Annual Report and Accounts -

RNS Number : 7282P

HSBC Holdings PLC

31 March 2009

Risk management of insurance operations

(Audited)

HSBC operates a bancassurance model which provides insurance products for customers with whom the Group has a banking relationship. Insurance products are sold to all customer groups, mainly utilising retail branches, the internet and phone centres. Personal Financial Services customers attract the majority of sales and comprise the majority of policyholders. HSBC offers its customers a wide range of insurance and investment products, many of which complement other bank and consumer finance products.

Many of these insurance products are manufactured by HSBC subsidiaries. The Group underwrites the insurance risk and retains the risks and rewards associated with writing insurance contracts, retaining both the underwriting profit and the commission paid by the manufacturer to the bank distribution channel within the Group. HSBC's exposure to risks associated with manufacturing insurance contracts in its subsidiaries and its management of these risks are discussed below.

Where the Group considers it operationally more effective, third parties are engaged to manufacture insurance products for sale through HSBC's banking network. The Group works with a limited number of market-leading partners to provide the products. These arrangements earn HSBC a commission.

HSBC's bancassurance business operates in all five of the Group's geographical regions with over 30 legal entities, the majority of which are subsidiaries of banking legal entities, manufacturing insurance products. Management of these insurance manufacturers set their own control procedures in addition to complying with guidelines issued by the Group Insurance Head Office. This is headed by HSBC's Managing Director of Insurance, supported by a Chief Operating Officer, Chief Financial Officer and Chief Risk Officer, the latter appointed in 2008. The role of Group Insurance Head Office includes setting the control framework for monitoring and measuring insurance risk in line with Group practices, and drawing up insurance-specific policies and guidelines for inclusion in the Group Instruction Manuals. The control framework for monitoring risk includes the Group Insurance Risk Committee, which oversees the status of the significant risk categories in the insurance

operations. Four sub-committees report to the Committee, focusing on market and liquidity risk, credit risk, operational and insurance risk. The processes and controls employed to monitor each risk are described under their respective headings below.

The main contracts manufactured by HSBC are as follows:

Life insurance business

(Audited)

Life insurance contracts with discretionary participation features ('DPF') allow policyholders to participate in the profits generated from such business, which may take the form of annual bonuses and a final bonus, in addition to providing cover on death. Certain minimum return levels are also guaranteed. The largest portfolio is in Hong Kong.

Credit life insurance business is written to underpin banking and finance products. The policy pays a claim if the holder of the loan is unable to make repayments due to early death or unemployment.

Annuities are contracts providing regular payments of income from capital investment for either a fixed period or during the annuitant's lifetime. Payments to the annuitant either begin on inception of the policy (immediate annuities) or at a designated future date (deferred annuities).

Term assurance and critical illness policies provide cover in the event of death (term assurance) and serious illness.

Linked life insurance contracts pay benefits to policyholders which are typically determined by reference to the value of the investments supporting the policies.

Investment contracts with DPF allow policyholders to participate in the profits generated by such business. The largest portfolio is written in France. Policyholders are guaranteed to receive a return on their investment plus any discretionary bonuses. In addition, certain minimum return levels are guaranteed.

Unit-linked investment contracts are those where the principal benefit payable is the value of assigned assets.

Other investment contracts include pension contracts written in Hong Kong.

Non-life insurance business

(Audited)

Non-life insurance contracts include motor, fire and other damage to property, accident and health, repayment protection and commercial insurances.

Motor insurance business covers vehicle damage and liability for personal injury. For fire and other damage to property, the main focus in most markets is providing individuals with home and contents insurance, with cover for selected commercial customers largely written in Asia and Latin America.

A very limited portfolio of liability business is written, other than that included in the motor book.

Credit non-life insurance is concentrated in North America and Europe, and is originated in conjunction with the provision of loans. Payment protection insurance ('PPI') products were suspended in the UK pending a final report from the Competition Commission on their provision by the financial services industry. The report was issued in early 2009. The business is in the process of assessing the impact of the reported findings on credit protection products in the UK.

Given the nature of the contracts written by the Group, the risks to which HSBC's insurance operations are exposed fall into two principal categories: insurance risk and financial risk. The following section describes the nature and extent of these risks and HSBC's approach to managing them. The majority of the risk in the insurance business derives from manufacturing activities.

Insurance risk

(Audited)

Insurance risk is a risk, other than financial risk, transferred from the holder of a contract to the issuer, in this case HSBC. The principal insurance risk faced by HSBC is that, over time, the combined cost of claims, administration and acquisition of the contract may exceed the aggregate amount of premiums received and investment income. The cost of a claim 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. Performance of the underlying assets is affected by changes in both interest rates and equity prices (see page 263).

HSBC's insurance risk appetite is proposed by local businesses and authorised centrally. The Group manages its exposure to insurance risk by applying formal underwriting, reinsurance and claims-handling procedures designed to ensure compliance with regulations. This is supplemented with stress testing.

Insurance contracts sold by HSBC relate, in the main, to core underlying banking activities, such as savings and investment products, and credit life products. The Group's manufacturing focuses on personal lines, i.e. contracts written for individuals, which tend to be of higher volume and lower individual value than commercial lines. They thus contribute to diversifying insurance risk.

Life and non-life business insurance risks are controlled by high-level policies and procedures set centrally, supplemented as appropriate with measures which take account of specific local market conditions and regulatory requirements. For example, manufacturing entities are required to obtain authorisation from Group Insurance Head Office to write certain classes of business, with restrictions applying to commercial and liability non-life insurance, in particular.

Local ALCOs and Risk Management Committees are required to monitor certain risk exposures, mainly for life business where the focus is on reviewing the risks associated with the duration and cash flow matching of insurance assets and liabilities.

Reinsurance is also used as a means of mitigating exposure, in particular to aggregations of catastrophe risk. Specific examples are as follows:

Accident and health insurance. Potential exposure to concentrations of claims arising from isolated events, such as earthquakes or a pandemic, are mitigated by the purchase of catastrophe reinsurance.
Motor insurance. Reinsurance protection is arranged to avoid excessive exposure to larger losses, particularly from personal injury claims.
Fire and other damage to property. Portfolios at risk from catastrophic losses are protected by reinsurance in accordance with information obtained from professional risk-modelling organisations.

Although reinsurance provides a means of managing insurance risk, such contracts expose the Group to counterparty risk, the risk of default by the reinsurer (see page 267).

The following tables provide an analysis of HSBC's insurance risk exposures by geographical region and by type of business. By definition, HSBC is not exposed to insurance risk on investment contracts, so they are not included in the insurance risk management analysis.

Life business tends to be longer-term in nature than non-life business and frequently involves an element of savings and investment in the contract. Accordingly, separate tables are provided for life and non-life businesses, reflecting their distinctive risk characteristics. The life insurance risk table provides an analysis of insurance liabilities as the best available overall measure of insurance exposure, because provisions for life contracts are typically set by reference to expected future cash outflows relating to the underlying policies. The table for non life business uses written premiums as the best available measure of risk exposure because policies are typically priced by reference to the risk being underwritten.

Analysis of life insurance risk - liabilities to policyholders

(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
At 31 December 2008
Life (non-linked)
Insurance contracts with DPF1	1,015	11,213	216	-	-	12,444
Credit life	252	-	-	65	-	317
Annuities	379	-	28	805	1,363	2,575
Term assurance and other long-term contracts	1,316	107	99	136	376	2,034

Total life (non-linked)	2,962	11,320	343	1,006	1,739	17,370

Life (linked)	1,548	2,276	310	-	1,933	6,067

Investment contracts with DPF1,2	17,732	-	34	-	-	17,766

Insurance liabilities to policyholders	22,242	13,596	687	1,006	3,672	41,203

At 31 December 2007
Life (non-linked)
Insurance contracts with DPF1	940	8,489	231	-	-	9,660
Credit life	235	-	-	82	-	317
Annuities	413	-	28	1,154	1,532	3,127
Term assurance and other long-term contracts	675	74	85	125	307	1,266

Total life (non-linked)	2,263	8,563	344	1,361	1,839	14,370

Life (linked)	1,720	2,019	467	-	2,193	6,399

Investment contracts with DPF1,2	18,954	-	29	-	-	18,983

Insurance liabilities to policyholders	22,937	10,582	840	1,361	4,032	39,752

1 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 is 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.

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

(Audited)

The above table of liabilities to life insurance policyholders highlights that the most significant products are investment contracts with DPF issued in France, insurance contracts with DPF issued in Hong Kong and unit-linked contracts issued in Hong Kong, Latin America and Europe.

The liabilities for long-term contracts are set by reference to a range of assumptions which include lapse and surrender rates, mortality and expense levels. These assumptions typically reflect each entity's own experience. Economic assumptions, such as investment returns and interest rates, are usually based on market observable data. Changes in underlying assumptions affect the liabilities. The sensitivity of profit after tax and shareholders' equity to changes in both economic and non-economic assumptions are considered below.

Insurance risk arising from life insurance depends on the type of business, and varies considerably. The principal risks are mortality, morbidity, lapse, surrender and expense levels.

