Annual Financial Report - 20

RNS Number : 4095J

HSBC Holdings PLC

30 March 2010

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. When the Group chooses to manage its exposure to insurance risk through the use of third-party reinsurers, the associated revenue and manufacturing profit is ceded to them. 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 six 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 role of Group Insurance Head Office includes forming and communicating the strategy for insurance, 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. Five sub-committees report to the Committee, focusing on products and pricing, market and liquidity risk, credit risk, operational and insurance risk.

All insurance products, whether manufactured internally or by a third party, are subjected to a detailed product approval process. Approval is provided by the Regional Insurance Head Office or Group Insurance Head Office depending on the type of product and its risk profile. The process consists of an analysis of the inherent risks of a product, including but not limited to market risk, credit risk, insurance and pricing risk and regulatory risk. Certain products, for example those of a particularly complex nature or those providing a guarantee, are reviewed by the Product and Pricing Committee as part of the approval process. The committee comprises the heads of the relevant risk functions within insurance and sits at both regional and Group Insurance levels.

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. Any benefits payable to policyholders related to insurance risk are not significant on these contracts.

· Other investment contracts include pension contracts written in Hong Kong.

Non-life insurance business

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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. Cover is also provided 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 is originated in conjunction with the provision of loans. Following a decision taken to close the Consumer Lending business in the US, insurance products written in conjunction with this business will now be run off. In December 2007, the group decided to cease selling payment protection insurance ('PPI') products in the UK and a phased withdrawal was completed across the HSBC, first direct and M&S Money brands during 2008. HFC ceased selling single premium PPI in 2008 and sales of regular PPI will reduce as HFC exits its remaining retail relationships. HSBC continues to distribute its UK short-term income protection ('STIP') product. In January 2009, the Competition Commission ('CC') published its report into the PPI market in which it stipulated that STIP products will also be subject to their remedies when sold in conjunction with or as a result of a referral following the sale of a loan or similar credit product. HSBC has undertaken an analysis of the required changes to the STIP product and its sales processes resulting from the CC's remedies. Following an appeal to the Competition Appeal Tribunal, the CC continues to consult on whether a ban on firms selling PPI at the point of sale of the credit product is an appropriate and justified remedy for the deficiencies it identified in the PPI market.

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, and consequently the following sections focus on how the Group manages risk arising in the manufacturing subsidiaries.

Insurance risk

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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, benefits, administration and acquisition of the contract may exceed the aggregate amount of premiums received and investment income.

The cost of claims and benefits can be influenced by many factors, including mortality and morbidity experience, lapse and surrender rates and, if the policy has a savings element, the performance of the assets held to support the liabilities. Performance of the underlying assets is affected by changes in both interest rates and equity prices (see page 274).

During 2009, Group Insurance agreed to a global risk appetite statement in relation to insurance risks, encompassing limits on the largest exposures the business will write in normal circumstances. In addition to the global statement, local businesses continue to propose their own risk appetites that are authorised centrally.

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.

Specifically, 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. In addition, 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 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 277).

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.

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

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 policyholders⁴⁹

(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 2009
Life (non-linked)..........................................	2,998	14,456	526	1,026	1,973	20,979
Insurance contracts with DPF⁵⁰ ...............	1,128	14,095	227	-	-	15,450
Credit life ................................................	953	-	20	50	-	1,023
Annuities .................................................	452	-	28	777	1,554	2,811
Term assurance and other long-term contracts .............................................	465	361	251	199	419	1,695

Life (linked) ................................................	2,125	2,896	437	-	3,528	8,986

Investment contracts with DPF^50,51..............	20,979	-	35	-	-	21,014

Insurance liabilities to policyholders ............	26,102	17,352	998	1,026	5,501	50,979

At 31 December 2008
Life (non-linked)..........................................	2,962	11,320	343	1,006	1,739	17,370
Insurance contracts with DPF⁵⁰ ...............	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


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

Investment contracts with DPF^50,51 .............	17,732	-	34	-	-	17,766

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

For footnotes, see page 291.

