Annual Financial Report - 33 of 56

RNS Number : 6322S

HSBC Holdings PLC

18 March 2016

 

Risk management of insurance operations

HSBC's bancassurance model	180
Overview of insurance products			219
Nature and extent of risks			220
Risk management of insurance manufacturing operations in 2015	181
Asset and liability matching	181				Balance sheet of insurance manufacturing subsidiaries by:
					- type of contract	181
					- geographical region	182
					Movement in total equity of insurance operations	183
Financial risks	183		220		Financial assets held by insurance manufacturing subsidiaries	184
Market risk	184		220		Financial return guarantees	185
					Sensitivity of HSBC's insurance manufacturing subsidiaries to market risk factors	185
Credit risk	185		222		Treasury bills, other eligible bills and debt securities in HSBC's insurance manufacturing subsidiaries	186
					Reinsurers' share of liabilities under insurance contracts	187
Liquidity risk	187		222		Expected maturity of insurance contract liabilities	187
					Remaining contractual maturity of investment contract liabilities	187
Insurance risk	188		223		Analysis of insurance risk - liabilities under insurance contracts	188
Sensitivities to non-economic assumptions	188				Sensitivity analysis	188
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 financial risk and insurance risk. Financial risks include market risk, credit risk and liquidity risk. Insurance risk is the risk, other than financial risk, of loss transferred from the holder of the insurance contract to the issuer (HSBC).

There were no material changes to our policies and practices for the management of risks arising in the insurance operations in 2015.

A summary of HSBC's policies and practice regarding the risk management of insurance operations and the main contracts we manufacture is provided in the Appendix to Risk on page 219.

HSBC's bancassurance model

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

The insurance contracts we sell 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.

We choose to manufacture these insurance products in HSBC subsidiaries based on an assessment of operational scale and risk appetite. Manufacturing insurance allows us to retain the risks and rewards associated with writing insurance contracts by keeping part of the underwriting profit and investment income within the Group.

Where we do not have the risk appetite or operational scale to be an effective insurance manufacturer, we engage with 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 a share of profits.

We distribute insurance products in all of our geographical regions. We have life insurance manufacturing subsidiaries in nine countries (Argentina, mainland China, France, Hong Kong, Malaysia, Malta, Mexico, Singapore and the UK). We also have a life insurance manufacturing associate in Saudi Arabia and a joint venture in India.

The life insurance manufacturing entities in Brazil were classified as held for sale during the period, following the announcement of our plan to sell our operations in the country.

The disposal of HSBC Life (UK)'s pensions business, which was agreed during 2014, was completed in August 2015.

Risk management of insurance manufacturing operations in 2015

We measure the risk profile of our insurance manufacturing businesses using an economic capital approach, where assets and liabilities are measured on a market value basis and a capital requirement is held to ensure that there is less than a 1 in 200 chance of insolvency over the next year, given the risks that the businesses are exposed to. The methodology for the economic capital calculation is largely aligned to the new pan-European Solvency II insurance capital regulations, which are applicable from 2016.

The risk profile of our life insurance manufacturing businesses did not change materially during 2015, however there was a decrease in liabilities under insurance contracts to $70bn (2014: $74bn) arising from the transfer to 'Liabilities of disposal groups held for sale' in respect of the planned disposal of our operations in Brazil.

Asset and liability matching

(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 close asset and liability matching strategy. For long-dated non‑linked contracts, in particular, this results in a duration mismatch between assets and liabilities. Portfolios are
structured to support these projected liabilities, with limits set to control the duration mismatch.

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 2015.

The Brazilian insurance operations are reported as a disposal group held for sale at 31 December 2015. The assets and liabilities of this disposal group are included within 'Other assets and liabilities' in the table below. The UK pensions business was reported as a disposal group held for sale at 31 December 2014 and the sale of this business was completed during August 2015. As a result, $6.8bn of total assets and $6.7bn of total liabilities were derecognised.

Our most significant life insurance products are investment contracts with DPF issued in France and insurance contracts with DPF issued in Hong Kong.

Our exposure to financial risks arising in the balance sheet below varies depending on the type of contract issued. For unit-linked contracts, the policyholder bears the majority of the exposure to financial risks whereas for contracts with DPF, the shareholder (i.e. HSBC) is exposed to financial risks to the extent that the exposure cannot be managed by utilising any discretionary participation.

The majority of financial risks are borne by the shareholder for all other contract types.