The main contracts which generate exposure to mortality and morbidity risks are term assurance contracts and annuities. These risks are monitored on a regular basis, and are primarily mitigated by medical underwriting and by retaining the ability in certain cases to amend premiums in the light of experience. The risk associated with lapses and surrenders is generally mitigated by the application of surrender charges, though other management actions, such as managing the level of bonus payments to policyholders, may be taken. Expense risk is generally managed through pricing. The level of expenses in the contract will be one of the factors considered when setting premiums rates.

Analysis of non-life insurance risk - net written insurance premiums1

(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
2008
Accident and health	14	155	5	3	27	204
Motor	350	15	14	-	273	652
Fire and other damage	150	26	3	4	22	205
Liability	-	14	4	-	34	52
Credit (non-life)	99	-	-	144	-	243
Marine, aviation and transport	-	11	4	-	24	39
Other non-life insurance contracts	49	28	-	15	29	121

Total net written insurance premiums	662	249	30	166	409	1,516

Net insurance claims incurred and movement in liabilities to policyholders	(553)	(121)	(13)	(98)	(176)	(961)

2007
Accident and health	27	132	5	-	25	189
Motor	369	15	10	-	224	618
Fire and other damage	178	23	7	2	19	229
Liability	-	12	3	8	34	57
Credit (non-life)	76	-	-	157	-	233
Marine, aviation and transport	-	12	4	-	18	34
Other non-life insurance contracts	30	24	-	30	24	108

Total net written insurance premiums	680	218	29	197	344	1,468

Net insurance claims incurred and movement in liabilities to policyholders	(598)	(90)	(10)	(79)	(151)	(928)

2006
Accident and health	26	97	5	-	10	138
Motor	185	15	13	-	157	370
Fire and other damage	221	22	5	2	9	259
Liability	1	13	2	8	24	48
Credit (non-life)	264	-	-	173	-	437
Marine, aviation and transport	1	11	3	-	12	27
Other non-life insurance contracts	13	24	-	37	20	94

Total net written insurance premiums	711	182	28	220	232	1,373

Net insurance claims incurred and movement in liabilities to policyholders	(451)	(76)	(11)	(79)	(111)	(728)

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

(Audited)

The above table of non-life net written insurance premiums provides an overall summary of the nonߛlife insurance activity of the Group. Motor business is written predominantly in Europe and Latin America and represented the largest class of non-life business in 2008. Fire and other damage to property business is written in all major markets, most significantly in Europe. Credit non-life insurance, which is originated in conjunction with the provision of loans, is concentrated in the US and Europe.

The main risks associated with non-life business are underwriting risk and claims experience risk. Underwriting risk is the risk that HSBC does not charge premiums appropriate to the cover provided and claims experience risk is the risk that portfolio experience is worse than expected. HSBC manages these risks through pricing (for example, imposing restrictions and deductibles in the policy terms and conditions), product design, risk selection, claims handling, investment strategy and reinsurance policy. The majority of non-life insurance contracts are renewable annually and the underwriters have the right to refuse renewal or to change the terms and conditions of the contract at that time.

Balance sheet of insurance manufacturing subsidiaries by type of contract

(Audited)

A principal tool used by HSBC to manage its exposure to insurance risk, in particular for life insurance contracts, is asset and liability matching. Models are used to assess the effect of a range of future scenarios on the values of financial assets and associated liabilities, and ALCOs employ the outcomes in determining how the assets and liabilities should be matched. The scenarios include stresses applied to factors which affect insurance risk such as mortality and lapse rates. Of particular importance is the need to match the expected pattern of cash inflows with the benefits payable on the underlying contracts, which can extend for many years. The table below shows the composition of assets and liabilities and demonstrates that there were sufficient assets to cover the liabilities to policyholders at the end of 2008. It may not always be possible to achieve a complete matching of asset and liability durations, partly because there is uncertainty over policyholder behaviour, which introduces uncertainty over the receipt of all future premiums and the timing of claims, and partly because the duration of liabilities may exceed the duration of the longest available dated fixed interest investments. In an environment where interest rates and yield curves are falling, insurance operations are exposed to re-investment risk as higher yielding assets held in the portfolio mature and are replaced with lower yielding assets. Given the objective to hold rather than trade investments, the current portfolio of assets includes debt securities issued at a time when coupon rates were higher than those observed in the current market. As a result, the current yield of the debt securities exceeds that which may be obtained on current issues. Management action has been taken in relation to certain participating contracts to reduce short-term bonus rates paid to policyholders to manage the immediate strain on the business. Should interest rates and yield curves stay low for prolonged periods, further management actions may be needed.

	Insurance contracts							Investment contracts
Contracts with DPF			Unit- linked	Annu- ities	Term assur- ance1	Non-life	Contracts with DPF2		Unit- linked	Other	Other assets3	Total
		US$m	US$m	US$m	US$m	US$m		US$m	US$m	US$m	US$m	US$m
At 31 December 2008
Financial assets:
- trading assets		-	-	-	-	35		-	-	-	4	39
- financial assets designated at fair value		959	4,738	457	496	52		4,597	5,525	1,481	1,970	20,275
- derivatives		27	3	-	26	-		60	170	91	24	401
- financial investments		9,383	-	1,282	399	860		12,482	-	1,482	2,576	28,464
- other financial assets		1,967	400	639	1,288	1,106		173	443	685	2,110	8,811

Total financial assets		12,336	5,141	2,378	2,209	2,053		17,312	6,138	3,739	6,684	57,990
Reinsurance assets		6	956	311	320	430			-		60	2,083
PVIF4		-	-	-	-	-		-	-	-	2,033	2,033
Other assets and investment properties		121	3	32	71	257		459	55	54	935	1,987

Total assets		12,463	6,100	2,721	2,600	2,740		17,771	6,193	3,793	9,712	64,093

Liabilities under investment contracts designated at fair value		-	-	-	-	-		-	6,012	3,271	-	9,283
Liabilities under investment contracts carried at amortised cost		-	-	-	-	-		-	-	284	-	284
Liabilities under insurance contracts		12,444	6,067	2,575	2,351	2,480		17,766	-	-	-	43,683
Deferred tax		8	7	22	30	1		1	-	3	515	587
Other liabilities		-	-	-	-	-		-	-	-	2,679	2,679

Total liabilities		12,452	6,074	2,597	2,381	2,481		17,767	6,012	3,558	3,194	56,516

Total equity		-	-	-	-	-		-	-	-	7,577	7,577

Total equity and liabilities5		12,452	6,074	2,597	2,381	2,481		17,767	6,012	3,558	10,771	64,093

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

(Audited)

	Insurance contracts							Investment contracts
Contracts with DPF			Unit- linked	Annu- ities	Term assur- ance1	Non-life	Contracts with DPF2		Unit- linked	Other	Other assets3	Total
		US$m	US$m	US$m	US$m	US$m		US$m	US$m	US$m	US$m	US$m
At 31 December 2007
Financial assets:
- trading assets		-	-	37	-	22		-	-	-	35	94
- financial assets designated at fair value		3,424	5,799	610	559	130		6,210	12,379	1,610	2,992	33,713
- derivatives		2	52	-	-	1		78	250	3	30	416
- financial investments		4,518	-	1,265	328	1,071		12,305	-	1,526	2,939	23,952
- other financial assets		1,896	520	1,047	716	1,175		3	762	714	1,483	8,316

Total financial assets		9,840	6,371	2,959	1,603	2,399		18,596	13,391	3,853	7,479	66,491
Reinsurance assets		4	57	337	264	653		-	-	-	54	1,369
PVIF4		-	-	-	-	-		-	-	-	1,965	1,965
Other assets and investment properties		65	2	30	104	193		399	46	52	1,196	2,087

Total assets		9,909	6,430	3,326	1,971	3,245		18,995	13,437	3,905	10,694	71,912

Liabilities under investment contracts designated at fair value		-	-	-	-	-		-	12,725	3,328	-	16,053
Liabilities under investment contracts carried at amortised cost		-	-	-	-	-		-	-	312	-	312
Liabilities under insurance contracts		9,660	6,399	3,127	1,583	2,854		18,983	-	-	-	42,606
Deferred tax		-	7	3	22	3		-	6	-	582	623
Other liabilities		-	-	-	-	-		-	-	-	3,888	3,888

Total liabilities		9,660	6,406	3,130	1,605	2,857		18,983	12,731	3,640	4,470	63,482

Total equity		-	-	-	-	-		-	-	-	8,430	8,430

Total equity and liabilities6		9,660	6,406	3,130	1,605	2,857		18,983	12,731	3,640	12,900	71,912

1 Term assurance includes credit life insurance.

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

3 Other assets comprise shareholder assets.

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

5 Does not include assets, liabilities and shareholders' funds of associated insurance company, Ping An Insurance, or joint venture insurance companies, Hana Life and Canara HSBC Oriental Bank of Commerce Life Insurance Company Limited.

6 Does not include assets, liabilities and shareholders' funds of associated insurance company, Ping An Insurance.

The table below shows the composition of assets and liabilities by region and demonstrates that there were sufficient assets to cover the liabilities to policyholders for each region at the end of 2008.

