investment contracts:
- designated at fair value .......	-	-	-	-	-		-	8,691	3,765	-	12,456
- carried at amortised cost	-	-	-	-	-		-	-	455	-	455
Liabilities under insurance contracts .........	24,477	13,056	2,287	3,920	81		24,374	-	-	-	68,195
Deferred tax .......	13	-	13	12	1		-	-	-	1,161	1,200
Other liabilities ...	-	-	-	-	-		-	-	-	2,760	2,760
	-	-
Total liabilities ...	24,490	13,056	2,300	3,932	82		24,374	8,691	4,220	3,921	85,066

Total equity .......	-	-	-	-	-		-	-	-	9,989	9,989
	-	-
Total equity and liabilities⁶⁴ ......	24,490	13,056	2,300	3,932	82		24,374	8,691	4,220	13,910	95,055

At 31 December 2011
Financial assets ...	20,520	10,355	2,531	3,398	1,656		20,745	7,843	4,103	7,219	78,370
- trading assets	-	-	3	-	24		-	-	-	-	27
- financial assets designated at fair value........	1,730	10,101	426	594	206		5,491	7,191	1,515	1,616	28,870
- derivatives ....	23	1	-	-	-		231	7	89	7	358
- financial investments ...	15,523	1	1,778	2,540	791		13,732	-	1,913	4,008	40,286
- other financial assets .............	3,244	252	324	264	635		1,291	645	586	1,588	8,829

Reinsurance assets ........................	12	903	441	196	250		-	-	-	42	1,844
PVIF⁶³ ................	-	-	-	-	-		-	-	-	4,092	4,092
Other assets and investment properties ........	384	6	14	188	169		744	28	34	753	2,320

Total assets ........	20,916	11,264	2,986	3,782	2,075		21,489	7,871	4,137	12,106	86,626

Liabilities under investment contracts:
- designated at fair value .......	-	-	-	-	-		-	7,813	3,586	-	11,399
- carried at amortised cost	-	-	-	-	-		-	-	435	-	435
Liabilities under insurance contracts .........	20,782	11,210	2,882	3,262	1,635		21,488	-	-	-	61,259
Deferred tax .......	15	-	21	6	1		-	-	-	931	974
Other liabilities ...	-	-	-	-	-		-	-	-	1,930	1,930

Total liabilities ...	20,797	11,210	2,903	3,268	1,636		21,488	7,813	4,021	2,861	75,997

Total equity .......	-	-	-	-	-		-	-	-	10,629	10,629

Total equity and liabilities⁶⁴ ......	20,797	11,210	2,903	3,268	1,636		21,488	7,813	4,021	13,490	86,626

For footnotes, see page 249.

Balance sheet of insurance manufacturing subsidiaries by geographical region⁵⁶

(Audited)

	Europe	Hong Kong	Rest of Asia- Pacific	North America⁵⁷	Latin America	Total
	US$m	US$m	US$m	US$m	US$m	US$m
At 31 December 2012
Financial assets ............................................	37,325	35,632	2,594	-	9,254	84,805
- trading assets ........................................	-	-	-	-	4	4
- financial assets designated at fair value ..	17,590	7,356	1,370	-	6,702	33,018
- derivatives ............................................	203	126	6	-	-	335
- financial investments ............................	17,139	23,275	994	-	1,998	43,406
- other financial assets ............................	2,393	4,875	224	-	550	8,042


Reinsurance assets .......................................	809	715	8	-	35	1,567
PVIF⁶³ .........................................................	1,140	2,846	304	-	557	4,847
Other assets and investment properties .......	849	983	230	1,573	201	3,836

Total assets .................................................	40,123	40,176	3,136	1,573	10,047	95,055

Liabilities under investment contracts:
- designated at fair value ..........................	7,783	4,673	-	-	-	12,456
- carried at amortised cost .......................	-	-	-	-	455	455
Liabilities under insurance contracts ............	28,954	29,402	2,200	-	7,639	68,195
Deferred tax ................................................	403	532	88	-	177	1,200
Other liabilities ............................................	782	347	267	1,037	327	2,760

Total liabilities ............................................	37,922	34,954	2,555	1,037	8,598	85,066

Total equity ................................................	2,201	5,222	581	536	1,449	9,989

Total equity and liabilities⁶⁴ .........................	40,123	40,176	3,136	1,573	10,047	95,055

At 31 December 2011
Financial assets ............................................	34,163	30,126	2,093	2,414	9,574	78,370
- trading assets ........................................	-	-	-	-	27	27
- financial assets designated at fair value ..	15,583	5,875	1,155	-	6,257	28,870
- derivatives ............................................	244	114	-	-	-	358
- financial investments ............................	15,531	19,858	617	1,846	2,434	40,286
- other financial assets ............................	2,805	4,279	321	568	856	8,829


Reinsurance assets .......................................	746	912	39	19	128	1,844
PVIF⁶³ .........................................................	1,097	2,322	282	65	326	4,092
Other assets and investment properties .......	909	946	31	24	410	2,320

Total assets .................................................	36,915	34,306	2,445	2,522	10,438	86,626

Liabilities under investment contracts:
- designated at fair value ..........................	6,961	4,405	33	-	-	11,399
- carried at amortised cost .......................	-	-	-	-	435	435
Liabilities under insurance contracts ............	25,795	25,160	1,802	1,079	7,423	61,259
Deferred tax ................................................	352	408	60	28	126	974
Other liabilities ............................................	1,200	269	69	13	379	1,930

Total liabilities ............................................	34,308	30,242	1,964	1,120	8,363	75,997

Total equity ................................................	2,607	4,064	481	1,402	2,075	10,629

Total equity and liabilities⁶⁴ .........................	36,915	34,306	2,445	2,522	10,438	86,626

For footnotes, see page 249.

Financial risks

(Audited)

Financial risk exposures can be categorised into:

· Market risk - risks arising from changes in the fair values of financial assets or their future cash flows from fluctuations in variables such as interest rates, foreign exchange rates and equity prices;

· Credit risk - the risk of financial loss following the default of third parties to meet their obligations; and

· Liquidity risk- the risk of not being able to make payments to policyholders as they fall due as there are insufficient assets that can be realised as cash.

Further details on the nature of these financial risks and how they are managed are provided in the Appendix to Risk on page 252.

The following table analyses the assets held in our insurance manufacturing subsidiaries at 31 December 2012 by type of contract, and provides a view of the exposure to financial risk. For linked contracts, which pay benefits to policyholders which are determined by reference to the value of the investments supporting the policies, we typically designate assets at fair value; for non-linked contracts, the classification of the assets is driven by the nature of the underlying contract.

