HSBC 2007 Annual Report Download - page 276

HSBC HOLDINGS PLC
Report of the Directors: The Management of Risk (continued)
Insurance operations > Financial risks > Market risk / Credit risk
274
these assets and the subsidiary will be exposed to a
strengthening of its local currency against the
currency of the related assets.
For unit-linked contracts, market risk is
substantially borne by the policyholder. HSBC
typically retains an exposure to market risk as the
market value of the linked assets influences the fees
HSBC earns for managing them.
How the risks are managed
(Audited)
HSBC’s insurance manufacturing subsidiaries
manage market risk by using some or all of the
techniques relevant to the contracts being written by
the subsidiary. The techniques applied may include:
• for products with DPF, adjusting bonus rates to
manage the liabilities to policyholders. The
management of bonus rates is achieved by
regularly evaluating their sustainability. In
practice, this means that a portion of the market
risk is borne by the policyholder;
• as far as possible, matching assets to liabilities.
For example, for products with annual return or
capital guarantees, HSBC invests in bonds
which produce a return at least equal to the
investment return implied by the guarantee;
• using derivatives, in a limited number of
instances;
• when designing new products with investment
guarantees, evaluating the cost of the guarantee
and considering this cost when determining the
premium level or the price structure;
• including features designed to mitigate market
risk in new products, for example, surrender
penalty charges to recoup losses incurred when
policyholders surrender their policies; and
• exiting investment portfolios when the level of
risk is no longer acceptable.
Each insurance manufacturing subsidiary is
required to have a market risk mandate which
specifies the investment instruments in which it is
permitted to invest and the maximum quantum of
market risk which it is permitted to retain. It is the
responsibility of the local ALCO to ensure that its
mandate is consistent with local regulations. All
mandates must be reviewed and agreed annually
with Group Insurance Head Office, and aggregate
limits are approved by the Risk Management
Meeting of the Group Management Board.
How the exposures to risks are measured
(Audited)
HSBC’s insurance manufacturing subsidiaries
monitor exposures against mandated limits regularly
and report these quarterly to Group Insurance Head
Office. Exposures are aggregated and reported to
senior risk management forums in the Group,
including the Group Insurance Market and Liquidity
Risk Meeting, Group Insurance Risk Committee and
the Group Stress Test Review Group.
The standard measures used to quantify the
market risks are as follows:
• for interest rate risk, the sensitivities of the net
present values of asset and expected liability
cash flows, in total and by currency, to a one
basis point parallel upward shift in the discount
curves used to calculate the net present values;
• for equity price risk, the total market value of
equity holdings and the market value of equity
holdings by region and country; and
• for foreign exchange rate risk, the total net short
foreign exchange position and the net foreign
exchange positions by currency.
Although these measures are relatively
straightforward to calculate and aggregate, there are
limitations. The most significant limitation is that the
one basis point parallel shift in yield curves measure
does not capture the non-linear relationships between
the value of certain assets and liabilities and interest
rates which arise, for example, from investment
return guarantees, and certain product features such
as the ability of policyholders to surrender their
policies. If the yields on investments held to support
contracts with guarantees are below the investment
return implied by the guarantee, shortfalls will fall to
the account of HSBC.
HSBC recognises these limitations and
augments its standard measures with stress tests
which examine the effect of a range of market rate
scenarios on the aggregated profits of the insurance
manufacturing subsidiaries for the year and their net
assets. A quarterly process was introduced for
HSBC’s insurance manufacturing subsidiaries during
2007 to report stress tests to Group Insurance Head
Office, where the reports are consolidated and
reviewed by the Group Insurance Market and
Liquidity Risk Meeting and the Group Stress Test
Review Group.
HSBC’s insurance manufacturing subsidiaries
identify those assets and liabilities whose values in
the financial statements are sensitive to each
category of market risk and revalue them assuming
different market rates. The outcome of the exercise