Balance sheet of insurance manufacturing subsidiaries by geographical region

(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
At 31 December 2008
Financial assets:
- trading assets	-	-	-	-	39	39
- financial assets designated at fair value	12,605	4,153	581	-	2,936	20,275
- derivatives	258	117	-	-	26	401
- financial investments	14,240	10,689	91	2,040	1,404	28,464
- other financial assets	4,143	2,906	289	585	888	8,811

Total financial assets	31,246	17,865	961	2,625	5,293	57,990

Reinsurance assets	920	1,004	20	13	126	2,083
PVIF1	845	905	81	-	202	2,033
Other assets and investment properties	933	400	9	354	291	1,987

Total assets	33,944	20,174	1,071	2,992	5,912	64,093

Liabilities under investment contracts designated at fair value	5,310	3,895	78	-	-	9,283
Liabilities under investment contracts carried at amortised cost	-	-	-	-	284	284
Liabilities under insurance contracts	23,752	13,873	745	1,237	4,076	43,683
Deferred tax	304	161	19	-	103	587
Other liabilities	2,184	190	42	11	252	2,679

Total liabilities	31,550	18,119	884	1,248	4,715	56,516

Total equity	2,394	2,055	187	1,744	1,197	7,577

Total equity and liabilities2	33,944	20,174	1,071	2,992	5,912	64,093

At 31 December 2007
Financial assets:
- trading assets	-	-	-	-	94	94
- financial assets designated at fair value	22,824	6,733	796	-	3,360	33,713
- derivatives	410	5	-	1	-	416
- financial investments	13,805	6,251	78	2,425	1,393	23,952
- other financial assets	3,345	3,259	197	653	862	8,316

Total financial assets	40,384	16,248	1,071	3,079	5,709	66,491

Reinsurance assets	1,095	48	28	83	115	1,369
PVIF1	892	810	65	-	198	1,965
Other assets and investment properties	787	926	7	52	315	2,087

Total assets	43,158	18,032	1,171	3,214	6,337	71,912

Liabilities under investment contracts designated at fair value	11,720	4,285	48	-	-	16,053
Liabilities under investment contracts carried at amortised cost	-	-	-	-	312	312
Liabilities under insurance contracts	24,788	10,843	903	1,652	4,420	42,606
Deferred tax	371	143	12	-	97	623
Other liabilities	3,392	193	28	18	257	3,888

Total liabilities	40,271	15,464	991	1,670	5,086	63,482

Total equity	2,887	2,568	180	1,544	1,251	8,430

Total equity and liabilities3	43,158	18,032	1,171	3,214	6,337	71,912

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

2 Does not include assets, liabilities and shareholders' funds of associated insurance company, Ping An Insurance, or joint venture insurance companies, Hana Life and Canara HSBC Oriental Bank of Commerce Life Insurance Company Limited.

3 Does not include assets, liabilities and shareholders' funds of associated insurance company, Ping An Insurance.

Financial risks

(Audited)

HSBC's insurance businesses are exposed to a range of financial risks, including market risk, credit risk and liquidity risk. Market risk includes interest rate risk, equity risk and foreign exchange risk. The nature and management of these risks is described below.

Manufacturing subsidiaries are exposed to financial risks, for example, when the proceeds from financial assets are not sufficient to fund the obligations arising from non-linked insurance and investment contracts. Certain insurance-related activities undertaken by HSBC subsidiaries such as insurance broking, insurance management (including captive management) and the administration and intermediation of insurance, pensions and annuities are exposed to financial risks, but not to a significant extent.

Risk management procedures which reflect local market conditions and regulatory requirements may be implemented by HSBC's insurance manufacturing subsidiaries in addition to policies provided for Group-wide application through the Group Instruction Manuals. In many jurisdictions, local regulatory requirements prescribe the type, quality and concentration of assets that these subsidiaries must maintain to meet insurance liabilities. Within each subsidiary, ALCOs are responsible for ensuring that exposures to financial risks remain within local requirements and risk mandates (as agreed with Group Insurance Head Office), and ensure compliance with the control framework established centrally through the Group Instruction Manuals.

The following table analyses the assets held in HSBC's insurance manufacturing subsidiaries at 31 December 2008 by type of contract, and provides a view of the exposure to financial risk:

Financial assets held by insurance manufacturing subsidiaries (Audited)
	At 31 December 2008
	Life linked	Life non-linked	Non-life	Other
	contracts1	contracts2	insurance3	assets4	Total5
	US$m	US$m	US$m	US$m	US$m
Trading assets
Debt securities	-	-	35	4	39

Financial assets designated at fair value
Treasury bills	31	197	-	8	236
Debt securities	4,091	3,109	52	1,625	8,877
Equity securities	6,141	4,684	-	337	11,162

	10,263	7,990	52	1,970	20,275

Financial investments
Held-to-maturity:
Debt securities	-	10,411	170	510	11,091

Available-for-sale:
Treasury bills	-	4	130	128	262
Other eligible bills	-	-	272	126	398
Debt securities	-	14,602	254	1,596	16,452
Equity securities	-	11	34	216	261

	-	14,617	690	2,066	17,373

Derivatives	173	204	-	24	401
Other financial assets6	843	4,752	1,106	2,110	8,811

	11,279	37,974	2,053	6,684	57,990

	At 31 December 2007
	Life linked	Life non-linked	Non-life	Other
	contracts1	contracts2	insurance3	assets4	Total7
	US$m	US$m	US$m	US$m	US$m
Trading assets
Debt securities	-	37	22	35	94

Financial assets designated at fair value
Treasury bills	51	-	96	34	181
Debt securities	7,741	3,591	28	2,272	13,632
Equity securities	10,386	8,822	6	686	19,900

	18,178	12,413	130	2,992	33,713

Financial investments
Held-to-maturity:
Treasury bills	-	-	-	-	-
Debt securities	-	6,253	144	408	6,805

	-	6,253	144	408	6,805

Available-for-sale:
Treasury bills	-	2	126	130	258
Other eligible bills	-	-	176	172	348
Debt securities	-	13,677	563	2,065	16,305
Equity securities	-	10	62	164	236

	-	13,689	927	2,531	17,147

Derivatives	302	83	1	30	416
Other financial assets6	1,282	4,376	1,175	1,483	8,316

	19,762	36,851	2,399	7,479	66,491

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

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

3 Comprises non-life insurance contracts.

4 Comprise shareholder assets.

5 Does not include financial assets of associated insurance company, Ping An Insurance.

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

7 Does not include financial assets of insurance manufacturing associate, Ping An Insurance.

The table demonstrates that for linked contracts, HSBC typically designates assets at fair value. For non-linked contracts, the classification of the assets is driven by the nature of the underlying contract.

The table also shows that approximately 62.9 per cent of financial assets was invested in debt securities at 31 December 2008 (2007: 55.4 per cent) with 19.7 per cent (2007: 30.3 per cent) invested in equity securities.

In life linked insurance, premium income less charges levied is invested in a portfolio of assets. HSBC manages 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. Typically, HSBC retains some exposure to market risk as the market value of the linked assets influences the fees charged by HSBC and thereby affects the recoverability of expenses incurred by the Group in managing the product. The assets held to support life linked liabilities represented 19.4 per cent of the total financial assets of HSBC's insurance manufacturing subsidiaries at the end of 2008 (2007: 29.7 per cent).

Market risk

(Audited)

Insurance and investment products manufactured by HSBC's insurance manufacturing subsidiaries typically comprise features or combinations of features which may not be easily or exactly replicated by investments. 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.

Description of market risk

(Audited)

The main features of products manufactured by HSBC's insurance manufacturing subsidiaries which generate market risk, and the market risk to which these features expose the subsidiaries, are discussed below.

Long-term insurance or investment products may incorporate either one investment return guarantee or a combination thereof, divided into the following categories:

annuities in payment;
deferred annuities: these consist of two phases
- the savings and investing phase and the retirement income phase;
annual return: the annual return is guaranteed to be no lower than a specified rate. This may be the return credited to the policyholder every year, or the average annual return credited to the policyholder over the life of the policy, which may occur on the maturity date or the surrender date of the contract;
capital: policyholders are guaranteed to receive no less than the premiums paid plus declared bonuses less expenses; and
market performance: policyholders receive an investment return which is guaranteed to be within a prescribed range of average investment returns earned by predetermined market participants on the specified product.

Subsidiaries manufacturing products with guarantees are usually exposed to falls in market interest rates as they result in lower yields on the assets supporting guaranteed investment returns payable to policyholders. In the current market environment, in which interest rates are falling, managing this risk is of increasing importance.

The table below shows, in respect of each category of guarantee, the total liabilities to policyholders established for guaranteed products, the range of investment returns (net of operating costs) implied by the guarantees, and the range of current yields of the investment portfolios supporting the guarantees.