Financial assets held by insurance manufacturing subsidiaries (Audited)
	Life linked	Life non-linked		Non-life	Other
	contracts⁶⁵		contracts⁶⁶	insurance⁶⁷	assets⁶²	Total
	US$m		US$m	US$m	US$m	US$m
At 31 December 2012
Trading assets
Debt securities ......................................	-		4	-	-	4
			-
Financial assets designated at fair value ....	20,646		11,189	196	987	33,018
Treasury bills .......................................	-		39	-	-	39
Debt securities ......................................	8,028		3,607	196	408	12,239
Equity securities ...................................	12,618		7,543	-	579	20,740

Financial investments
Held-to-maturity: debt securities ..............	-		20,245	-	1,548	21,793

Available-for-sale: ...................................	-		20,160	73	1,380	21,613
- debt securities ....................................	-		20,160	66	1,354	21,580
- equity securities .................................	-		-	7	26	33

Derivatives ..............................................	17		249	-	69	335
Other financial assets⁶⁸ ............................	736		6,511	87	708	8,042

Total financial assets⁶⁴ ............................	21,399		58,358	356	4,692	84,805

At 31 December 2011
Trading assets
Debt securities ......................................	-		3	-	-	3
Equity securities ...................................	-		-	24	-	24

Financial assets designated at fair value ....	17,292		9,756	206	1,616	28,870
Treasury bills .......................................	4		107	-	-	111
Debt securities ......................................	6,823		3,198	206	795	11,022
Equity securities ...................................	10,465		6,451	-	821	17,737

Financial investments
Held-to-maturity: debt securities ..............	-		17,506	175	1,300	18,981

Available-for-sale: ...................................	1		17,980	616	2,708	21,305
- other eligible bills ..............................	-		-	-	50	50
- debt securities ....................................	-		17,963	599	2,520	21,082
- equity securities .................................	1		17	17	138	173

Derivatives ..............................................	8		343	-	7	358
Other financial assets⁶⁸ ............................	897		5,709	635	1,588	8,829

Total financial assets⁶⁴ ............................	18,198		51,297	1,656	7,219	78,370

For footnotes, see page 249.

Approximately 65.6% of financial assets were invested in debt securities at 31 December 2012 (2011: 65.2%) with 24.5% (2011: 22.9%) invested in equity securities.

In life linked insurance, premium income less charges levied is invested in a portfolio of assets. We manage the financial risks of this product on behalf of the policyholders by holding appropriate assets in segregated funds or portfolios to which the liabilities are linked. These assets represented 25.2% (2011: 23.2%) of the total financial assets of our insurance manufacturing subsidiaries at the end of 2012.

The remaining financial risks are managed either solely on behalf of the shareholder, or jointly on behalf of the shareholder and policyholders where DPF exist.

Market risk

(Audited)

Market risk arises when mismatches occur between product liabilities and the investment assets which back them. For example, mismatches between asset and liability yields and maturities give rise to interest rate risk.

Long-term insurance or investment products may incorporate benefits that are guaranteed. Where mismatches exist as a result of current yields falling below guaranteed levels for a prolonged period, the risk that shareholder capital is required to meet liabilities to policyholders increases. The table below shows, in respect of each category of guarantee, the total liabilities to policyholders established for guaranteed products manufactured by our insurance subsidiaries. The table also shows the range of investment returns on the assets supporting these products and the implied investment returns that would enable the business to meet the guarantees.

Immediate annuities, where current investment returns are below guarantees, relate to a closed portfolio in the US which is held for sale at 31 December 2012. Annual return guarantees between 4.5-6%, where current investment returns are below guarantees, is a closed portfolio in Hong Kong. The only other portfolio of contracts identified where current investment returns are below guarantees relate to a closed portfolio in France. This portfolio has reserves of US$495m for which current portfolio yields are 3.25% but investment returns implied by the guarantees are 4.5%.

Liabilities to policyholders⁶⁹

(Audited)

	2012			2011
	Amount of reserve	Investment returns implied by guarantee⁶⁴	Current yields	Amount of reserve	Investment returns implied by guarantee⁶⁴	Current yields
	US$m	%	%	US$m	%	%

Annuities in payment ................................	1,379	0.0 - 11.7	4.6 - 20.8	1,414	0.0 - 9.6	4.2 - 25.2
Deferred annuities ......................................	179	0.0 - 6.0	3.3 - 20.4	175	0.0 - 6.0	3.2 - 22.7
Immediate annuities⁷⁰ ................................	485	6.0 - 12.0	5.4 - 5.5	538	6.0 - 12.0	5.3 - 5.4
Annual return ............................................	23,878	0.0 - 2.5	1.4 - 4.7	20,465	0.0 - 2.5	0.0 - 6.9
Annual return ............................................	4,315	2.5 - 4.5	3.3 - 6.7	3,849	2.5 - 4.5	3.3 - 10.0
Annual return ............................................	155	4.5 - 6.0	4.1 - 4.2	163	4.5 - 6.0	6.4 - 6.5
Capital .......................................................	18,779	-	0.0 - 7.2	17,400	-	2.3 - 7.8

For footnotes, see page 249.

The following table illustrates the effects of selected interest rate, equity price, foreign exchange rate and credit spread scenarios on our profit for the year and total equity of our insurance manufacturing subsidiaries.

Where appropriate, we include the impact of the stress on the PVIF in the results of the sensitivity tests. The relationship between the profit and total equity and the risk factors is non-linear and, therefore, the results disclosed should not be extrapolated to measure sensitivities to different levels of stress. The sensitivities are stated before allowance for management actions which may mitigate the effect of changes in market rates, and for any factors such as policyholder behaviour that may change in response to changes in market risk.

Sensitivity of HSBC's insurance manufacturing subsidiaries to market risk factors

(Audited)

	2012		2011
	Effect on profit for the year	Effect on total equity	Effect on profit for the year	Effect on total equity
	US$m	US$m	US$m	US$m

+ 100 basis points parallel shift in yield curves ...................	125	(263)	108	(178)
- 100 basis points parallel shift in yield curves ...................	(208)	205	(115)	191
10% increase in equity prices .............................................	91	91	106	106
10% decrease in equity prices .............................................	(92)	(92)	(164)	(164)
10% increase in US dollar exchange rate compared to all currencies ..............................................	40	40	31	31
10% decrease in US dollar exchange rate compared to all currencies ..............................................	(40)	(40)	(31)	(31)
Sensitivity to credit spread increases ..................................	(18)	(50)	(30)	(75)

Credit risk

(Audited)

Credit risk can give rise to losses through default and can lead to volatility in our income statement and balance sheet figures through movements in credit spreads, principally on the US$48bn (2011: US$44bn) non‑linked bond portfolio.

As tabulated above, the sensitivity of the net profit after tax of our insurance subsidiaries to the effects of increases in credit spreads has decreased since 2011 due to narrowing of credit spreads experienced in 2012. The balance and related movement are small because about 90% of the debt securities held by our insurance subsidiaries are classified as either held to maturity or available for sale, and consequently any changes in the fair value of these financial investments, absent impairment, would have no effect on the profit after tax. We calculate the sensitivity using simplified assumptions based on a one-day movement in credit spreads over a two-year period. A confidence level of 99%, consistent with our Group VAR, is applied.