Balance sheet of insurance manufacturing subsidiaries by type of contract

(Audited)

		Insurance contracts									Investment contracts
		With DPF		Unit- linked		Annuities		Other35				With DPF36		Unit- linked		Other				Other        assets and            liabilities37				Total
		$m		$m		$m		$m				$m		$m		$m				$m				$m
Financial assets		31,801		6,569		1,138		6,618				21,720		2,271		3,935				5,531				79,583
- trading assets		-		-		2		-				-		-		-				-				2
- financial assets designated at fair value		4,698		6,435		296		563				6,421		2,000		1,859				1,015				23,287
- derivatives		49		-		-		4				111		1		29				62				256
- financial investments - HTM38		22,840		-		468		2,334				-		-		1,387				3,050				30,079
- financial investments - AFS38		1,743		-		312		3,685				13,334		-		23				1,233				20,330
- other financial assets39		2,471		134		60		32				1,854		270		637				171				5,629
Reinsurance assets		202		264		-		951				-		-		-				-				1,417
PVIF40		-		-		-		-				-		-		-				5,685				5,685
Other assets and investment properties		838		1		11		105				888		6		23				4,576				6,448
Total assets		32,841		6,834		1,149		7,674				22,608		2,277		3,958				15,792				93,133
Liabilities under investment contracts		-		-		-		-				-		2,256		3,771				-				6,027
- designated at fair value		-		-		-		-				-		2,256		3,771				-				6,027
- carried at amortised cost		-		-		-		-				-		-		-				-				-
Liabilities under insurance contracts		32,414		6,791		1,082		7,042				22,609		-		-				-				69,938
Deferred tax41		11		-		11		3				-		-		-				1,056				1,081
Other liabilities		-		-		-		-				-		-		-				5,553				5,553
Total liabilities		32,425		6,791		1,093		7,045				22,609		2,256		3,771				6,609				82,599
Total equity		-		-		-		-				-		-		-				10,534				10,534
Total liabilities and equity at 31 December 201542		32,425		6,791		1,093		7,045				22,609		2,256		3,771				17,143				93,133

Balance sheet of insurance manufacturing subsidiaries by type of contract (continued)

		Insurance contracts								Investment contracts
		With DPF		Unit- linked		Annuities		Other35		With DPF36		Unit- linked		Other		Other      assets           and liabilities37		Total
		$m		$m		$m		$m		$m		$m		$m		$m		$m
Financial assets		29,040		11,278		1,517		6,253		24,238		2,561		4,322		5,732		84,941
- trading assets		-		-		3		-		-		-		-		-		3
- financial assets designated at fair value		4,304		11,111		533		782		6,346		2,223		1,684		1,713		28,696
- derivatives		12		1		-		1		101		1		10		73		199
- financial investments - HTM38		18,784		-		542		1,019		-		-		1,444		2,494		24,283
- financial investments - AFS38		2,368		-		344		4,148		15,677		-		363		1,318		24,218
- other financial assets39		3,572		166		95		303		2,114		337		821		134		7,542
Reinsurance assets		190		262		-		617		-		-		-		2		1,071
PVIF40		-		-		-		-		-		-		-		5,307		5,307
Other assets and investment properties		698		328		23		107		831		7		26		7,383		9,403
Total assets		29,928		11,868		1,540		6,977		25,069		2,568		4,348		18,424		100,722
Liabilities under investment contracts		-		-		-		-		-		2,542		4,155		-		6,697
- designated at fair value		-		-		-		-		-		2,542		3,770		-		6,312
- carried at amortised cost		-		-		-		-		-		-		385		-		385
Liabilities under insurance contracts		29,479		11,820		1,473		6,021		25,068		-		-		-		73,861
Deferred tax41		12		-		11		18		-		-		-		1,180		1,221
Other liabilities		-		-		-		-		-		-		-		8,577		8,577
Total liabilities		29,491		11,820		1,484		6,039		25,068		2,542		4,155		9,757		90,356
Total equity		-		-		-		-		-		-		-		10,366		10,366
Total liabilities and equity at 31 December 201442		29,491		11,820		1,484		6,039		25,068		2,542		4,155		20,123		100,722

For footnotes, see page 191.

Balance sheet of insurance manufacturing subsidiaries by geographical region⁴³

(Audited)

		Europe		Asia		Latin                   America		Total
		$m		$m		$m		$m
Financial assets		26,897		51,087		1,599		79,583
- trading assets		-		-		2		2
- financial assets designated at fair value		9,987		12,668		632		23,287
- derivatives		163		93		-		256
- financial investments - HTM38		-		29,496		583		30,079
- financial investments - AFS38		14,525		5,503		302		20,330
- other financial assets39		2,222		3,327		80		5,629
Reinsurance assets		287		1,122		8		1,417
PVIF40		807		4,761		117		5,685
Other assets and investment properties		919		1,358		4,171		6,448
Total assets		28,910		58,328		5,895		93,133
Liabilities under investment contracts:
- designated at fair value		1,376		4,651		-		6,027
- carried at amortised cost		-		-		-		-
Liabilities under insurance contracts		24,699		43,975		1,264		69,938
Deferred tax41		274		767		40		1,081
Other liabilities		832		974		3,747		5,553
Total liabilities		27,181		50,367		5,051		82,599
Total equity		1,729		7,961		844		10,534
Total liabilities and equity at 31 December 201542		28,910		58,328		5,895		93,133

		Europe		Asia		Latin                    America		Total
		$m		$m		$m		$m
Financial assets		30,178		47,443		7,320		84,941
- trading assets		-		-		3		3
- financial assets designated at fair value		10,610		12,497		5,589		28,696
- derivatives		172		27		-		199
- financial investments - HTM38		-		23,546		737		24,283
- financial investments  - AFS38		16,947		6,464		807		24,218
- other financial assets39		2,449		4,909		184		7,542
Reinsurance assets		308		748		15		1,071
PVIF40		711		4,175		421		5,307
Other assets and investment properties		7,650		1,145		608		9,403
Total assets		38,847		53,511		8,364		100,722
Liabilities under investment contracts:
- designated at fair value		1,585		4,727		-		6,312
- carried at amortised cost		-		-		385		385
Liabilities under insurance contracts		27,312		39,990		6,559		73,861
Deferred tax41		273		806		142		1,221
Other liabilities		7,932		460		185		8,577
Total liabilities		37,102		45,983		7,271		90,356
Total equity		1,745		7,528		1,093		10,366
Total liabilities and equity at 31 December 201442		38,847		53,511		8,364		100,722

For footnotes, see page 191.