Liabilities to policyholders1

(Audited)

	2008			2007
	Amount of reserve	Investment returns implied by guarantee2	Current yields	Amount of reserve	Investment returns implied by guarantee3	Current yields
	US$m	%	%	US$m	%	%

Annuities in payment	744	0.0 - 11.5	6.5 - 28.0	716	0.0 - 8.5	5.1 - 18.1
Deferred annuities	120	0.0 - 6.0	3.9 - 7.4	116	0.0 - 6.0	3.8 - 8.6
Deferred annuities	576	6.0 - 9.0	5.4 - 5.4	609	6.0 - 9.0	5.7
Annual return	13,717	0.0 - 4.5	2.2 - 4.9	12,875	0.0 - 4.5	3.2 - 8.7
Annual return	302	4.5 - 6.0	3.4 - 7.3	352	4.5 - 6.0	3.2 - 8.5
Capital	13,346	0.0	2.0 - 4.3	11,311	0.0	3.8 - 4.8
Market performance4	n/a	n/a	n/a	3,605	n/a	n/a

1 The table excludes contracts where the market risk is 100 per cent reinsured.

2 Excluding guarantees from associated insurance company, Ping An Insurance, or joint venture insurance companies, Hana Life and Canara HSBC Oriental Bank of Commerce Life Insurance Company Limited

3 Excluding guarantees from associate insurance company, Ping An Insurance.

4 There is no specific investment return implied by market performance guarantees because the guarantees are expressed as lying within prescribed ranges of average market returns.

A certain number of these products have been discontinued, including the US$576 million deferred annuity portfolio in HSBC Finance where, as highlighted in the above table, the current portfolio yield is less than the guarantee. On acquisition of this block of business by HSBC Finance, a provision was established to mitigate the shortfall in yields. There has been no further deterioration in the shortfall since acquisition. There are a limited number of additional contracts where the current portfolio yield is less than the guarantee implied by the contract.

The proceeds from insurance and investment products with DPF are primarily invested in bonds with a proportion allocated to equity securities in order to provide customers with the potential for enhanced returns. Subsidiaries with portfolios of such products are exposed to the risk of falls in the market price of equity securities when they cannot be fully reflected in the discretionary bonuses. An increase in market volatility could also result in an increase in the value of the guarantee to the policyholder.

Long-term insurance and investment products typically permit the policyholder to surrender the policy or let it lapse at any time. When the surrender value is not linked to the value realised from the sale of the associated supporting assets, the subsidiary is exposed to market risk. In particular, when customers seek to surrender their policies when asset values are falling, assets may have to be sold at a loss to fund redemptions.

A subsidiary holding a portfolio of long-term insurance and investment products, especially with DPF, may attempt to reduce exposure to its local market by investing in assets in countries other than that in which it is based. These assets may be denominated in currencies other than the subsidiary's local currency. It is often not cost effective for the subsidiary to hedge the foreign exchange exposure associated with these assets, and this exposes it to the risk that its local currency will strengthen against the currency of the related assets.

For unit-linked contracts, market risk is substantially borne by the policyholder, but HSBC typically remains exposed 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 following techniques, depending on the nature of the contracts they write:

for products with DPF, adjusting bonus rates to manage the liabilities to policyholders. Bonus rates are managed by regularly evaluating their sustainability. The effect is 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 returns at least equal to the investment returns implied by the guarantees;
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 level of premiums or the price structure;
periodically reviewing products identified as higher risk, which contain guarantees and embedded optionality features linked to savings and investment products. The scope of the review would include pricing, risk management and profitability (a control introduced during 2008). Guaranteed products which expose the Group to risk beyond the levels deemed acceptable in any of these categories are either altered or are no longer offered to customers;
including features designed to mitigate market risk in new products, such as charging surrender penalties to recoup losses incurred when policyholders surrender their policies; and
exiting, to the extent possible, investment portfolios whose risk is considered unacceptable - for example, by implementing asset reallocation strategies in order to manage risk exposures.

During 2008, the credit, market and liquidity risk functions in Group Insurance Head Office were strengthened by the creation of two new positions, Chief Credit Officer and Chief Market and Liquidity Risk Officer, both reporting to the Chief Risk Officer. Also, due diligence procedures were enhanced during the current lower yield environment to more critically assess embedded risk in respect of new products, for example, those including options and guarantees within the contract. When such product features are identified, the product proposal is reviewed by Group Insurance Head Office to ensure that the key risks are identified and that the related risk management procedures are adequate. The frequency with which management reviews certain exposures is increased in markets demonstrating increasing volatility to ensure that any matters arising are dealt with in a timely fashion.

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 subsidiary's ALCO and the Market and Liquidity Risk Committee (sub-committee to the Group Insurance Risk Committee) to ensure that each mandate is consistent with local regulations. All mandates are reviewed and agreed annually by Group Insurance Head Office, and aggregate limits are approved by the Risk Management Meeting of GMB. During 2008, market risk mandates were enhanced in some of the major insurance subsidiaries by introducing stop loss limits and management action limits designed to control risk in certain portfolios.

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 Committee, 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 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 with them. The most significant limitation is that a parallel shift in yield curves of one basis point does not capture the non-linear relationships between the values of certain assets and liabilities and interest rates. Non-linearity arises, 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 less than the investment returns implied by the guarantees, shortfalls will be 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 aggregate annual profits and total equity of the insurance manufacturing subsidiaries. HSBC's insurance manufacturing subsidiaries report the results of their stress tests every quarter 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 the assets and liabilities in their financial statements whose values are sensitive to each category of market risk and revalue them at various market rates. The outcome of the exercise is expressed in terms of the effect on profit for the year and total equity under the stress-tested assumptions, after taking into consideration tax and accounting treatments where material and relevant.

The following table illustrates the effect on the aggregated profit for the year and total equity under various interest rate, equity price, foreign exchange rate and credit spread scenarios. Where appropriate, the impact of the stress on the PVIF is included in the results of the stress tests. The relationship between the values of certain assets and liabilities and the risk factors may be non-linear and, therefore, the results disclosed cannot be extrapolated to measure sensitivities to different levels of stress. The sensitivities are stated before allowance for the effect of management actions which may mitigate 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 subsidiaries to risk factors (Audited)
	2008		2007
	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	94	(13)	67	(29)
- 100 basis points parallel shift in yield curves	(82)	24	(71)	49
10 per cent increase in equity prices	10	10	147	151
10 per cent decrease in equity prices	(12)	(12)	(145)	(149)
10 per cent increase in US dollar exchange rate compared to all currencies	28	29	12	12
10 per cent decrease in US dollar exchange rate compared to all currencies	(28)	(29)	(12)	(12)
Sensitivity to credit spread increases	(73)	(134)	(15)	(30)

The sensitivity of the net profit after tax of HSBC's insurance subsidiaries to the effects of increases in credit spreads is a fall of US$73 million (2007: US$15 million fall). The sensitivity is consistent with the other sensitivities noted above, and is calculated using simplified assumptions based on a one-day movement in credit spreads over a two-year period. A confidence level of 99 per cent, consistent with the Group's VAR, has been applied. The effect of movements in credit spreads became more significant in 2008 due to increased volatility in credit spreads.

Credit risk

(Audited)

Credit risk can give rise to losses through default and can lead to volatility in income statement and balance sheet figures through movements in credit spreads, principally on the US$33.2 billion (2007: US$29.8 billion) non-linked bond portfolio. The exposure of the income statement to the effect of changes in credit spreads is small (see the table on page 266). 49 per cent of the financial assets held by 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 impact on the profit after tax.

HSBC sells certain unit-linked life insurance contracts which are reinsured with a thirdߛparty. These insurance contracts include market return guarantees which are underwritten by the thirdߛparty. HSBC is exposed to credit risk to the extent that the third-party (the counterparty) is unable to meet the terms of the guarantees. As highlighted in 'Market Risk' above, the cost to the Group of market return guarantees increases when interest rates fall, equity markets fall or market volatility increases. In addition, when determined by reference to a discounted cash flow model in which the discount rate is based on current interest rates, guarantee costs increase in a falling interest rate environment. As a consequence of the rise in these costs, the Group's counterparty exposure to the guarantees under the reinsurance agreement at 31 December 2008 was greater than at 31 December 2007. During 2008, sales of these contracts ceased, reflecting the adjusted risk appetite of the business.

The exposure to credit risk products and the management of the risks associated with credit protection products are included in the description of life and non-life insurance risk on pages 257 to 258. HSBC's insurance manufacturing subsidiaries are responsible for the credit risk, quality and performance of their investment portfolios. Investment credit mandates and limits are set by the subsidiaries and approved by their local insurance ALCOs and Credit Risk functions before being submitted to Group Credit Risk for concurrence. The form and content of the mandates must accord with centrally set investment credit risk guidance regarding credit quality, industry sector concentration and liquidity restrictions, but allow for the inclusion of local regulatory and country-specific conditions. The 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 the 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.

As noted above, under certain circumstances, the Group is able to dilute the effect of investment losses by sharing them with policyholders. However, when, for example, a contract includes a guarantee, losses which would result in a breach of the guaranteed benefits due to the policyholder are borne by the Group.

In response to adverse credit market conditions, various initiatives were introduced during 2008 to better manage and report credit risk, including an Early Warning Report which is produced on a weekly basis to identify investments which may be at risk of future impairment. This report is circulated to senior management in Group Insurance Head Office and the Regional Chief Risk Officers, and risk reduction strategies are implemented when considered appropriate. Similarly, a watch list of investments with current credit concerns is circulated weekly.