Credit quality

(Audited)

The following table presents an analysis of treasury bills, other eligible bills and debt securities within our Insurance business by measures of credit quality. The five credit quality classifications are defined in the Appendix to Risk on page 253. Only assets supporting liabilities under non-linked insurance and investment contracts and shareholders' funds are included in the table as financial risk on assets supporting linked liabilities is predominantly borne by the policyholder. 83.5% (2011: 86.6%) of the assets included in the table are invested in investments rated as strong.

Treasury bills, other eligible bills and debt securities in HSBC's insurance manufacturing subsidiaries

(Audited)

	Neither past due nor impaired
	Strong⁶²	Good	Satisfactory	Sub-standard	Total
	US$m	US$m	US$m	US$m	US$m
At 31 December 2012

Supporting liabilities under non-linked insurance and investment contracts
Trading assets - debt securities ..............................	1	-	3	-	4

Financial assets designated at fair value ..................	2,807	638	219	178	3,842
- treasury and other eligible bills ........................	39	-	-	-	39
- debt securities .................................................	2,768	638	219	178	3,803

Financial investments ............................................	34,392	4,265	1,627	187	40,471
- debt securities .................................................	34,392	4,265	1,627	187	40,471


	37,200	4,903	1,849	365	44,317

	Neither past due nor impaired
	Strong⁶²	Good	Satisfactory	Sub-standard	Total
	US$m	US$m	US$m	US$m	US$m
Supporting shareholders' funds⁷¹
Financial assets designated at fair value ..................	229	146	13	20	408
- debt securities .................................................	229	146	13	20	408

Financial investments ............................................	2,356	353	131	62	2,902
- debt securities .................................................	2,356	353	131	62	2,902


	2,585	499	144	82	3,310

Total⁶⁴
Trading assets - debt securities ..............................	1	-	3	-	4

Financial assets designated at fair value ..................	3,036	784	232	198	4,250
- treasury and other eligible bills ........................	39	-	-	-	39
- debt securities .................................................	2,997	784	232	198	4,211

Financial investments ............................................	36,748	4,618	1,758	249	43,373
- debt securities .................................................	36,748	4,618	1,758	249	43,373


	39,785	5,402	1,993	447	47,627

At 31 December 2011

Supporting liabilities under non-linked insurance and investment contracts
Trading assets - debt securities .............................	1	-	2	-	3

Financial assets designated at fair value ................	2,851	168	349	143	3,511
- treasury and other eligible bills .......................	107	-	-	-	107
- debt securities ................................................	2,744	168	349	143	3,404

Financial investments ..........................................	32,062	2,716	1,269	196	36,243
- debt securities ................................................	32,062	2,716	1,269	196	36,243


	34,914	2,884	1,620	339	39,757

Supporting shareholders' funds⁷¹
Financial assets designated at fair value ................	341	348	61	45	795
- debt securities ................................................	341	348	61	45	795

Financial investments ..........................................	3,198	560	83	29	3,870
- other eligible bills ..........................................	50	-	-	-	50
- debt securities ................................................	3,148	560	83	29	3,820


	3,539	908	144	74	4,665

Total⁶⁴
Trading assets - debt securities .............................	1	-	2	-	3

Financial assets designated at fair value ................	3,192	516	410	188	4,306
- treasury and other eligible bills .......................	107	-	-	-	107
- debt securities ................................................	3,085	516	410	188	4,199

Financial investments ..........................................	35,260	3,276	1,352	225	40,113
- other eligible bills ..........................................	50	-	-	-	50
- debt securities ................................................	35,210	3,276	1,352	225	40,063


	38,453	3,792	1,764	413	44,422

For footnotes, see page 249.

Credit risk also arises when assumed insurance risk is ceded to reinsurers. The split of liabilities ceded to reinsurers and outstanding reinsurance recoveries, analysed by credit quality, is shown below. Our exposure to third parties under the reinsurance agreements described in the Appendix to Risk on page 274 is included in this table.

Reinsurers' share of liabilities under insurance contracts

(Audited)

	Neither past due nor impaired				Past due
	Strong	Good	Satisfactory	Sub- standard	but not impaired	Total
	US$m	US$m	US$m	US$m	US$m	US$m

At 31 December 2012
Linked insurance contracts ..........................	55	400	-	-	-	455
Non-linked insurance contracts ...................	936	4	6	-	6	952

Total⁶⁴ ........................................................	991	404	6	-	6	1,407

Reinsurance debtors .....................................	19	133	-	-	8	160

At 31 December 2011
Linked insurance contracts ..........................	45	858	-	-	-	903
Non-linked insurance contracts ...................	782	10	104	3	-	899

Total⁶⁴ ........................................................	827	868	104	3	-	1,802

Reinsurance debtors .....................................	18	2	9	1	12	42

For footnote, see page 249.

Liquidity risk

(Audited)

The following tables show the expected undiscounted cash flows for insurance contract liabilities and the remaining contractual maturity of investment contract liabilities at 31 December 2012. A significant proportion of our non-life insurance business is viewed as short-term, with the settlement of liabilities expected to occur within one year of the period of risk. There is a greater spread of expected maturities for the life business where, in a large proportion of cases, the liquidity risk is borne in conjunction with policyholders (wholly borne by the policyholder in the case of unit-linked business).

The profile of the expected maturity of the insurance contracts at 31 December 2012 remained comparable with 2011.

Expected maturity of insurance contract liabilities

(Audited)

	Expected cash flows (undiscounted)
	Within 1 year	1-5 years	5-15 years	Over 15 years	Total
	US$m	US$m	US$m	US$m	US$m
At 31 December 2012
Non-life insurance ...................................	78	3	-	-	81
Life insurance (non-linked) ......................	4,176	12,199	23,420	27,836	67,631
Life insurance (linked) .............................	1,243	3,761	10,446	13,497	28,947

Total⁶⁴ ....................................................	5,497	15,963	33,866	41,333	96,659

At 31 December 2011
Non-life insurance ...................................	742	704	176	13	1,635
Life insurance (non-linked) ......................	2,006	12,243	21,332	25,990	61,571
Life insurance (linked) .............................	920	3,262	9,070	15,546	28,798

Total⁶⁴ ....................................................	3,668	16,209	30,578	41,549	92,004

For footnote, see page 249.

Remaining contractual maturity of investment contract liabilities

(Audited)

	Liabilities under investment contracts by insurance manufacturing subsidiaries
	Linked investment contracts	Other investment contracts	Investment contracts with DPF	Total
	US$m	US$m	US$m	US$m
At 31 December 2012
Remaining contractual maturity:⁶⁴
- due within 1 year ........................................................	195	458	4	657
- due between 1 and 5 years ...........................................	675	-	-	675
- due between 5 and 10 years .........................................	731	-	-	731
- due after 10 years .......................................................	2,061	-	-	2,061
- undated⁷² ....................................................................	5,029	3,762	24,370	33,161

	8,691	4,220	24,374	37,285
At 31 December 2011
Remaining contractual maturity:⁶⁴
- due within 1 year ........................................................	191	438	8	637
- due between 1 and 5 years ...........................................	595	-	3	598
- due between 5 and 10 years .........................................	548	-	-	548
- due after 10 years .......................................................	2,063	-	-	2,063
- undated⁷² ....................................................................	4,416	3,583	21,477	29,476

	7,813	4,021	21,488	33,322

For footnotes, see page 249.