Movement in total equity of insurance operations

(Audited)

		Total equity
		2015		2014
		$m		$m
At 1 January		10,366		9,700
Movements in PVIF40		799		261
Return on net assets		410		1,835
Capital transactions		(468)		(673)
Disposals of subsidiaries/portfolios		(13)		1
Exchange differences and other		(560)		(758)
At 31 December		10,534		10,366

For footnotes, see page 191.

Financial risks

(Audited)

Details on the nature of financial risks and how they are managed are provided in the Appendix to Risk on page 220.

Financial risks can be categorised into:

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

·   credit risk - the risk of financial loss following the failure 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.

The following table analyses the assets held in our insurance manufacturing subsidiaries at 31 December 2015 by type of contract, and provides a view of the exposure to financial risk. For unit‑linked contracts, which pay benefits to policyholders 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)

		Unit-linked		Non-linked		Other
		contracts44		contracts45		assets39		Total
		$m		$m		$m		$m
Trading assets
Debt securities		-		2		-		2
Financial assets designated at fair value		8,435		13,837		1,015		23,287
Treasury bills		-		146		56		202
Debt securities		448		3,547		228		4,223
Equity securities		7,987		10,144		731		18,862
Financial investments
Held-to-maturity: debt securities		-		27,029		3,050		30,079
Available-for-sale:		-		19,097		1,233		20,330
- debt securities		-		19,097		1,177		20,274
- equity securities		-		-		56		56
Derivatives		1		193		62		256
Other financial assets39		404		5,054		171		5,629
Total financial assets at 31 December 201542		8,840		65,212		5,531		79,583
Trading assets
Debt securities		-		3		-		3
Financial assets designated at fair value		13,334		13,649		1,713		28,696
Treasury bills		-		40		16		56
Debt securities		4,589		3,507		618		8,714
Equity securities		8,745		10,102		1,079		19,926
Financial investments
Held-to-maturity: debt securities		-		21,789		2,494		24,283
Available-for-sale:		-		22,899		1,319		24,218
- debt securities		-		22,899		1,290		24,189
- equity securities		-		-		29		29
Derivatives		2		124		73		199
Other financial assets39		503		6,905		134		7,542
Total financial assets at 31 December 201442		13,839		65,369		5,733		84,941

For footnotes, see page 191.

Approximately 69% of financial assets were invested in debt securities at 31 December 2015 (2014: 67%) with 24% (2014: 24%) invested in equity securities.

Under unit-linked contracts, 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 11% (2014: 16%) of the total financial assets of our insurance manufacturing subsidiaries at the end of 2015.

The remaining assets of $71bn (2014: $71bn) are where financial risks are managed either solely on behalf of the shareholder, or jointly on behalf of the shareholder and policyholders where DPF exist. These assets relate primarily to operations in Asia and France.

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.

The proceeds from insurance and investment products are primarily invested in bonds. A proportion is also allocated to other asset classes, such as equities, property, private equity and hedge funds to provide customers with the potential for enhanced returns. Portfolios of such assets are exposed to the risk of changes in market prices and where not fully reflected in bonuses paid to policyholders, will affect shareholder funds.

Long-term insurance or investment products may incorporate benefits that are guaranteed. Fixed guaranteed benefits, for example for annuities in payment, are reserved for as part of the calculation of liabilities under insurance contracts.

The risk of shareholder capital being required to meet liabilities to policyholders increases in products that offer guaranteed financial returns where current yields fall below guaranteed levels for a prolonged period. Reserves are held against the cost of guarantees, calculated by stochastic modelling. Where local rules require, these reserves are held as part of liabilities under insurance contracts. Any remainder is accounted for as a deduction to PVIF on the relevant product. The table below shows the total reserve held for the cost of guarantees, the range of investment returns on assets supporting these products and the implied investment return that would enable the business to meet the guarantees.

The financial guarantees offered on some portfolios exceeded the current yield on the assets that back them. The cost of guarantees decreased to $748m (2014: $777m) primarily because of rising yields and updates to interest rate parameters in France during 2015. Following these changes, the cost of guarantees on closed portfolios reported in the 2.0% to 4.0% and 4.1% to 5.0% categories decreased, driven principally by the increased reinvestment yield assumptions. In addition, there was a closed portfolio in Hong Kong with a guaranteed rate of 5.0% compared with the current yield of 4.1%.