Credit quality

(Audited)

The following table presents an analysis of treasury bills, other eligible bills and debt securities within HSBC's insurance business by measures of credit quality. The definitions of the four credit quality classifications are included on page 217. Only assets supporting non-linked liabilities are included in the table as financial risk on assets supporting linked liabilities is predominantly borne by the policyholder. 93.7 per cent (2007: 88.7 per cent) 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 subsidiaries

(Audited)

	Neither past due nor impaired
	Strong	Medium	Sub- standard	Impaired1	Total
	US$m	US$m	US$m	US$m	US$m
At 31 December 2008

Supporting liabilities under non-linked insurance and investment contracts
Trading assets - debt securities	27	8	-		35

Financial assets designated at fair value	2,704	654	-		3,358
- treasury and other eligible bills	197	-	-		197
- debt securities	2,507	654	-		3,161

Financial investments	24,881	913	45	4	25,843
- treasury and other similar bills	404	2	-	-	406
- debt securities	24,477	911	45	4	25,437


	27,612	1,575	45	4	29,236

Supporting shareholders' funds2
Trading assets - debt securities	4	-	-		4

Financial assets designated at fair value	1,502	131	-		1,633
- treasury and other eligible bills	8	-	-		8
- debt securities	1,494	131	-		1,625

Financial investments	2,033	228	99	-	2,360
- treasury and other similar bills	245	7	2	-	254
- debt securities	1,788	221	97	-	2,106


	3,539	359	99	-	3,997

Total3
Trading assets - debt securities	31	8	-		39

Financial assets designated at fair value	4,206	785	-		4,991
- treasury and other eligible bills	205	-	-		205
- debt securities	4,001	785	-		4,786

Financial investments	26,914	1,141	144	4	28,203
- treasury and other similar bills	649	9	2	-	660
- debt securities	26,265	1,132	142	4	27,543


	31,151	1,934	144	4	33,233

	Neither past due nor impaired
	Strong	Medium	Sub- standard	Total
	US$m	US$m	US$m	US$m
At 31 December 2007

Supporting liabilities under non-linked insurance and investment contracts
Trading assets - debt securities	-	59	-	59

Financial assets designated at fair value	2,748	967	-	3,715
- treasury and other eligible bills	-	96	-	96
- debt securities	2,748	871	-	3,619

Financial investments	19,352	1,575	14	20,941
- treasury and other similar bills	290	14	-	304
- debt securities	19,062	1,561	14	20,637


	22,100	2,601	14	24,715

Supporting shareholders' funds2
Trading assets - debt securities	-	35	-	35

Financial assets designated at fair value	1,833	473	-	2,306
- treasury and other eligible bills	-	34	-	34
- debt securities	1,833	439	-	2,272

Financial investments	2,537	233	5	2,775
- treasury and other similar bills	290	7	5	302
- debt securities	2,247	226	-	2,473


	4,370	741	5	5,116

Total4
Trading assets - debt securities	-	94	-	94

Financial assets designated at fair value	4,581	1,440	-	6,021
- treasury and other eligible bills	-	130	-	130
- debt securities	4,581	1,310	-	5,891

Financial investments	21,889	1,808	19	23,716
- treasury and other similar bills	580	21	5	606
- debt securities	21,309	1,787	14	23,110


	26,470	3,342	19	29,831

1 Impairment is not measured for debt securities 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 through the income statement. Consequently, all such balances are reported under 'neither past due nor impaired'.

2 Shareholders' funds comprise solvency and unencumbered assets.

3 Does not include treasury bills, other eligible bills and debt securities held by associated insurance company, Ping An Insurance, or joint venture insurance companies, Hana Life and Canara HSBC Oriental Bank of Commerce Life Insurance Company Limited.

4 Does not include treasury bills, other eligible bills and debt securities held by insurance manufacturing associate, Ping An Insurance.

Issuers of treasury bills, other eligible bills and debt securities in HSBC's insurance subsidiaries

(Audited)

	Treasury bills	Other eligible bills	Debt securities	Total
	US$m	US$m	US$m	US$m
At 31 December 2008
Governments	467	24	6,109	6,600
Local authorities	-	-	525	525
Asset-backed securities	-	-	14	14
Corporates and other	-	374	25,720	26,094

	467	398	32,368	33,233

At 31 December 2007
Governments	388	-	7,140	7,528
Local authorities	-	-	175	175
Asset-backed securities	-	-	201	201
Corporates and other	-	348	21,579	21,927

	388	348	29,095	29,831

(Audited)

Credit risk also arises when part of the insurance risk incurred by HSBC is assumed by reinsurers. The credit risk exposure to reinsurers is monitored by Group Insurance Head Office and is reported quarterly to the Group Insurance Risk Committee and the Group Insurance Credit Risk Meeting.

split of liabilities ceded to reinsurers and outstanding reinsurance recoveries, analysed by Standard & Poor's reinsurance credit rating data or their equivalent, is shown below. The Group's exposure to third parties under the reinsurance agreement described in the Credit Risk section above is included in this table.

Reinsurers' share of liabilities under insurance contracts

(Audited)

	Neither past due nor impaired		Past due but not impaired
	Strong	Medium	Past due but not impaired	Total
	US$m	US$m	US$m	US$m

At 31 December 2008
Linked insurance contracts	9	947	-	956
Non-linked insurance contracts	1,001	62	4	1,067

Total1	1,010	1,009	4	2,023

Reinsurance debtors	30	20	10	60

At 31 December 2007
Linked insurance contracts	35	22	-	57
Non-linked insurance contracts	998	257	3	1,258

Total2	1,033	279	3	1,315

Reinsurance debtors	37	9	8	54

1 Does not include reinsurers' share of liabilities under insurance contracts and reinsurance debtors of associated insurance company, Ping An Insurance, or joint venture insurance companies, Hana Life and Canara HSBC Oriental Bank of Commerce Life Insurance Company Limited.

2 Does not include reinsurers' share of liabilities under insurance contracts and reinsurance debtors of insurance manufacturing associate, Ping An Insurance.

Liquidity risk

(Audited)

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 leads to liquidity risk.

To fund the cash outflows arising from claims liabilities, HSBC's insurance manufacturing subsidiaries primarily utilise liquidity from the following sources:

cash inflows arising from premiums from new business, policy renewals and recurring premium products;
cash inflows arising from interest and dividends on investments and principal repayments of maturing debt investments;
cash resources; and
cash inflows from the sale of investments.

HSBC's insurance manufacturing subsidiaries 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.

Every quarter, HSBC's 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 series of stress scenarios designed to determine the effect of reducing expected available liquidity and accelerating cash outflows. This is achieved by, for example, assuming new business or renewals are lower, and surrenders or lapses are greater, than expected.

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 2008. As indicated in the analyses of life and non-life insurance risks on pages 257 to 258, a significant proportion of the Group's 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 in the case of unit-linked business).

The profile of the expected maturity of the insurance contracts as at 31 December 2008 remained comparable with 2007.

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 2008
Non-life insurance	1,178	1,186	115	1	2,480
Life insurance (non-linked)	2,527	7,789	16,695	14,432	41,443
Life insurance (linked)	1,295	1,251	3,269	5,390	11,205

Total1	5,000	10,226	20,079	19,823	55,128

At 31 December 2007
Non-life insurance	1,337	1,352	164	1	2,854
Life insurance (non-linked)	1,887	5,310	15,986	13,269	36,452
Life insurance (linked)	507	1,894	3,644	5,014	11,059

Total2	3,731	8,556	19,794	18,284	50,365

1 Does not include insurance contracts issued by associated insurance company, Ping An Insurance, or joint venture insurance companies, Hana Life and Canara HSBC Oriental Bank of Commerce Life Insurance Company Limited.

2 Does not include insurance contracts issued by insurance manufacturing associate, Ping An Insurance.

Remaining contractual maturity of investment contract liabilities

(Audited)

	Liabilities under investment contracts by insurance underwriting subsidiaries
	Linked investment contracts	Other investment contracts	Investment contracts with DPF	Total
	US$m	US$m	US$m	US$m
At 31 December 2008
Remaining contractual maturity:
- due within 1 year	178	314	-	492
- due between 1 and 5 years	610	21	34	665
- due between 5 and 10 years	482	31	-	513
- due after 10 years	1,649	42	-	1,691
- undated1	3,093	3,147	17,732	23,972

Total2	6,012	3,555	17,766	27,333

At 31 December 2007
Remaining contractual maturity:
- due within 1 year	286	331	1	618
- due between 1 and 5 years	1,234	48	28	1,310
- due between 5 and 10 years	950	-	-	950
- due after 10 years	3,386	44	-	3,430
- undated1	6,869	3,217	18,954	29,040

Total3	12,725	3,640	18,983	35,348

1 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 above.

2 Does not include investment contracts issued by associated insurance company, Ping An Insurance, or joint venture insurance companies, Hana Life and Canara HSBC Oriental Bank of Commerce Life Insurance Company Limited.