Present value of in-force long-term insurance business

(Audited)

Our life insurance business is accounted for using the embedded value approach which, inter alia, provides a risk and valuation framework. The PVIF asset at 31 December 2012 was US$4.8bn (2011: US$4.1bn), representing the present value of the shareholders' interest in the profits expected to emerge from the book of in-force policies at that date.

The PVIF calculation projects expected cash flows, adjusted for a variety of assumptions made by each insurance operation to reflect local market conditions and management's judgement of future trends. The main assumptions relate to economic and non-economic assumptions and policyholder behaviour. Assumptions are subject to uncertainty and can contribute to volatility in the results of the Insurance business.

The key drivers of the movement in the value of the PVIF asset are the expected cash flows from:

· new business adjusted for anticipated maturities and assumptions relating to policyholder behaviour ('Value of new business written during the year');

· unwind of the discount rate less the reversal of expected cash flows for the period ('Expected return');

· changes in non-economic operating assumptions such as mortality or lapse rates ('Change in operating assumptions');

· impacts arising from changes in projected future cash flows associated with operating assumption experience variances compared to those assumed at the start of the period ('Experience variances');

· changes related to future investment returns ('Changes in investment assumptions'); and

· the impact of actual investment experience on future cash flows compared to those assumed at the start of the period ('Investment return variances').

The valuation of the PVIF asset includes explicit risk margins for non-economic risks in the projection assumptions and explicit allowances for financial options and guarantees using stochastic methods. Risk discount rates are set on an active basis with reference to market risk free yields.

The following table shows the movements recorded during the year in respect of total equity and PVIF of insurance operations.

Movements in PVIF and total equity of insurance operations

(Audited)

	2012		2011
	PVIF	Total equity	PVIF	Total equity
	US$m	US$m	US$m	US$m

At 1 January ......................................................................	4,092	10,629	3,440	9,778

Change in PVIF of long-term insurance business .................	737	737	726	726
Value of new business written during the year⁷³ ...................	1,027		943
Movements arising from in-force business:
- expected return ...........................................................	(420)		(428)
- experience variances⁷⁴ .................................................	12		1
- changes in operating assumptions ................................	(3)		(222)
Investment return variances ...............................................	(18)		(103)
Changes in investment assumptions ...................................	78		294
Other adjustments ..............................................................	61		241

Return on net assets ...........................................................	-	1,232	-	1,057
Capital transactions ...........................................................	-	(1,525)	-	(500)
Disposals of subsidiaries/portfolios .....................................	-	(382)	-	(96)
Exchange differences and other ..........................................	18	(702)	(74)	(336)

At 31 December .................................................................	4,847	9,989	4,092	10,629

For footnotes, see page 249.

Other adjustments for 2012 included a one-off gain of US$119m for a PVIF asset recognised on linked insurance business in Brazil. For 2011, other adjustments related to the US$243m gain recognised upon refinement of the PVIF calculation.

Key assumptions used in the computation of PVIF for main life insurance operations

(Audited)

	2012			2011
	UK	Hong Kong	France	UK	Hong Kong	France
	%	%	%	%	%	%

Risk free rate ................................................	1.53	0.60	2.12	2.24	1.47	2.77
Risk discount rate .........................................	2.03	7.46	4.05	2.74	8.00	5.95
Expense inflation .........................................	2.84	3.00	2.00	3.45	3.00	2.00

Economic assumptions

(Audited)

The following table shows the effect on the PVIF of reasonably possible changes in the main economic assumption, risk-free rates, across all insurance manufacturing subsidiaries.

Due to certain characteristics of the contracts, the relationships are non-linear and the results of the sensitivity testing should not be extrapolated to higher levels of stress. The sensitivities shown are before actions that could be taken by management to mitigate effects and before resultant changes in policyholder behaviour.

Sensitivity of PVIF to changes in economic assumptions

(Audited)

	PVIF at 31 December
	2012	2011
	US$m	US$m

+ 100 basis point shift in risk-free rate ............	137	128
- 100 basis point shift in risk-free rate ............	(191)	(91)

Non-economic assumptions

(Audited)

We determine the policyholder liabilities for non-life manufacturers by reference to non-economic assumptions including claims costs and expense rates.

Policyholder liabilities and PVIF for life manufacturers are determined by reference to non-economic assumptions including mortality and/or morbidity, lapse rates and expense rates. The table below shows the sensitivity of profit for 2012 and total equity at 31 December 2012 to reasonably possible changes in these non-economic assumptions at that date across all our insurance manufacturing subsidiaries, with comparatives for 2011.

The cost of claims is a risk associated with non-life insurance business. An increase in claims costs would have a negative effect on profit. Sensitivities have significantly decreased since 2011 due to the disposal of the non-life entities or portfolios in Argentina, Hong Kong, Ireland and Singapore during 2012.

Mortality and morbidity risk is typically associated with life insurance contracts. The effect on profit of an increase in mortality or morbidity depends on the type of business being written. Our largest exposures to mortality and morbidity risk exist in Brazil, France, Hong Kong and the US.

Sensitivity to lapse rates depends on the type of contracts being written. For insurance contracts, claims are funded by premiums received and income earned on the investment portfolio supporting the liabilities. For a portfolio of term assurance, an increase in lapse rates typically has a negative effect on profit due to the loss of future premium income on the lapsed policies. However, some contract lapses have a positive effect on profit due to the existence of policy surrender charges. Brazil, France, Hong Kong and the UK are where we are most sensitive to a change in lapse rates.

Expense rate risk is the exposure to a change in expense rates. To the extent that increased expenses cannot be passed on to policyholders, an increase in expense rates will have a negative impact on our profits.