Financial return guarantees⁴²

(Audited)

		2015						2014
		Investment                 returns            implied by           guarantee		Current                     yields		Cost of         guarantees		Investment                  returns            implied by            guarantee		Current                     yields		Cost of          guarantees
		%		%		$m		%		%		$m
Capital		0.0		0.0 - 3.8		85		0.0		0.0 - 3.5		81
Nominal annual return		0.1 - 1.9		3.9 - 3.9		4		0.1 - 2.0		3.6 - 3.6		6
Nominal annual return46		2.0 - 4.0		3.8 - 4.0		603		2.1 - 4.0		3.5 - 4.1		646
Nominal annual return		4.1 - 5.0		3.8 - 4.1		28		4.1 - 5.0		3.5 - 4.1		30
Real annual return47		0.0 - 6.0		5.9 - 6.1		28		0.0 - 6.0		4.7 - 7.5		14
At 31 December						748						777

For footnotes, see page 191.

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

Where appropriate, the effects of the sensitivity tests on profit after tax and equity incorporate the impact of the stress on the PVIF. 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. For the same reason, the impact of the stress is not symmetrical on the upside and downside. The sensitivities are stated before allowance for management actions which may mitigate the effect of changes in the market environment. The sensitivities presented allow for adverse changes in policyholder behaviour that may arise in response to changes in market rates.

The effects on profit after tax of +/-100 basis points parallel shifts in yield curves have decreased from 2014 to 2015, driven mainly by rising yields and updates to interest rate parameters in France. In a low yield environment the projected cost of options and guarantees described above is particularly sensitive to yield curve movements. The market value of available-for-sale bonds is also sensitive to yield curve movements hence the larger opposite stresses on equity.

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

(Audited)

		2015				2014
		Effect on                     profit               after tax		Effect on                       total                    equity		Effect on                      profit                after tax		Effect on                       total                    equity
		$m		$m		$m		$m
+100 basis points parallel shift in yield curves		39		(474)		290		(345)
-100 basis points parallel shift in yield curves48		(213)		404		(549)		214
10% increase in equity prices		176		176		180		180
10% decrease in equity prices		(158)		(158)		(153)		(153)
10% increase in US dollar exchange rate compared to all currencies		16		16		54		54
10% decrease in US dollar exchange rate compared to all currencies		(16)		(16)		(54)		(54)

 

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 $54bn (2014: $53bn) bond portfolio supporting non-linked contracts and shareholders' funds.

The sensitivity of the profit after tax of our insurance subsidiaries to the effects on asset values of increases in credit spreads (as modelled in line with the methodology described below) was a reduction of $2m (2014: $7m). The sensitivity of total equity was a reduction of $10m (2014: $9m). The sensitivities are relatively small because the vast majority 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 (or to total equity in the case of the held-to-maturity securities). We calculate the sensitivity 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 internal measures of credit quality.

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 unit-linked liabilities is predominantly borne by the policyholder. 85.4% (2014: 84.8%) of the assets included in the table are invested in investments rated as 'strong'.

For a definition of the five credit quality classifications, see page 197.

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

(Audited)

		Neither past due nor impaired
		Strong		Good		Satisfactory		Sub-standard				Total
		$m		$m		$m		$m				$m
Supporting liabilities under non-linked insurance and investment contracts
Trading assets - debt securities		-		-		2		-				2
Financial assets designated at fair value		2,719		406		300		268				3,693
- treasury and other eligible bills		130		-		-		16				146
- debt securities		2,589		406		300		252				3,547
Financial investments - debt securities		39,741		4,333		1,886		166				46,126
		42,460		4,739		2,188		434				49,821
Supporting shareholders' funds49
Financial assets designated at fair value		138		22		20		104				284
- treasury and other eligible bills		8		-		-		48				56
- debt securities		130		22		20		56				228
Financial investments - debt securities		3,827		201		199		-				4,227
		3,965		223		219		104				4,511
Total42
Trading assets - debt securities		-		-		2		-				2
Financial assets designated at fair value		2,857		428		320		372				3,977
- treasury and other eligible bills		138		-		-		64				202
- debt securities		2,719		428		320		308				3,775
Financial investments - debt securities		43,568		4,534		2,085		166				50,353
At 31 December 2015		46,425		4,962		2,407		538				54,332
Supporting liabilities under non-linked insurance and investment contracts
Trading assets - debt securities		3		-		-		-				3
Financial assets designated at fair value		2,550		530		214		255				3,549
- treasury and other eligible bills		5		-		-		35				40
- debt securities		2,545		530		214		220				3,509
Financial investments - debt securities		38,515		4,312		1,662		200				44,689
		41,068		4,842		1,876		455				48,241
Supporting shareholders' funds49
Financial assets designated at fair value		214		322		30		69				635
- treasury and other eligible bills		-		-		-		16				16
- debt securities		214		322		30		53				619
Financial investments - debt securities		3,378		196		154		54				3,782
		3,592		518		184		123				4,417
Total42
Trading assets - debt securities		3		-		-		-				3
Financial assets designated at fair value		2,764		852		244		324				4,184
- treasury and other eligible bills		5		-		-		51				56
- debt securities		2,759		852		244		273				4,128
Financial investments - debt securities		41,893		4,508		1,816		254				48,471
At 31 December 2014		44,660		5,360		2,060		578				52,658

For footnotes, see page 191.