3 Does not include investment contracts issued by insurance manufacturing associate, Ping An Insurance.

Present value of in-force long-term insurance business

(Audited)

The HSBC life insurance business is accounted for using the embedded value approach which, inter alia, provides a comprehensive framework for the evaluation of insurance and related risks. The present value of the in-force long-term ('PVIF') asset at 31 December 2008 was US$2.0 billion (2007: US$2.0 billion). The present value of the shareholders' interest in the profits expected to emerge from the book of in-force policies at 31 December can be stress-tested to assess the ability of the life business book to withstand adverse developments. A key feature of the life insurance business is the importance of managing the assets, liabilities and risks in a coordinated fashion rather than individually. This reflects the greater interdependence of these three elements for life insurance than is generally the case for non-life insurance.

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

Sensitivity of PVIF to changes in economic assumptions

(Audited)

	PVIF at 31 December
	2008	2007
	US$m	US$m

+ 100 basis point shift in risk-free rate	179	195
- 100 basis point shift in risk-free rate	(100)	(232)
+ 100 basis point shift in risk discount rate	(109)	(95)
- 100 basis point shift in risk discount rate	122	106

Due to certain characteristics of the contracts, the relationships may be non-linear and the results of the stress-testing disclosed above should not be extrapolated to higher levels of stress. In calculating the various scenarios, all assumptions are held stable except when testing the effect of the shift in the risk-free rate, when consequential changes to investment returns, risk discount rates and bonus rates are also incorporated. The sensitivities shown are before actions that could be taken by management to mitigate effects and before consequential changes in policyholder behaviour.

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

Movements in total equity and PVIF of insurance operations

(Audited)

	2008			2007
		Total equity	Of which includes: PVIF	Total equity	Of which includes: PVIF
		US$m	US$m	US$m	US$m

At 1 January		8,430	1,965	5,949	1,549
Value of new business written during the year1		452	452	380	380
Acquisitions of subsidiaries/portfolios		-	-	652	390
Movements arising from in-force business:
- expected return		(186)	(186)	(175)	(175)
- experience variances2		(36)	(36)	53	53
- change in operating assumptions		(7)	(7)	(86)	(86)
Investment return variances		(94)	(94)	-	-
Changes in investment assumptions		12	12	4	4
Return on net assets		(310)	-	1,235	-
Disposals of subsidiaries/portfolios		-	-	(250)	-
Exchange differences and other		(93)	(73)	(91)	(150)
Capital transactions		(591)	-	759	-

At 31 December		7,577	2,033	8,430	1,965

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

2 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.

Non-economic assumptions

(Audited)

The policyholder liabilities and PVIF are determined by reference to non-economic assumptions which include, for non-life manufacturers, claims costs and expense rates and, for life manufacturers, mortality and/or morbidity, lapse rates and expense rates. The table below shows the sensitivity of profit for the year to, and total equity at, 31 December 2008 to reasonably possible changes in these non-economic assumptions at that date across all insurance manufacturing subsidiaries, with comparatives for 2007.

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. The main exposures to this scenario are in the UK, Hong Kong and Latin America.

Mortality and morbidity risk is typically associated with life insurance contracts. The effect of an increase in mortality or morbidity on profit depends on the type of business being written. For a portfolio of term assurance contracts, an increase in mortality usually has a negative effect on profit as the number of claims increases. For a portfolio of annuity contracts, an increase in mortality rates typically has a positive effect on profit as the period over which the benefit is being paid to the policyholder is shortened. However, when an annuity contract includes life cover, the positive effect on profit of the increase in mortality may be offset by the benefits payable under the life insurance. The largest exposures to mortality and morbidity risk exist in France, Hong Kong and the UK.

Sensitivity to lapse rates is dependent on the type of contracts being written. For insurance contracts, the cost of claims is 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. For a portfolio of annuity contracts, an increase in lapse rates has a positive effect on profit as the obligation to pay future benefits on the lapsed contracts is extinguished. France, Hong Kong and the UK are the sites which 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 profits.

Sensitivity analysis

(Audited)

	Effect on profit for the year to 31 December			Effect on total equity at 31 December
	Life	Non-life	Total	Life	Non-life	Total
	US$m	US$m	US$m	US$m	US$m	US$m

2008
20% increase in claims costs	-	(122)	(122)	-	(122)	(122)
20% decrease in claims costs	-	121	121	-	121	121
10% increase in mortality and/or morbidity rates	(28)	-	(28)	(28)	-	(28)
10% decrease in mortality and/or morbidity rates	30	-	30	30	-	30
50% increase in lapse rates	(96)	-	(96)	(96)	-	(96)
50% decrease in lapse rates	194	-	194	194	-	194
10% increase in expense rates	(42)	(9)	(51)	(42)	(9)	(51)
10% decrease in expense rates	41	9	50	41	9	50

2007
20% increase in claims costs	-	(138)	(138)	-	(138)	(138)
20% decrease in claims costs	-	138	138	-	138	138
10% increase in mortality and/or morbidity rates	(21)	-	(21)	(21)	-	(21)
10% decrease in mortality and/or morbidity rates	9	-	9	9	-	9
50% increase in lapse rates	(16)	-	(16)	(16)	-	(16)
50% decrease in lapse rates	61	-	61	61	-	61
10% increase in expense rates	(23)	(6)	(29)	(23)	(6)	(29)
10% decrease in expense rates	23	6	29	23	6	29

Capital management and allocation

Capital management

(Audited)

HSBC's capital management approach is driven by its strategy and organisational requirements, taking into account the regulatory, economic and commercial environment in which it operates. The Group's strategy underpins HSBC's Capital Management Framework which has been approved by the Group Management Board. It is HSBC's policy to maintain a strong capital base to support the development of its business and to meet regulatory capital requirements at all times. Through its structured internal governance processes, HSBC also maintains discipline over its investment decisions and where it allocates its capital, seeking to ensure that returns on investment are appropriate after taking account of capital costs. In addition, the level of capital held by HSBC Holdings and certain subsidiaries, particularly HSBC Finance, is determined by rating targets.

HSBC's strategy is to allocate capital to businesses based on their economic profit generation and, within this process, regulatory and economic capital requirements and the cost of capital are key factors. The responsibility for global capital allocation principles and decisions rests with the Group Management Board. Stress testing is used as an important mechanism in understanding the sensitivities of the core assumptions in the capital plans to the adverse impact of extreme, but plausible, events. Stress testing allows senior management to formulate management action in advance of conditions starting to reflect the stress scenarios identified. The actual market stresses which occurred throughout the financial system in 2008 have been used to inform capital planning and further develop the stress scenarios employed by the Group. The Group has identified the following as being the material risks faced and managed through the Capital Management Framework; credit, market, operational, interest rate risk in the banking book, pension fund, residual and insurance risks. All of these risks pose a significantly greater challenge in severe downturn economic conditions and the management response to these risks has, correspondingly, been intensified.

During 2008, with the Group now operating under Basel II, it targeted a tier 1 ratio within the range 7.5 to 9.0 per cent for the purposes of its long-term capital planning. In 2007, under the Basel I approach, HSBC managed its capital against a tier 1 ratio of 8.25 per cent. For 2009 onwards, in light of revised market expectations on capital strength and higher volatility of capital requirements resulting from procyclicality embedded within the Basel II rules, the upper end of the target tier 1 range is being extended to 10 per cent.

HSBC's capital management process continues to stress the advantages and flexibility afforded by a strong capital position and, through its policies, seeks to maintain a conservative stance with regard to equity leverage.

The Capital Management Framework covers the different capital measures within which HSBC manages its capital in a consistent and aligned manner. These include market capitalisation, invested capital, economic capital and regulatory capital. HSBC defines invested capital as the equity capital invested in HSBC by its shareholders. Economic capital is the capital requirement calculated internally by HSBC deemed necessary to support the risks to which it is exposed, and is set at a confidence level consistent with a target credit rating of AA. Regulatory capital is the capital which HSBC is required to hold as determined by the rules established by the FSA for the consolidated Group and by HSBC's local regulators for individual Group companies.

An annual Group capital plan is prepared and approved by the Board with the objective of maintaining both the optimal amount of capital and the mix between the different components of capital. The Group's policy is to hold capital in a range of different forms and from diverse sources and all capital raising is agreed with major subsidiaries as part of their individual and the Group's capital management processes. HSBC Holdings and its major subsidiaries raise non-equity tier 1 capital and subordinated debt in accordance with the Group's guidelines on market and investor concentration, cost, market conditions, timing, effect on composition and maturity profile.

Each subsidiary manages its own capital required to support planned business growth and meet local regulatory requirements within the context of the approved annual Group capital plan. As part of HSBC's Capital Management Framework, capital generated in excess of planned requirements is returned to HSBC Holdings, normally by way of dividends.

HSBC Holdings is primarily the provider of equity capital to its subsidiaries. These investments are substantially funded by HSBC Holdings' own capital issuance and profit retentions. HSBC Holdings seeks to maintain a prudent balance between the composition of its capital and that of its investment in subsidiaries.

Capital measurement and allocation

(Audited)

In June 2006, the Basel Committee on Banking Supervision published 'International Convergence of Capital Measurement and Capital Standards', known as Basel II. Basel II is structured around three 'pillars': minimum capital requirements, supervisory review process and market discipline. The Capital Requirements Directive ('CRD') implements Basel II in the EU and the FSA then gives effect to the CRD by including the requirements of the CRD in its own rulebooks.