Sensitivity analysis

(Audited)

	Effect on profit and total equity at 31 December
	Life	Non-life	Total
	US$m	US$m	US$m

2012
20% increase in claims costs ......................................................	-	(12)	(12)
20% decrease in claims costs .....................................................	-	12	12
10% increase in mortality and/or morbidity rates ......................	(88)	-	(88)
10% decrease in mortality and/or morbidity rates ......................	92	-	92
50% increase in lapse rates ........................................................	(491)	-	(491)
50% decrease in lapse rates ........................................................	842	-	842
10% increase in expense rates ...................................................	(105)	(1)	(106)
10% decrease in expense rates ...................................................	106	1	107

2011
20% increase in claims costs ......................................................	-	(135)	(135)
20% decrease in claims costs .....................................................	-	135	135
10% increase in mortality and/or morbidity rates ......................	(100)	-	(100)
10% decrease in mortality and/or morbidity rates ......................	110	-	110
50% increase in lapse rates ........................................................	(349)	-	(349)
50% decrease in lapse rates ........................................................	609	-	609
10% increase in expense rates ...................................................	(89)	(12)	(101)
10% decrease in expense rates ...................................................	89	12	101

Other material risks

	Page	App¹	Tables	Page

Reputational risk .......................................	246	278

Pension risk ................................................	246	278
Pension plans in the UK ................................		279
The principal plan .........................................	246		The principal plan - target asset allocation .................	247
			Benefit payments (US$m) ............................................	247
Future developments ......................................	248
Pension plans in Hong Kong ..........................		279
The HSBC Group Hong Kong Local Staff Retirement Benefit Scheme ........................	248
Pension plans in North America ....................		280
The HSBC North America (US) Retirement Income Plan ..............................................	249

Sustainability risk .....................................	249	280


1. Appendix to Risk - risk policies and practices.

Reputational risk

(Unaudited)

The safeguarding of our reputation is paramount. It is the responsibility of all members of staff, supported by a global risk management structure underpinned by relevant policies and practices, readily available guidance, and regular training.

We have acknowledged, in the context of last year's US Senate Permanent Subcommittee on Investigations, the Deferred Prosecution Agreements with US authorities and the undertakings with the UK FSA, that it was not enough to fix the specific issues that they focused on. Additionally, therefore, we have outlined our implementation of a global strategy to tackle the root causes of these identified deficiencies.

With a new senior leadership team and a new strategy in place since 2011, HSBC has already taken steps to augment the framework to address these issues including making significant changes to strengthen compliance, risk management and culture. These steps, which should also serve, over time, to enhance our reputational risk management, are discussed further on page 278.

Success in detecting and preventing illicit actors' access to the global financial system calls for constant vigilance and HSBC will continue to work in close cooperation with all governments to achieve this. This is integral to the execution of HSBC's strategy, to our core values and to preserving and enhancing our reputation.

Pension risk

(Audited)

We operate a number of pension plans throughout the world. Some are defined benefit plans, of which the largest is the HSBC Bank (UK) Pension Scheme ('the principal plan').

There were no material changes to our policies and procedures for the management of pension risk in 2012.

During 2012, the Group's defined benefit pension plans reduced from a net liability of US$0.2bn to a net asset of US$0.03bn. This was mainly due to growth in the value of the principal plan's assets outstripping the comparable growth in liabilities.

The principal plan

(Audited)

In 2006 the principal plan assets consisted of a strategic portfolio. At the time, HSBC and the trustee of the principal plan agreed to change the investment strategy in order to reduce the investment risk. The target asset allocations for this strategy at that time, as revised in 2011 and at this year end are shown below, demonstrating the ongoing evolution of the strategy. The strategy is to hold the majority of assets in bonds, with the remainder in a more diverse range of investments, and includes a commitment to undertake a programme of swap arrangements (see Note 44 on the Financial Statements) by which the principal plan makes Libor-related interest payments in exchange for the receipt of cash flows which are based on projected future benefit payments to be made from the principal plan.

The principal plan - target asset allocation

	2012	2011	2006
	%	%	%

Equities .................	15.5	15.5	15.0
Bonds ....................	60.5	60.5	50.0
Alternative assets⁷⁵ ..............................	9.5	9.5	10.0
Property ...............	9.0	9.0	10.0
Cash ......................	5.5	5.5	15.0

	100.0	100.0	100.0

For footnote, see page 249.

As a result of a special contribution to the principal plan in June 2010 of £1,760m (US$2,638m), a cash generating portfolio was established. The portfolio comprised supra-national, agency and government-guaranteed securities, ABSs, corporate subordinated debt and auction rate securities. A further special contribution in December 2011 of £184m (US$286m) added to this portfolio. The contribution was used to purchase ABSs from HSBC at an arm's length value determined by the Scheme's independent third-party advisers. However, these assets may be supplemented with other assets from time to time.

The latest actuarial valuation of the principal plan was made as at 31 December 2011 by C G Singer, Fellow of the Institute of Actuaries, of Towers Watson Limited. At that date, the market value of the HSBC Bank (UK) Pension Scheme's assets was £18.3bn (US$28.3bn) (including assets relating to the defined benefit plan, the defined contribution plan and additional voluntary contributions). The market value of the plan assets represented 100% of the amount expected to be required, on the basis of the assumptions adopted, to provide the benefits accrued to members after allowing for expected future increases in earnings. There was therefore no resulting surplus/deficit. The method adopted for this valuation was the projected unit method.

The expected cash flows from the principal plan were projected by reference to the Retail Price Index ('RPI') swap break-even curve at 31 December 2011. Salary increases were assumed to be 0.5% per annum above RPI and inflationary pension increases, subject to a minimum of 0% and a maximum of 5% (maximum of 3% per annum in respect of service accrued since 1 July 2009), were assumed to be in line with RPI. The projected cash flows were discounted at the Libor swap curve at 31 December 2011 plus a margin for the expected return on the investment strategy of 160bps per annum. The mortality experience of the principal plan's pensioners over the six-year period (2006-2011) was analysed and, on the basis of this analysis, the mortality assumptions were set, based on the SAPS S1 series of tables adjusted to reflect the pensioner experience. Allowance was made for future improvements to mortality rates in line with the Continuous Mortality Investigation core projections with a long run improvement rate set at 2% for males and 1.5% for females. The benefits payable from the defined benefit plan from 2013 are expected to be as shown in the chart below.

Benefit payments (US$m)

As part of the 31 December 2011 valuation, calculations were also carried out as to the amount of assets that might be needed to meet the liabilities if the Scheme was discontinued and the members' benefits bought out with an insurance company (although in practice this may not be possible for a plan of this size) or the Trustee continued to run the plan without the support of HSBC. The amount required under this approach was estimated to be £26.2bn (US$40.6bn) as at 31 December 2011. In arriving at this estimation, a more prudent assumption about future mortality was made than for the assessment of the ongoing position and it was assumed that the Trustee would alter the investment strategy to be an appropriately matched portfolio of UK government bonds. An explicit allowance for expenses was also included.

Based on the latest valuation as at 31 December 2011 and there being no deficit, no Technical Provisions Recovery Plan is required and the schedule of future funding payments agreed after the 2008 actuarial valuation was dissolved.

HSBC and the Trustee have developed a general framework, which, over time, will see the Scheme's asset strategy evolve to be less risky and further aligned to future cash-flows, referred to as the Target Matching Portfolio ('TMP'). Evolution to the TMP can be achieved by asset returns in excess of that assumed and/or additional funding. In February 2013, HSBC agreed to make three general framework contributions of £64m (US$103m) in each of the calendar years 2013, 2014 and 2015.