(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 in 'Sensitivity of HSBC's insurance subsidiaries to risk factors' and 'Sensitivity analysis'.

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.

Analysis of non-life insurance risk - net written insurance premiums^49,52

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	Europe	Hong Kong	Rest of Asia- Pacific	North America	Latin America	Total
	US$m	US$m	US$m	US$m	US$m	US$m
2009
Accident and health .....................................	94	160	7	3	23	287
Motor .........................................................	123	14	20	-	234	391
Fire and other damage .................................	72	22	8	16	22	140
Liability ......................................................	-	15	4	-	2	21
Credit (non-life) ..........................................	35	-	-	86	-	121
Marine, aviation and transport ....................	7	9	4	-	17	37
Other non-life insurance contracts ..............	24	32	1	12	58	127

Total net written insurance premiums .........	355	252	44	117	356	1,124

Net insurance claims incurred and movement in liabilities to policyholders ....................	(748)	(107)	(17)	(96)	(155)	(1,123)


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)

For footnotes, see page 291.

(Audited)

The above table of non-life net written insurance premiums provides an overall summary of the non‑life 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 2009. However, following a decision to close to new business in the second half of 2009, the UK motor book is now in run-off. 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 differs from expectations. 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. Management may decide to withdraw a product from the market when it is no longer considered commercially viable, such as the closure of the UK motor book to new business in 2009.

Balance sheet of insurance manufacturing subsidiaries by type of contract

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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. In addition to assessing the actual cash inflow required to meet cash outflows, 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 2009.

Balance sheet of insurance manufacturing subsidiaries by type of contract

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	Insurance contracts						Investment contracts
With DPF		Unit- linked	Annu- ities	Term assur- ance⁵³	Non-life	With DPF⁵¹		Unit- linked	Other	Other assets⁵²	Total
	US$m	US$m	US$m	US$m	US$m		US$m	US$m	US$m	US$m	US$m
At 31 December 2009
Financial assets................	15,322	8,204	2,567	2,053	2,290		20,501	7,366	4,008	7,252	69,563
- trading assets ............	-	-	-	-	10		-	-	-	-	10
- financial assets designated at fair value	599	7,837	446	482	63		5,498	6,572	1,582	2,085	25,164
- derivatives ................	16	1	-	3	-		144	299	2	3	468
- financial investments	13,013	-	1,511	1,033	742		13,948	-	1,701	3,901	35,849
- other financial assets	1,694	366	610	535	1,475		911	495	723	1,263	8,072

Reinsurance assets ..........	6	831	376	389	467		-	-	-	60	2,129
PVIF⁵⁵ ............................	-	-	-	-	-		-	-	-	2,780	2,780
Other assets and investment properties ..	165	5	25	634	242		516	13	56	601	2,257

Total assets ....................	15,493	9,040	2,968	3,076	2,999		21,017	7,379	4,064	10,693	76,729

Liabilities under investment contracts:
- designated at fair value ..................................	-	-	-	-	-		-	7,347	3,518	-	10,865
- carried at amortised cost	-	-	-	-	-		-	-	417	-	417
Liabilities under insurance contracts ......	15,450	8,986	2,811	2,718	2,728		21,014	-	-	-	53,707
Deferred tax ...................	6	-	22	1	7		1	-	2	750	789
Other liabilities ...............	-	-	-	-	-		-	-	-	2,371	2,371

Total liabilities ...............	15,456	8,986	2,833	2,719	2,735		21,015	7,347	3,937	3,121	68,149

Total equity ...................	-	-	-	-	-		-	-	-	8,580	8,580

Total equity and liabilities⁵³ ...................	15,456	8,986	2,833	2,719	2,735		21,015	7,347	3,937	11,701	76,729