The FSA supervises HSBC on a consolidated basis and therefore receives information on the capital adequacy of, and sets capital requirements for, HSBC as a whole. Individual banking subsidiaries are directly regulated by their local banking supervisors, who set and monitor their capital adequacy requirements. Although HSBC calculates capital at a Group level using the Basel II framework, local regulators are at different stages of implementation and local rules may still be on a Basel I basis, notably in the US. In most jurisdictions, non-banking financial subsidiaries are also subject to the supervision and capital requirements of local regulatory authorities.

HSBC's capital is divided into two tiers:

Tier 1 capital comprises core equity tier 1 capital, non-innovative preference shares and innovative tier 1 securities. Core equity tier 1 capital comprises shareholders' funds and minority interests in tier 1 capital, after adjusting for items reflected in shareholders' funds which are treated differently for the purposes of capital adequacy. The book values of goodwill and intangible assets are deducted in arriving at core equity tier 1 capital.
Tier 2 capital comprises qualifying subordinated loan capital, allowable collective impairment allowances, minority and other interests in tier 2 capital and unrealised gains arising on the fair valuation of equity instruments held as available-for-sale. Tier 2 capital also includes reserves arising from the revaluation of properties.

Various limits are applied to elements of the capital base. The amount of innovative tier 1 securities cannot exceed 15 per cent of overall tier 1 capital, qualifying tier 2 capital cannot exceed tier 1 capital, and qualifying term subordinated loan capital cannot exceed 50 per cent of tier 1 capital.

There are also limitations on the amount of collective impairment allowances which may be included as part of tier 2 capital. For regulatory purposes, banking associates are proportionally consolidated, rather than being recognised using the equity method used for financial reporting.

The carrying amounts of investments in the capital of banks that exceed certain limits and the excess of expected losses over impairment allowances are deducted 50 per cent from each of tier 1 and tier 2 capital in the published disclosures. This also applies to deductions of investments in insurance subsidiaries and associates, but the FSA has granted a transitional provision, until 31 December 2012, under which those insurance investments that were acquired before 20 July 2006 may be deducted from the total of tier 1 and tier 2 capital instead. HSBC has elected to apply this transitional provision.

The basis of calculating capital changed with effect from 1 January 2008 and the effect on both tier 1 capital and total capital is shown in the table below, 'Capital Structure'. The Group's capital base is reduced compared with Basel I by the extent to which expected losses exceed the total of individual and collective impairment allowances on IRB portfolios. These collective impairment allowances are no longer eligible for inclusion in tier 2 capital.

For disclosure purposes, this excess of expected losses over total impairment allowances in IRB portfolios is deducted 50 per cent from core equity tier 1 and 50 per cent from tier 2 capital. In addition, a tax credit adjustment is made to tier 1 capital to reflect the tax consequences insofar as they affect the availability of tier 1 capital to cover risks or losses.

Expected losses derived under Basel II rules represent losses that would be expected in the scenario of a severe downturn over a 12-month period. This definition differs from loan impairment allowances, which only address losses incurred within lending portfolios at the balance sheet date and are not permitted to recognise the additional level of conservatism that the regulatory measure requires by the adoption of through-the-cycle, downturn and stressed conditions that may not exist at the balance sheet date.

The effect of deducting the difference between expected losses and total impairment allowances is to equate the total effect on capital with the regulatory definition of expected losses. As expected losses are based on long-term estimates and incorporate through-the-cycle considerations, they are expected to be less volatile than actual loss experience. The impact of this deduction, however, may vary from time to time as the accounting measure of impairment moves closer to or further away from the regulatory measure of expected losses.

The FSA's rules permit the inclusion of profits in tier 1 capital to the extent that they have been verified in accordance with the FSA's General Prudential Sourcebook by the external auditor. Verification procedures covering profits for the year to 31 December 2008 were completed by the external auditor on 2 March 2009 and therefore these profits have been included in the Group's tier 1 capital. Technically, from 1 January 2008, the FSA's regulatory reporting forms defer the recognition of these profits in tier 1 capital until the conclusion of the external auditor's procedures.

Basel II provides three approaches of increasing sophistication to the calculation of pillar 1 credit risk capital requirements. The most basic, the standardised approach, requires banks to use external credit ratings to determine the risk weightings applied to rated counterparties, and groups other counterparties into broad categories and applies standardised risk weightings to these categories. The next level, the internal ratings-based ('IRB') foundation approach, allows banks to calculate their credit risk capital requirements on the basis of their internal assessment of the probability that a counterparty will default ('PD'), but with quantification of exposure at default ('EAD') and loss given default ('LGD') estimates being subject to standard supervisory parameters. Finally, the IRB advanced approach allows banks to use their own internal assessment of not only PD but also the quantification of EAD and LGD. The regulatory measure of expected losses is calculated by multiplying PD by EAD and LGD. The capital resources requirement under the IRB approaches is intended to cover unexpected losses and is derived from a formula specified in the regulatory rules, which incorporates these factors and other variables such as maturity and correlation.

For credit risk, with FSA approval, HSBC has adopted the IRB advanced approach for the majority of its business with effect from 1 January 2008, with the remainder on either IRB foundation or standardised approaches. For consolidated group reporting, the FSA's rules permit the use of other regulators' standardised approaches where they are considered equivalent. The use of other regulators' IRB approaches is subject to the agreement of the FSA. A rollout plan, over the next few years, is in place to extend coverage of the advanced approaches, for both local and consolidated Group reporting, leaving a small residue of exposures on the standardised approach.

Market risk is derived from fluctuations on trading book assets arising from changes in values, income, interest and foreign exchange rates and is measured using VAR models with FSA permission or the standard rules prescribed by the FSA. Counterparty credit risk in the trading book and the non-trading book is the risk that the counterparty to a transaction may default before completing the satisfactory settlement of the transaction. Three counterparty credit risk calculation approaches are defined by Basel II to determine exposure values, being the standardised, mark to market and the internal model method. These exposure values are then used to determine capital requirements using one of the credit risk approaches, standardised, IRB foundation and IRB advanced. Across the Group, HSBC uses both VAR and standard rules approaches for market risk and the mark to market and internal model method approaches for counterparty credit risk. It is the longer-term aim of HSBC to migrate more positions from standard rules to VAR for market risk and from mark to market to internal model method for counterparty credit risk.

Basel II also introduces capital requirements for operational risk and, again, contains three levels of sophistication. The capital required under the basic indicator approach is a simple percentage of gross revenues, whereas under the standardised approach it is one of three different percentages of gross revenues allocated to each of eight defined business lines. Both these approaches use an average of the last three financial years' revenues. Finally, the advanced measurement approach uses banks' own statistical analysis and modelling of operational risk data to determine capital requirements. HSBC has adopted the standardised approach to the determination of Group operational risk capital requirements.

The second pillar of Basel II (Supervisory Review and Evaluation Process - 'SREP') involves both firms and regulators taking a view on whether a firm should hold additional capital against risks not covered in pillar 1. Part of the pillar 2 process is the Internal Capital Adequacy Assessment Process ('ICAAP') which is the firm's self assessment of the levels of capital that it needs to hold. The pillar 2 process culminates in the FSA providing firms with Individual Capital Guidance ('ICG'). The ICG replaces the trigger ratio and is set as a capital resources requirement higher than that required under pillar 1.

Pillar 3 of Basel II is related to market discipline and aims to make firms more transparent by requiring them to publish specific, prescribed details of their risks, capital and risk management under the Basel II framework. On 10 November 2008, HSBC published summary qualitative pillar 3 disclosures ('Interim Pillar 3 Disclosures 2008') for 30 June 2008 on the investor relations section of its website, www.hsbc.com. HSBC expects to publish the first full set of pillar 3 disclosures for 31 December 2008, including quantitative tables, during the first half of 2009.

During 2007, HSBC was supervised under Basel I. Under Basel I, banking operations are categorised as either trading book or banking book and risk-weighted assets are determined accordingly. Banking book risk-weighted assets are measured by means of a hierarchy of risk weightings classified according to the nature of each asset and counterparty, taking into account any eligible collateral or guarantees. Banking book off-balance sheet items giving rise to credit, foreign exchange or interest rate risk are assigned weights appropriate to the category of the counterparty, taking into account any eligible collateral or guarantees. Trading book risk-weighted assets are determined by taking into account market-related risks such as foreign exchange, interest rate and equity position risks, and counterparty risk.