After the 2008 valuation, HSBC considered that the agreed recovery plan payments, together with investment returns (at an expected level of 240 basis points above the Libor swap curve), would be sufficient to meet the deficit as at 31 December 2008 over the agreed period. HSBC also agreed with the Trustee, that at each subsequent actuarial valuation any shortfall in investment returns relative to this expected level, subject to a maximum of 50 basis points per annum, would be eliminated by payment of equal cash instalments over the remaining years to the end of the recovery plan period.

Although the 2011 triennial valuation disclosed no deficit and therefore no technical provisions recovery plan is required, HSBC and the Trustee have agreed to maintain this investment performance underwriting agreement. The investment performance will be assessed every three years, with an end date of 31 December 2017. Any payments due would only be payable if a Technical Provisions deficit is present at the reference date.

HSBC Bank is also making ongoing contributions to the principal plan in respect of the accrual of benefits of defined benefit section members. Since April 2010, after completion of the 2008 valuation, HSBC has paid contributions at the rate of 34% of pensionable salaries (less member contributions).

Following completion of the 2011 triennial valuation, HSBC will pay contributions at the rate of 43% of pensionable salaries (less member contributions) from 1 April 2013. An additional employer contribution will be paid on or before 30 April 2013 equal to 9% of pensionable salaries, in respect of the period 1 January 2012 to 31 March 2013.

Future developments

(Unaudited)

In January 2013, as part of a wider review of employee benefits, HSBC announced proposals to cease future accrual of service for active members of the Defined Benefit Section with effect from 30 June 2014. Under the proposals, all active members of the Defined Benefit Section will become deferred members from 30 June 2014 (and will become members of the Defined Contribution Section from 1 July 2014).

The valuation of the Scheme's defined benefit obligation is sensitive to changes in actuarial assumptions. The proposed removal of future salary escalation from the pay assumptions is estimated to reduce the defined benefit obligation by approximately US$0.3bn and the proposed change in the underlying inflation assumption for indexation from RPI, for active members, to CPI, for deferred members, by a further US$0.5bn. The proposed cessation of the Scheme to provide ill-health benefits to members, to be covered by insurance policies provided by HSBC under these proposals, is estimated to reduce the defined benefit obligation by approximately US$0.5bn.

The consultation period for these proposals will end, and a final decision is expected to be made, in the second quarter of 2013 at which time a past service credit will be recognised in the income statement.

The future effect of these proposed changes on the income statement is dependent primarily on the level of pension contributions made by HSBC and employees to the Defined Contribution Section, the final outcome of which remains uncertain. In all reasonably likely scenarios, the net effect on earnings over time is not expected to be material.

The HSBC Group Hong Kong Local Staff Retirement Benefit Scheme

(Audited)

The scheme mainly invests in bonds with a smaller portion in equities and each investment manager has been assigned an investment mandate with the targeted asset allocation. The ranges of target asset allocations for the portfolio are as follows: Bonds and cash 55-100%, Equity 0-25% and Alternative Investments 0-20%. Alternative Investments refer to high-return and high-risk alternatives, including but not limited to private equity funds, hedge funds, energy, gold, agriculture, commodities and distressed assets.

The latest actuarial valuation of the defined benefit scheme was made at 31 December 2010 by Wing Lui, Fellow of the Society of Actuaries, of Towers Watson Hong Kong Limited. At that valuation date, the market value of the defined benefit scheme's assets was US$1,109m. On an ongoing basis, the defined benefit scheme's assets represented 104% of the actuarial present value of the benefits accrued to members, after allowing for expected future increases in salaries, and the resulting surplus amounted to US$41m. On a wind-up basis, the scheme's assets represented 110% of the members' vested benefits, based on current salaries, and the resulting surplus amounted to US$105m. The attained age method has been adopted for the valuation and the major assumptions used in this valuation were a discount rate of 6% per annum and long-term salary increases of 5% per annum. The recommended employer contribution rate as a percentage of scheme salaries is 14.3% over the period 1 January 2011 to 31 December 2013. No additional special contributions have been agreed.

The HSBC North America (US) Retirement Income Plan

(Audited)

In 2010, the Investment Committee (the 'Committee') unanimously agreed to transition the Plan's target asset allocation mix to 40% equity securities, 59% fixed income securities and 1% cash over a 24‑month period. In 2011, the Committee decided to accelerate this shift to the 2011 year-end and the target asset allocation mix was maintained during 2012. Should interest rates rise faster than currently projected by the Committee, a further shift to a higher percentage of fixed income securities may be made.

In the third quarter of 2012, it was agreed to cease all future contributions under the cash balance formula and freeze the plan with effect from 1 January 2013. While participants with existing balances continue to receive interest credits until the account is distributed, they no longer accrue benefits beginning in 2013.

The most recent actuarial valuation of the plan to determine compliance with US statutory funding requirements was made at 1 January 2012 by Jennifer Jakubowski, Fellow of the Society of Actuaries, Enrolled Actuary, member of the American Academy of Actuaries, formerly of Mercer. At that date, the market value of the plan's assets was US$3,194m. The assets represented 118% of the benefits accrued to members as valued under the provisions of the Pension Protection Act of 2006 that was effective for the plan year beginning 1 January 2008. The resulting surplus amounted to US$479m. The method employed for this valuation was the traditional unit credit method and the discount rate was determined using a segment rate method as selected by HSBC under the relevant regulations, which resulted in an effective interest rate of 7.13% per annum.

Sustainability risk

(Unaudited)

Assessing the environmental and social impacts of providing finance to our customers is integral to our overall risk management processes.

In 2012, we implemented several changes to our policies and procedures to streamline our management of sustainability risks. This ranged from producing guidelines on how we extend the Equator Principles beyond project finance into corporate loans, to technical fixes in our systems to improve the accuracy of our management information.

A summary of our current policies and practices regarding reputational risk, pension risk and sustainability risk is provided in the Appendix to Risk on page 278.

Footnotes to Risk

Credit risk

1 'Other personal loans and advances' include second lien mortgages and other property-related lending.

2 'Financial' includes loans and advances to banks.

3 The amount of the loan commitments reflects, where relevant, the expected level of take-up of pre-approved loan offers made by mailshots to personal customers. In addition to those amounts, there is a further maximum possible exposure to credit risk of US$28bn (2011: US$171bn), reflecting the full take-up of such irrevocable loan commitments. The take-up of such offers is generally at modest levels.

4 Includes residential mortgages of HSBC Bank USA and HSBC Finance.

5 Comprising Rest of Asia-Pacific, Middle East and North Africa, and Latin America.

6 HSBC Finance lending is shown on a management basis and includes loans transferred to HSBC USA Inc. which are managed by HSBC Finance.

7 Property acquired through foreclosure is initially recognised at the lower of the carrying amount of the loan or its fair value less estimated costs to sell ('Initial Foreclosed Property Carrying Amount'). The average loss on sale of foreclosed properties is calculated as cash proceeds less the Initial Foreclosed Properties Carrying Amount divided by the unpaid loan principal balance prior to write-down (excluding any accrued finance income) plus certain other ancillary disbursements that, by law, are reimbursable from the cash proceeds (e.g. real estate tax advances) and were incurred prior to our taking title to the property. This ratio represents the portion of our total loss on foreclosed properties that occurred after we took title to the property.