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 223 is included in this table.

Reinsurers' share of liabilities under insurance contracts⁴²

(Audited)

		Neither past due nor impaired								Past due but
		Strong		Good		Satisfactory		Sub-standard		not impaired		Total
		$m		$m		$m		$m		$m		$m
Unit-linked insurance		84		179		-		-		-		263
Non-linked insurance50		1,102		4		9		-		-		1,115
At 31 December 2015		1,186		183		9		-		-		1,378
Reinsurance debtors		19		3		-		-		17		39
Unit-linked insurance		75		185		-		-		-		260
Non-linked insurance50		751		11		10		-		-		772
At 31 December 2014		826		196		10		-		-		1,032
Reinsurance debtors		11		6		-		-		21		38

For footnotes, see page 191.

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 2015. The liquidity risk exposure is borne in conjunction with policyholders for the majority of our business, and wholly borne by the policyholder in the case of unit-linked business.

The classification of Brazilian insurance operations as held for sale has reduced the undiscounted expected cash flows relating to insurance liabilities by $(5.1)bn. However, the profile of the expected maturity of the insurance contracts at 31 December 2015 remained comparable with 2014.

Expected maturity of insurance contract liabilities⁴²

(Audited)

		Expected cash flows (undiscounted)
		Within 1 year			1-5 years				5-15 years				Over 15 years				Total
		$m				$m				$m				$m				$m
Unit-linked insurance		549				2,164				5,945				11,080				19,738
Non-linked insurance50		3,715				15,131				30,596				32,336				81,778
At 31 December 2015		4,264				17,295				36,541				43,416				101,516
Unit-linked insurance		709				3,280				9,243				14,544				27,776
Non-linked insurance50		3,504				12,718				29,905				33,108				79,235
At 31 December 2014		4,213				15,998				39,148				47,652				107,011

For footnotes, see page 191.

Remaining contractual maturity of investment contract liabilities

(Audited)

		Liabilities under investment contracts issued by insurance manufacturing subsidiaries
		Unit-linked              investment                  contracts		Investment                  contracts                   with DPF		Other              investment                  contracts		Total
		$m		$m		$m		$m
Remaining contractual maturity:
- undated51		1,160		22,609		3,747		27,516
- due within 1 year		136		-		24		160
- due over 1 year to 5 years		117		-		-		117
- due over 5 years to 10 years		170		-		-		170
- due after 10 years		673		-		-		673
At 31 December 2015		2,256		22,609		3,771		28,636
Remaining contractual maturity:
- undated51		1,298		25,068		3,765		30,131
- due within 1 year		151		-		389		540
- due over 1 year to 5 years		133		-		-		133
- due over 5 years to 10 years		194		-		-		194
- due after 10 years		766		-		-		766
At 31 December 2014		2,542		25,068		4,154		31,764

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.

Insurance risk

Insurance risk is the risk, other than financial risk, of loss transferred from the holder of the insurance contract to the issuer (i.e. HSBC). It is principally measured in terms of liabilities under the contracts in force.

The principal risk we face is that, over time, the cost of the contract, including claims and benefits may exceed the
total amount of premiums and investment income received. The cost of claims and benefits can be influenced by many factors, including mortality and morbidity experience, lapse and surrender rates. The following table analyses our life insurance risk exposures by geographical region and by type of business. The insurance risk profile and related exposures remain largely consistent with those observed at 31 December 2014.

Analysis of insurance risk - liabilities under insurance contracts⁴³

(Audited)

		Europe		Asia		Latin America		Total
		$m		$m		$m		$m
Non-linked insurance50		749		38,525		1,264		40,538
- insurance contracts with DPF52		343		32,071		-		32,414
- credit life		49		80		-		129
- annuities		69		108		905		1,082
- other53		288		6,266		359		6,913
Unit-linked insurance		1,341		5,450		-		6,791
Investment contracts with DPF36,52		22,609		-		-		22,609
Liabilities under insurance contracts at 31 December 2015		24,699		43,975		1,264		69,938
Non-linked insurance50		829		34,261		1,883		36,973
- insurance contracts with DPF52		367		29,112		-		29,479
- credit life		56		87		-		143
- annuities		71		127		1,275		1,473
- other53		335		4,935		608		5,878
Unit-linked insurance		1,415		5,729		4,676		11,820
Investment contracts with DPF36,52		25,068		-		-		25,068
Liabilities under insurance contracts at 31 December 2014		27,312		39,990		6,559		73,861

For footnotes, see page 191.

Our most significant life insurance products are insurance contracts with DPF issued in Hong Kong, investment contracts with DPF issued in France and unit-linked contracts issued in Latin America, Hong Kong and the UK.

Sensitivities to non-economic assumptions

(Audited)

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 and total equity to reasonably possible changes in these non-economic assumptions at that date across all our insurance manufacturing subsidiaries.

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 France and Hong Kong.