Capital structure at 31 December


	2008 Basel II Actual	2007 Basel II Pro forma1	2007 Basel I Actual
	US$m	US$m	US$m
	(Audited)	(Unaudited)	(Audited)
Composition of regulatory capital
Tier 1 capital
Shareholders' equity2	93,591	128,160	128,160
Minority interests	6,638	7,256	7,256
Less:
Preference share premium	(1,405)	(1,405)	(1,405)
Preference share minority interests	(2,110)	(2,181)	(2,181)
Goodwill capitalised and intangible assets	(26,861)	(38,855)	(38,855)
Unrealised losses on available-for-sale debt securities3	21,439	2,445	2,445
Other regulatory adjustments4, 5	(8,222)	(3,325)	(4,551)
50% of excess of expected losses over impairment allowances	(2,660)	(4,508)	-

Core equity tier 1 capital	80,410	87,587	90,869
Preference share premium	1,405	1,405	1,405
Preference share minority interests	2,110	2,181	2,181
Innovative tier 1 securities	11,411	10,512	10,512

Tier 1 capital	95,336	101,685	104,967

Tier 2 capital
Reserves arising from revaluation of property and unrealised
gains on available-for-sale equities	1,726	4,393	4,393
Collective impairment allowances6	3,168	2,176	14,047
Perpetual subordinated debt	2,996	3,114	3,114
Term subordinated debt	41,204	37,658	37,658
Minority and other interests in tier 2 capital	300	300	300

Total qualifying tier 2 capital before deductions	49,394	47,641	59,512


Unconsolidated investments7	(9,613)	(11,092)	(11,092)
50% of excess of expected losses over impairment allowances	(2,660)	(4,508)	-
Other deductions	(997)	(747)	(747)

Total deductions other than from tier 1 capital	(13,270)	(16,347)	(11,839)

Total regulatory capital	131,460	132,979	152,640


Risk-weighted assets
(Unaudited)
Credit and counterparty risk	956,596	1,011,343	-
Market risk	70,264	45,840	-
Operational risk	121,114	107,466	-
Banking book	-	-	1,020,747
Trading book	-	-	103,035

Total	1,147,974	1,164,649	1,123,782

Capital ratios	%	%	%
(Unaudited)
Core equity tier 1 ratio	7.0	7.5	8.1
Tier 1 ratio	8.3	8.7	9.3
Total capital ratio	11.4	11.4	13.6
	2008 Basel II Actual	2007 Basel II Pro forma1	2007 Basel I Actual
	US$m	US$m	US$m
	(Audited)	(Unaudited)	(Audited)
Composition of regulatory capital
Tier 1 capital
Shareholders' equity2	93,591	128,160	128,160
Minority interests	6,638	7,256	7,256
Less:
Preference share premium	(1,405)	(1,405)	(1,405)
Preference share minority interests	(2,110)	(2,181)	(2,181)
Goodwill capitalised and intangible assets	(26,861)	(38,855)	(38,855)
Unrealised losses on available-for-sale debt securities3	21,439	2,445	2,445
Other regulatory adjustments4, 5	(8,222)	(3,325)	(4,551)
50% of excess of expected losses over impairment allowances	(2,660)	(4,508)	-

Core equity tier 1 capital	80,410	87,587	90,869
Preference share premium	1,405	1,405	1,405
Preference share minority interests	2,110	2,181	2,181
Innovative tier 1 securities	11,411	10,512	10,512

Tier 1 capital	95,336	101,685	104,967

Tier 2 capital
Reserves arising from revaluation of property and unrealised
gains on available-for-sale equities	1,726	4,393	4,393
Collective impairment allowances6	3,168	2,176	14,047
Perpetual subordinated debt	2,996	3,114	3,114
Term subordinated debt	41,204	37,658	37,658
Minority and other interests in tier 2 capital	300	300	300

Total qualifying tier 2 capital before deductions	49,394	47,641	59,512


Unconsolidated investments7	(9,613)	(11,092)	(11,092)
50% of excess of expected losses over impairment allowances	(2,660)	(4,508)	-
Other deductions	(997)	(747)	(747)

Total deductions other than from tier 1 capital	(13,270)	(16,347)	(11,839)

Total regulatory capital	131,460	132,979	152,640


Risk-weighted assets
(Unaudited)
Credit and counterparty risk	956,596	1,011,343	-
Market risk	70,264	45,840	-
Operational risk	121,114	107,466	-
Banking book	-	-	1,020,747
Trading book	-	-	103,035

Total	1,147,974	1,164,649	1,123,782

Capital ratios	%	%	%
(Unaudited)
Core equity tier 1 ratio	7.0	7.5	8.1
Tier 1 ratio	8.3	8.7	9.3
Total capital ratio	11.4	11.4	13.6

1 As Basel II rules were implemented across the Group, adjustments to the previously published 31 December 2007 pro forma risk-weighted assets were identified, amounting to US$35,198 million. The pro forma position at 31 December 2007 has been adjusted accordingly.

2 Includes externally verified profits for the year to 31 December 2008.

3 Under FSA rules, unrealised gains/losses on debt securities net of deferred tax must be excluded from capital resources.

4 Includes removal of the fair value gains and losses, net of deferred tax, arising from the credit spreads on debt issued by HSBC Holdings and its subsidiaries and designated at fair value.

5 Includes a tax credit adjustment in respect of the excess of expected losses over impairment allowances.

6 Under Basel II, only collective impairment allowances on loan portfolios on the standardised approach are included in tier 2 capital.

7 Mainly comprise investments in insurance entities.

Source and application of tier 1 capital

(Audited)

	2008 Basel II US$m	2007 Basel I US$m

Movement in tier 1 capital
(Audited)
At 1 January	104,967	87,842
Changes to tier 1 capital arising from transition to pro forma Basel II basis2	(3,282)

Opening pro-forma tier 1 capital under Basel II rules2	101,685
Consolidated profits attributable to shareholders of the parent company	5,728	19,133
Dividends to shareholders	(11,301)	(10,241)
Add back: shares issued in lieu of dividends	3,593	4,351
Decrease/(increase) in goodwill and intangible assets deducted	11,994	(2,366)
Removal of own credit spread	(4,610)	(2,205)
Ordinary shares issued	470	477
Innovative tier 1 securities issued	2,133	-
Other (including exchange differences)2	(14,356)	7,976

At 31 December	95,336	104,967

Movement in risk-weighted assets
(Unaudited)

At 1 January	1,123,782	938,678
Changes arising to risk-weighted assets from transition to pro forma Basel II basis1	40,867

Opening Basel II pro forma risk-weighted assets	1,164,649
Movements	(16,675)	185,104

At 31 December	1,147,974	1,123,782

2 Pro forma capital items as at 1 January 2008 are unaudited.

Movement in tier 1 capital

(Audited)

HSBC complied with the FSA's capital adequacy requirements throughout 2008 and 2007. Opening tier 1 capital at 1 January 2008 was reduced by US$3.3 billion arising from the transition to Basel II. Profits attributable to shareholders of the parent company of US$5.7 billion included goodwill write-offs of US$10.6 billion and profits from own credit spread, net of deferred tax, of US$4.7 billion, neither of which impact regulatory capital. The resulting contribution to tier 1 capital was therefore US$11.6 billion. Dividends to shareholders of US$11.3 billion were partly offset by shares issued, including those issued in lieu of dividends, of US$4.1 billion and innovative tier 1 securities issued of US$2.1 billion. The strengthening US dollar caused foreign currency translation differences, mainly on the investment in non-US dollar subsidiaries, which reduced tier 1 capital by US$11.8 billion.

Movement in risk-weighted assets

(Unaudited)

Total RWAs increased by US$24 billion. The transition to Basel II at 1 January 2008 increased RWAs by US$41 billion, meaning that RWAs on a Basel II basis fell by US$17 billion during the year. Foreign exchange translation effects are estimated to have reduced RWAs by US$80 billion, again a result of the strengthening US dollar, particularly against sterling, resulting in an estimated underlying increase of US$63 billion. Of this underlying increase, US$26 billion was due to credit and counterparty risk RWAs, reflecting decreases in North America being more than offset by increases in both Europe and Asia. Market risk RWAs increased by US$24 billion primarily due to the impact of market volatility. Operational risk RWAs increased by US$13 billion because the three year averaging of gross revenues used in the calculation now includes revenues for 2008 in place of 2005.

Risk-weighted assets by principal subsidiary

(Unaudited)

In order to give an indication of how HSBC's capital is deployed, the table below analyses the disposition of risk-weighted assets by principal subsidiary. The risk-weighted assets are calculated using FSA rules and exclude intra-HSBC items.

Risk-weighted assets by principal subsidiary (Unaudited)
	2008 Basel II US$m	2007 Basel I US$m

The Hongkong and Shanghai Banking Corporation	247,626	256,761
Hang Seng Bank	44,211	55,043
The Hongkong and Shanghai Banking Corporation and other subsidiaries	203,415	201,718

HSBC Bank	379,695	423,941
HSBC Private Banking Holdings (Suisse)	20,422	32,942
HSBC France	65,557	76,188
HSBC Bank and other subsidiaries	293,716	314,811

HSBC North America	373,955	336,998
HSBC Finance	187,660	135,757
HSBC Bank Canada	35,336	50,659
HSBC Bank USA and other subsidiaries	150,959	150,582

HSBC Mexico	21,037	18,513
HSBC Bank Middle East	35,217	25,226
HSBC Bank Malaysia	11,182	8,601
HSBC Brazil	30,851	27,365
HSBC Bank Panama	9,498	7,824
Bank of Bermuda	4,759	4,133
Other	34,154	14,420

	1,147,974	1,123,782

This information is provided by RNS

The company news service from the London Stock Exchange

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