8 The average total loss on foreclosed properties includes both the loss on sale of the foreclosed property as discussed in footnote 7 and the cumulative write-downs recognised on the loans up to the time we took title to the property.

9 'Other commercial loans and advances' include advances in respect of agriculture, transport, energy and utilities.

10 Impairment allowances are not reported for financial instruments whereby the carrying amount is reduced directly for impairment and not through the use of an allowance account.

11 Impairment is not measured for assets held in trading portfolios or designated at fair value as assets in such portfolios are managed according to movements in fair value, and the fair value movement is taken directly to the income statement. Consequently, we report all such balances under 'Neither past due nor impaired'.

12 'Loans and advances to customers' includes asset-backed securities that have been externally rated as strong (2012: US$2.3bn; 2011: US$3.5bn), good (2012: US$457m; 2011: US$476m), satisfactory (2012: US$390m; 2011: US$428m), sub-standard (2012: US$422m; 2011: US$556m) and impaired (2012: US$259m; 2011: US$229m).

13 Included in this category are loans of US$2.3bn (2011: US$2.9bn) that have been re-aged once and were less than 60 days past due at the point of re-age. These loans are not classified as impaired following re-age due to the overall expectation that these customers will perform on the original contractual terms of their borrowing in the future.

14 'Impaired loans and advances' are those classified as CRR 9, CRR 10, EL 9 or EL 10, retail loans 90 days or more past due, unless individually they have been assessed as not impaired (see page 156, 'Past due but not impaired gross financial instruments') and renegotiated loans and advances meeting the criteria to be disclosed as impaired (see page 162).

15 'Collectively assessed loans and advances' comprise homogeneous groups of loans that are not considered individually significant, and loans subject to individual assessment where no impairment has been identified on an individual basis, but on which a collective impairment allowance has been calculated to reflect losses which have been incurred but not yet identified.

16 'Collectively assessed loans and advances not impaired' are those classified as CRR1 to CRR8 and EL1 to EL8 but excluding retail loans 90 days past due and renegotiated loans and advances meeting the criteria to be disclosed as impaired.

17 'Collectively assessed impairment allowances' are allocated to geographical segments based on the location of the office booking the allowances or provisions. Consequently, the collectively assessed impairment allowances booked in Hong Kong may cover assets booked in branches located outside Hong Kong, principally in Rest of Asia-Pacific, as well as those booked in Hong Kong.

18 Included within 'Exchange and other movements' is US$0.8bn of impairment allowances reclassified to held for sale (2011: US$1.6bn).

19 Net of repo transactions, settlement accounts and stock borrowings.

20 As a percentage of loans and advances to banks and loans and advances to customers, as applicable.

21 'Currency translation' is the effect of translating the results of subsidiaries and associates for the previous year at the average rates of exchange applicable in the current year.

22 Negative numbers are favourable: positive numbers are unfavourable.

23 Equity securities not included.

24 'First lien residential mortgages' include Hong Kong Government Home Ownership Scheme loans of US$3.2bn at 31 December 2012 (2011: US$3.3bn). Where disclosed, earlier comparatives were 2010: US$3.5bn; 2009: US$3.5bn; 2008: US$3.9bn.

25 The impairment allowances on loans and advances to banks in 2012 relate to the geographical regions, Europe, North America, and Middle East and North Africa. (2011: Europe and North America).

26 Carrying amount of the net principal exposure.

27 Total includes holdings of ABSs issued by The Federal Home Loan Mortgage Corporation ('Freddie Mac') and The Federal National Mortgage Association ('Fannie Mae').

28 'Directly held' includes assets held by Solitaire where we provide first loss protection and assets held directly by the Group.

29 'Effect of impairments' represents the reduction or increase in the reserve on initial impairment and subsequent reversal of impairment of the assets.

30 The gross principal is the redemption amount on maturity or, in the case of an amortising instrument, the sum of the future redemption amounts through the residual life of the security.

31 Credit default swap ('CDS') gross protection is the gross principal of the underlying instrument that is protected by CDSs.

32 Net principal exposure is the gross principal amount of assets that are not protected by CDSs. It includes assets that benefit from monoline protection, except where this protection is purchased with a CDS.

33 Net exposure after legal netting and any other relevant credit mitigation prior to deduction of the credit valuation adjustment.

34 Cumulative fair value adjustment recorded against exposures to OTC derivative counterparties to reflect their creditworthiness.

35 Funded exposures represent the loan amount advanced to the customer, less any fair value write-downs, net of fees held on deposit.

36 Unfunded exposures represent the contractually committed loan facility amount not yet drawn down by the customer, less any fair value write-downs, net of fees held on deposit.

Eurozone exposures

37 Our available-for-sale holdings in sovereign and agency debt of Italy and Spain include debt held to support insurance contracts which provide discretionary profit participation to policyholders. For such contracts, unrealised movements in liabilities are recognised in other comprehensive income, following the treatment of the unrealised movements on related available-for-sale assets. To the extent that the movements are matched, no movement in the available-for-sale reserve is recognised. For those available-for-sale debt instruments described above that are not held to support insurance contracts which provide discretionary profit participation to policyholders, the available-for-sale reserves at 31 December 2012 were insignificant.

38 'In-country liabilities' in Italy include liabilities issued under local law but booked outside the country.

Liquidity and funding

39 The most favourable metrics are a smaller advances to core funding and larger stressed one-month and three-month coverage ratios.

40 The HSBC UK entity shown comprises three legal entities; HSBC Bank plc (including SPEs consolidated by HSBC Bank plc for Financial Statement purposes, HFC Bank Ltd, and all overseas branches), Marks and Spencer Financial Services Limited and HSBC Trust Company (UK) Limited, managed as a single operating entity, in line with the application of UK liquidity regulation as agreed with the UK FSA.

41 The Hongkong and Shanghai Banking Corporation represents the bank in Hong Kong including all overseas branches. Each branch is monitored and controlled for liquidity and funding risk purposes as a stand-alone operating entity.

42 The HSBC USA principal entity shown represents the HSBC USA Inc consolidated group; predominantly HSBC USA Inc and HSBC Bank USA, NA. The HSBC USA Inc consolidated group is managed as a single operating entity.

43 The total shown for other principal HSBC operating entities represents the combined position of all the other operating entities overseen directly by the Risk Management Meeting of the GMB.

44 Estimated liquidity value represents the expected realisable value of assets prior to management assumed haircuts.

45 The undrawn balance for the five largest committed liquidity facilities provided to customers other than facilities to conduits.

46 The undrawn balance for the total of all committed liquidity facilities provided to the largest market sector, other than facilities to conduits.