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 income on the lapsed policies. However, some contract lapses have a positive effect on profit due to the existence of policy surrender charges. France, Hong Kong and Singapore are where we are most sensitive to a change in lapse rates.

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

Sensitivity analysis

(Audited)

		2015		2014
		$m		$m
Effect on profit after tax and total equity at 31 December
10% increase in mortality and/or morbidity rates		(70)		(65)
10% decrease in mortality and/or morbidity rates		75		72
10% increase in lapse rates		(90)		(108)
10% decrease in lapse rates		102		122
10% increase in expense rates		(85)		(106)
10% decrease in expense rates		83		106

For footnote, see page 191.

Other material risks

A summary of our current policies and practices regarding reputational risk, fiduciary risk, pension risk and sustainability risk is provided in the Appendix to Risk on pages 224 to 226.

Reputational risk

Reputational risk is the risk of failure to meet stakeholder expectations as a result of any event, behaviour, action or inaction, either by HSBC itself, our employees or those with whom we are associated, that might cause stakeholders to form a negative view of the Group. This may have financial or non-financial effects, resulting in a loss of confidence, or have other consequences.

Reputational risk relates to stakeholders' perceptions, whether based on fact or otherwise. Stakeholders' expectations are constantly changing and thus reputational risk is dynamic and varies between geographical regions, groups and individuals. As a global bank, HSBC has an unwavering commitment to operating to the high standards we have set for ourselves in every jurisdiction. Any lapse in standards of integrity, compliance, customer service or operating efficiency represents a potential reputational risk.

A number of measures to address the requirements of the US DPA and otherwise to enhance our AML, sanctions and other regulatory compliance frameworks have been taken and/or are ongoing. These measures should also serve over time to enhance our reputational risk management. For further details on the implementation of the Global Standards, see Strategic Report on page 21 and 'Compliance risk' on page 178.

We have a zero tolerance for knowingly engaging in any business, activity or association where foreseeable reputational risk or damage has not been considered and mitigated. There must be no barriers to open discussion and the escalation of issues that could affect the Group negatively. While there is a level of risk in every aspect of business activity, appropriate consideration of potential harm to HSBC's good name must be a part of all business decisions.

In 2015, we restructured our Reputational Risk sub-function to increase our focus on the management of reputational risk. With an expanded mandate, the unit is better positioned to provide bespoke advisory services to the business on reputational risks to the Group and to work with the Financial Crime and Regulatory Compliance teams to mitigate such risks where possible.

Fiduciary risk

Fiduciary risk is the risk to the Group of breaching our fiduciary duties when we act in a fiduciary capacity as trustee or investment manager or as mandated by law or regulation.

A fiduciary duty is one where HSBC holds, manages, oversees or has responsibility for assets on behalf of a third party that involves a legal and/or regulatory duty to act with a high standard of care and with good faith. A fiduciary must make decisions and act in the interests of the third party and must place the wants and needs of the client first, above the needs of the Group.

We may be held liable for damages or other penalties caused by failure to act in accordance with these duties. Fiduciary duties may also arise in other circumstances, such as when we act as an agent for a principal, unless the fiduciary duties are specifically excluded (e.g. under the agency appointment contract).

Our principal fiduciary businesses (the 'designated businesses') have developed fiduciary limits, key risk indicators and key performance indicators to monitor their related risks.

Pension risk

We operate a number of defined benefit and defined contribution pension plans throughout the world. Most of our pension risk arises from defined benefit plans. The largest of these is the HSBC Bank (UK) Pension Scheme ('the principal plan').

At 31 December 2015, the Group's aggregate defined benefit pension obligation was $38bn and the net asset on the balance sheet was $3.1bn (2014: $42bn and $2.7bn, respectively). The principal plan is the largest contributor to pension risk in the Group: it contributed $28bn to the Group's defined benefit obligation and $5.0bn to the Group's net asset.

The principal plan

The principal plan has a defined benefit section and a defined contribution section and is overseen by a corporate trustee. This trustee has a fiduciary responsibility to run the plan. Unless stated otherwise, this section relates to the defined benefit section.

The investment strategy of the principal plan is to hold the majority of assets in bonds, with the remainder in a diverse range of investments. It also includes some interest rate and inflation swaps to reduce the level of interest rate risk and inflation risk (see Note 41 in the Financial Statements). The target asset allocation of the principal plan at the year-end is shown in the table below.

The principal plan - target asset allocation

		2015		2014
		%		%
Equities54		19.4		19.4
Bonds		64.5		64.5
Alternative assets55		10.6		10.6
Property		5.5		5.5
Cash56		-		-
At 31 December		100.0		100.0

For footnotes, see page 191.

The latest actuarial valuation of the principal plan was made as at 31 December 2011 by C G Singer, Fellow of the Institute and Faculty of Actuaries, of Willis Towers Watson Limited. At that date, the market value of the plan's assets was £18bn ($28bn) (including assets relating to both the defined benefit and defined contribution sections, and additional voluntary contributions). This asset value was the same amount as the actuary said was needed to meet all future expected benefit payments, based on pensions earned to that date and allowing for expected future salary increases. As there was no resulting surplus or deficit, there was no need for the Bank to pay any additional contributions.

