HSBC 2011 Annual Report Download - page 210

HSBC HOLDINGS PLC
Report of the Directors: Operating and Financial Review (continued)
Risk > Appendix – Risk policies and practices > Insurance risk / Reputational risk / Pension risk
208
flow model in which the discount rate is based on current interest rates, guarantee costs increase in a falling interest
rate environment. The sale of these contracts ceased in 2008, reflecting our adjusted risk appetite.
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 Meeting and the Group Insurance
Risk 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 Risk
Committee.
We use a number of tools to manage and monitor credit risk. These include an Early Warning Report and a watch list
of investments with current credit concerns which are circulated fortnightly to senior management in Group
Insurance Head Office and the Regional 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
• the sale of investments.
They manage liquidity risk by utilising some or all of the following techniques:
• matching cash inflows with expected cash outflows using specific cash flow projections or more general asset
and liability matching techniques such as duration matching;
• maintaining sufficient cash resources;
• investing in good credit-quality investments with deep and liquid markets to the degree to which they exist;
• monitoring investment concentrations and restricting them where appropriate, for example, by debt issues or
issuers; and
• establishing committed contingency borrowing facilities.
Each of these techniques contributes to mitigating the three types of liquidity risk described above.
Every quarter, our insurance manufacturing subsidiaries are required to complete and submit liquidity risk reports to
Group Insurance Head Office for collation and review by the Group Insurance Market and Liquidity Risk Meeting.
Liquidity risk is assessed in these reports by measuring changes in expected cumulative net cash flows under a