47 As a result of the significant level of disposal groups held for sale at 31 December 2012, the financial liabilities of the disposal groups held for sale has been separately shown in the table. For further details of the disposal groups held for sale, refer to Note 30 on the Financial Statements.

Market risk

48 The standard deviation measures the variation of daily revenues about the mean value of those revenues.

49 Revenues within the daily distribution graph include all revenues booked in Global Markets (gross of brokerage fees). The effect of any month-end adjustments, not attributable to a specific daily market move, is spread evenly over the days in the month in question. The 2012 daily distribution of trading revenues excludes the effect of the one-off credit valuation adjustment on derivative assets of US$903m.

50 Trading intent portfolios include positions arising from market-making and position taking.

51 Portfolio diversification is the market risk dispersion effect of holding a portfolio containing different risk types. It represents the reduction in unsystematic market risk that occurs when combining a number of different risk types, for example, interest rate, equity and foreign exchange, together in one portfolio. It is measured as the difference between the sum of the VAR by individual risk type and the combined total VAR. A negative number represents the benefit of portfolio diversification. As the maximum and minimum occur on different days for different risk types, it is not meaningful to calculate a portfolio diversification benefit for these measures.

52 The total VAR is non-additive across risk types due to diversification effects.

53 Investments in private equity are primarily made through managed funds that are subject to limits on the amount of investment. Potential new commitments are subject to risk appraisal to ensure that industry and geographical concentrations remain within acceptable levels for the portfolio as a whole. Regular reviews are performed to substantiate the valuation of the investments within the portfolio.

54 Investments held to facilitate ongoing business include holdings in government-sponsored enterprises and local stock exchanges.

55 Instead of assuming that all interest rates move together, we group our interest rate exposures into currency blocs whose rates are considered likely to move together. See 'Cautionary Statement regarding Forward-Looking Statements' on page 525.

Risk management of insurance operations

56 HSBC has no insurance manufacturing subsidiaries in the Middle East and North Africa.

57 The decline in life insurance liabilities in North America reflects the classification of the majority of this business as held for sale at 31 December 2012. At 31 December 2012, the held-for-sale North American life insurance liabilities by contract type comprised credit life contracts (US$15m), annuities (US$723m) and term assurance and other long-term contracts (US$205m).

58 Insurance contracts and investment contracts with discretionary participation features ('DPF') can give policyholders the contractual right to receive, as a supplement to their guaranteed benefits, additional benefits that may be a significant portion of the total contractual benefits, but whose amount and timing are determined by HSBC. These additional benefits are contractually based on the performance of a specified pool of contracts or assets, or the profit of the company issuing the contracts.

59 Although investment contracts with DPF are financial investments, HSBC continues to account for them as insurance contracts as permitted by IFRS 4.

60 Net written insurance premiums represent gross written premiums less gross written premiums ceded to reinsurers.

61 Term assurance includes credit life insurance.

62 The Other assets column shows shareholder assets as well as assets and liabilities classified as held for sale. The majority of the assets for insurance businesses classified as held for sale are reported as 'Other assets and investment properties' and totalled US$2.0bn at 31 December 2012 (2011: US$0.1bn). Assets classified as held for sale consist primarily of debt securities, the majority of which have a 'strong' credit rating at 31 December 2012. All liabilities for insurance businesses classified as held for sale are reported in 'Other liabilities' and totalled US$1.2bn at 31 December 2012 (2011: US$0.1bn). The majority of these liabilities were life and non-life policyholder liabilities expected to mature after 5 years.

63 Present value of in-force long-term insurance contracts and investment contracts with DPF.

64 Does not include associated insurance companies, SABB Takaful Company and Bao Viet Holdings, or joint venture insurance companies, Hana Life and Canara HSBC Oriental Bank of Commerce Life Insurance Company Limited.

65 Comprise life linked insurance contracts and linked long-term investment contracts.

66 Comprise life non-linked insurance contracts and non-linked long-term investment contracts.

67 Comprise non-life insurance contracts.

68 Comprise mainly loans and advances to banks, cash and intercompany balances with other non-insurance legal entities.

69 The table excludes contracts where the risk is 100% reinsured.

70 The majority of reserves for immediate annuities with guarantees are within insurance businesses that are held for sale at 31 December 2012.

71 Shareholders' funds comprise solvency and unencumbered assets.

72 In most cases, policyholders have the option to terminate their contracts at any time and receive the surrender values of their policies. These may be significantly lower than the amounts shown.

73 Value of net new business during the year is the present value of the projected stream of profits from the business.

74 Experience variances include the effect of the difference between demographic, expense and persistency assumptions used in the previous PVIF calculation and actual experience observed during the year to the extent this impacts profits on future business.

Pension risk

75 In 2011 and 2012, alternative assets included ABSs, MBSs and infrastructure assets. In 2006, alternative assets included loans and infrastructure assets.

This information is provided by RNS

The company news service from the London Stock Exchange

END

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HSBC Holdings (HSBA)

Thursday, 23rd May 2024

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Annual Financial Report - 30 of 48

(Audited)

Europe

Hong Kong

Rest of Asia- Pacific

North

America57

Latin America

Total

US$m

Investment contracts with DPF58,59 .............

Investment contracts with DPF58,59 .............

Analysis of non-life insurance risk - net written insurance premiums60

Europe

Hong Kong

Rest of Asia- Pacific

North America

Latin America

Total

US$m

Europe

Hong Kong

Rest of Asia- Pacific

North America

Latin America

Total

US$m

Unit-

Other

US$m

US$m

Total assets ........

Total liabilities ...

Total assets ........

Total liabilities ...

Hong Kong

Rest of Asia- Pacific

North

America57

Latin America

Total

US$m

US$m

Life linked

Trading assets

Financial assets designated at fair value ....

Financial investments

Held-to-maturity: debt securities ..............

Available-for-sale: ...................................

Derivatives ..............................................

Other financial assets68 ............................

Total financial assets64 ............................

Trading assets

Financial assets designated at fair value ....

Financial investments

Held-to-maturity: debt securities ..............

Available-for-sale: ...................................

Derivatives ..............................................

Other financial assets68 ............................

Total financial assets64 ............................

Credit risk

Liquidity risk

(Audited)

Within 1 year

At 31 December 2012

Non-life insurance ...................................

Total64 ....................................................

At 31 December 2011

Non-life insurance ...................................

Total64 ....................................................

2012

2011

PVIF

Total

PVIF

Total

equity

2012

2011

France

America⁵⁷

Latin
America

Investment contracts with DPF^58,59 .............

Investment contracts with DPF^58,59 .............

Analysis of non-life insurance risk - net written insurance premiums⁶⁰

North
America

Latin
America

North
America

Latin
America

Hong
Kong

Rest of
Asia- Pacific

America⁵⁷

Latin
America

Other financial assets⁶⁸ ............................

Total financial assets⁶⁴ ............................

Other financial assets⁶⁸ ............................

Total financial assets⁶⁴ ............................

Total⁶⁴ ....................................................

Total⁶⁴ ....................................................