In carrying out this assessment, the future expected pension payments out of the plan were valued with the following assumptions:

·   future inflation was assumed to be in line with the Retail Price Index ('RPI') swap break-even curve at 31 December 2011;

·   salary increases were assumed to be 0.5% above the RPI each year;

·   pensions were assumed to increase in line with the 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 1.6% a year;

·   the mortality assumptions were set based on the SAPS S1 series of tables adjusted to reflect the plan's actual mortality experience over the prior six years (2006 to 2011); and

·   mortality rates were also assumed to improve further in the future in line with standard tables of improvements, the Continuous Mortality Investigation core projections, but with the additional assumption that the long run improvement rate would not fall below 2% a year for men and 1.5% a year for women.

The benefits expected to be paid from the defined benefit section from 2016 are shown in the chart below.

Future benefit payments ($m)

As part of the 31 December 2011 valuation, the actuary also assessed the amount needed to meet the obligations of the principal plan if the plan was stopped and an insurance company was asked to guarantee all future payments. Because the plan is large, it is unlikely that an insurance company would be able to do this for the whole plan, so in practice the Trustee would continue to manage the plan without further support from HSBC. The amount of assets needed under this approach was estimated to be £26bn ($41bn). This is larger than the previous amount because it assumes that people will live for even longer and that the Trustee would adopt a much less risky investment strategy, investing mainly in UK government bonds, which would have a lower expected investment return. It also included an explicit allowance for the future administrative expenses of the plan.

HSBC and the Trustee have developed a general framework which will see the principal plan's investment strategy become less risky over time. This is referred to as the Target Matching Portfolio ('TMP'), as it would contain investments that closely match the expected benefit payment profile. Progress towards the TMP can be achieved by investment returns or additional funding from HSBC. In 2013, HSBC agreed to make general framework contributions of £64m ($95m) in each of the calendar years 2013, 2014 and 2015 and £128m ($190m) in 2016. Further contributions had been agreed to be made in future years, which were linked to the continued implementation of the general framework.

The 31 December 2014 valuation has been agreed in principle with the Trustee, and is expected to be finalised by its statutory deadline of 31 March 2016. The final agreement should result in a surplus of circa £500m ($741m) as at the valuation date of 31 December 2014 and on the Trustee's prudent actuarial assumptions. The general framework implementation has also continued such that the conditions on the future contributions would be removed. As a result the following payments would be payable in the future: £64m ($95m) in each of 2017, 2018, 2019, and £160m ($237m) in each of 2020 and 2021, which in addition to the amounts agreed before would give a total of £640m ($949m) payable from 2016 to 2021.

The principal plan changed in 2015 and from 30 June members stopped accruing future defined benefits. Defined benefit pensions accrued up to 30 June 2015 will retain their link to employee salaries, underpinned by the Consumer Price Index ('CPI'), while members are still employees of the bank. To support the establishment of the ServCo group and to ensure that employees transferred retained existing pension benefits, a new section of the principal plan was created with segregated assets and liabilities. The new section provides ServCo group employees with their defined contribution pension and, where relevant, defined benefit pension benefits arising from future salary increases above CPI.

Defined contribution plans

Our global strategy is to move from defined benefit to defined contribution plans, where local law allows and it is considered competitive to do so. In defined contribution pension plans, the sponsor contributions are known, while the ultimate pension benefit will vary, typically with investment returns achieved by investment choices made by the employee. While the market risk of defined contribution plans is significantly less than that of defined benefit plans, the Bank is still exposed to operational and reputational risk.

Sustainability risk

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

In 2015, we continued to implement all of our sustainability risk policies. Our training for risk and relationship managers during the year focused on the new policies on agricultural commodities, forestry and World Heritage Sites and Ramsar Wetlands, issued in 2014. Following a recommendation by Internal Audit in 2015, we took steps to integrate the management of sustainability risk more fully into the Risk Function. For example, we raised standards of risk analysis and policy implementation; updated internal instruction manuals; and improved the way sustainability risk is recorded in our information management system.

 

Footnotes to Risk

Managing risk

  1   The sum of balances presented does not agree to consolidated amounts because inter-company eliminations are not presented here.

Credit risk

  2    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 $59bn (2014: $71bn), reflecting the full take-up of loan commitments. The take-up of such offers is generally at low levels. At 31 December 2015, the credit quality of loan and other credit-related commitments was: $348bn strong, $180bn good, $129bn satisfactory, $9bn sub-standard and $1bn impaired.

  3   'Other personal lending' includes second lien mortgages and other property-related lending.

  4   'Other commercial loans and advances' includes advances in respect of agriculture, transport, energy utilities and ABS reclassified to 'Loans and advances'.

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

  6   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'.

  7   Loans and advances to customers' includes asset-backed securities that have been externally rated as strong (2015: $504m; 2014: $1.2bn), good (2015: $95m; 2014: $256m), satisfactory (2015: $107m; 2014: $332m), sub-standard (2015: $19m; 2014: $94m) and impaired (2015: $73m; 2014: $128m).

  8   'Collection re-age' includes loans that are reset to 'current' and any arrears are reset but does not involve any changes to the original terms and conditions of the loan, where the account is brought up-to-date without fully paying the outstanding arrears but after the demonstration of ongoing payment ability.

  9   'Modification re-age' includes loans where there are changes to the original terms and conditions of the loan, either temporarily or permanently, and also resets the contractual delinquency status of an account to current.

10  'Collectively assessed impairment allowances' are allocated to geographical segments based on the location of the office booking the allowances or provisions.

11  Included within 'Exchange and other movements' is $2.1bn of impairment allowances reclassified to held for sale (2014: $0.4bn).

12  Of the $2,134m (2014: $2,724m) of renegotiated loans, $477m (2014: $608m) were neither past due nor impaired, $1m (2014: $1m) was past due but not impaired and $1,656m (2014: $2,115m) were impaired.

13  Includes balances in Middle East and North Africa that are impaired and past due and therefore considered due on demand.

14  French Banking Federation Master Agreement Relating to Transactions on Forward Financial Instruments plus CSA equivalent.

15  The German Master Agreement for Financial Derivative Transactions.

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

17  Included in this category are loans of $1.2bn (2014: $1.5bn) 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.

18  '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.

Liquidity and funding

19  The HSBC UK Liquidity Group shown comprises four legal entities; HSBC Bank plc (including all overseas branches, and SPEs consolidated by HSBC Bank plc for Financial Statement purposes), Marks and Spencer Financial Services plc, HSBC Private Bank (UK) Ltd 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 PRA.

20  The Hongkong and Shanghai Banking Corporation - Hong Kong branch and The Hongkong and Shanghai Banking Corporation - Singapore branch represent the material activities of the Hongkong and Shanghai Banking Corporation. Each branch is monitored and controlled for liquidity and funding risk purposes as a stand-alone operating entity.

21  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.

22  HSBC France and HSBC Canada represent the consolidated banking operations of the Group in France and Canada respectively. HSBC France and HSBC Canada are each managed as single distinct operating entities for liquidity purposes.

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

24  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. This coverage changed during 2015 and so comparative figures for 2014 have been re-stated to enable a like-for-like comparison.

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

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

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

28  The residual contractual maturity profile of the balance sheet is set out on in Note 31 on the Financial Statements.

Market risk

29  Trading portfolios comprise positions arising from the market-making and warehousing of customer-derived positions.

30  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 occurs on different days for different risk types, it is not meaningful to calculate a portfolio diversification benefit for these measures.

31  The total VaR is non-additive across risk types due to diversification effects.

32  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.

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

34  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'.

Risk management of insurance operations

35  'Other' includes term assurance, credit life insurance, universal life insurance and remaining non-life insurance.

36  Although investment contracts with discretionary participation features ('DPF') are financial investments, HSBC continues to account for them as insurance contracts as required by IFRS 4 'Insurance Contracts'. The corresponding liabilities are therefore recorded as 'liabilities under insurance contracts'.

37  'Other assets and liabilities' 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 $4.1bn at 31 December 2015 (2014: $6.8bn). The majority of these assets were debt and equity securities and PVIF. All liabilities for insurance businesses classified as held for sale are reported in 'Other liabilities' and totalled $3.7bn at 31 December 2015 (2014: $6.8bn). The majority of these liabilities were liabilities under insurance contracts and liabilities under investment contracts.

38  Financial investments held to maturity (HTM) and available for sale (AFS).

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

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

41  'Deferred tax' includes the deferred tax liabilities arising on recognition of PVIF.

42  Does not include associated insurance company SABB Takaful Company or joint venture insurance company Canara HSBC Oriental Bank of Commerce Life Insurance Company Limited.

43  HSBC has no insurance manufacturing subsidiaries in Middle East and North Africa or North America.

44  Comprise unit-linked life insurance contracts and linked long-term investment contracts.

45  Comprise all insurance and long-term investment contracts other than those classified as unit-linked.

46  A block of contracts in France with guaranteed nominal annual returns in the range 1.25%-3.72% are reported entirely in the 2.0%-4.0% category in line with the average guaranteed return of 2.7% offered to policyholders by these contracts.

47  Real annual return guarantees provide the policyholder a guaranteed return in excess of the rate of inflation, and are supported by inflation-linked debt securities with yields that are also expressed in real terms.

48  Where a -100 basis point parallel shift in the yield curve would result in a negative interest rate, the effects on profit after tax and total equity have been calculated using a minimum rate of 0%.

49  Shareholders' funds comprise solvency and unencumbered assets.

50  'Non-linked insurance' comprises all insurance contracts other than unit-linked, including remaining non-life business.

51  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.

52  Insurance contracts and investment contracts with 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.

53  'Other' includes term assurance, universal life assurance and remaining non-life insurance.

Pension risk

54  In 2014, option overlay strategies which are expected to improve the risk/return profile of the equity allocation were implemented.

55  Alternative assets include ABSs, MBSs and infrastructure assets.

56  Whilst there is no target cash allocation, the amount of cash is expected to vary between 0%-5% depending upon the liquidity requirements of the scheme, which will affect the actual allocation of bonds correspondingly.

 

END

 

 

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