	Insurance contracts						Investment contracts
With DPF		Unit- linked	Annu- ities	Term assur- ance⁵³	Non-life	With DPF⁵¹		Unit- linked	Other	Other assets⁵²	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 ...............	12,336	5,141	2,378	2,209	2,053		17,312	6,138	3,739	6,684	57,990
- 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

Reinsurance assets ..........	6	956	311	320	430		-	-	-	60	2,083
PVIF⁵⁵ ............................	-	-	-	-	-		-	-	-	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
- 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 liabilities⁵⁶ ...................	12,452	6,074	2,597	2,381	2,481		17,767	6,012	3,558	10,771	64,093

For footnotes, see page 291.

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 yields 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 was 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 return to lower levels for prolonged periods, further management actions may be needed.

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 2009.

Balance sheet of insurance manufacturing subsidiaries by geographical region⁴⁹

(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 2009
Financial assets ............................................	35,704	22,337	1,330	2,582	7,610	69,563
- trading assets ........................................	-	-	-	-	10	10
- financial assets designated at fair value ..	14,756	4,758	877	-	4,773	25,164
- derivatives ............................................	446	18	3	-	1	468
- financial investments ............................	16,940	14,771	133	2,037	1,968	35,849
- other financial assets ............................	3,562	2,790	317	545	858	8,072


Reinsurance assets .......................................	1,100	849	25	19	136	2,129
PVIF⁵⁵ .........................................................	1,022	1,248	113	138	259	2,780
Other assets and investment properties .......	1,380	498	23	40	316	2,257

Total assets .................................................	39,206	24,932	1,491	2,779	8,321	76,729

Liabilities under investment contracts:
- designated at fair value ..........................	6,500	4,299	66	-	-	10,865
- carried at amortised cost .......................	-	-	-	-	417	417
Liabilities under insurance contracts ............	27,845	17,618	1,072	1,268	5,904	53,707
Deferred tax ................................................	334	220	27	82	126	789
Other liabilities ............................................	1,744	284	54	3	286	2,371

Total liabilities ............................................	36,423	22,421	1,219	1,353	6,733	68,149

Total equity ................................................	2,783	2,511	272	1,426	1,588	8,580

Total equity and liabilities⁵⁶ .........................	39,206	24,932	1,491	2,779	8,321	76,729

At 31 December 2008
Financial assets ............................................	31,246	17,865	961	2,625	5,293	57,990
- 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


Reinsurance assets .......................................	920	1,004	20	13	126	2,083
PVIF⁵⁵ .........................................................	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
- 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 liabilities⁵⁶ .........................	33,944	20,174	1,071	2,992	5,912	64,093

For footnotes, see page 291.

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 2009 by type of contract, and provides a view of the exposure to financial risk:

Financial assets held by insurance manufacturing subsidiaries (Audited)
	Life linked	Life non-linked		Non-life	Other
	contracts⁵⁷		contracts⁵⁸	insurance⁵⁹	assets⁵⁴	Total⁶⁰
	US$m		US$m	US$m	US$m	US$m
At 31 December 2009
Trading assets
Debt securities ................................	-		-	10	-	10

Financial assets designated at fair value..............................................	14,409		8,607	63	2,085	25,164
Treasury bills ..................................	46		174	-	3	223
Debt securities ................................	5,086		3,428	63	1,220	9,797
Equity securities ..............................	9,277		5,005	-	862	15,144

Financial investments
Held-to-maturity:
- debt securities ..............................	-		13,995	186	670	14,851

Available-for-sale ...............................	-		17,211	556	3,231	20,998
- Treasury bills ...............................	-		-	211	86	297
- other eligible bills .........................	-		26	127	126	279
- debt securities ..............................	-		17,169	199	2,787	20,155
- equity securities ...........................	-		16	19	232	267

Derivatives .........................................	300		165	-	3	468
Other financial assets⁶¹ .......................	861		4,473	1,475	1,263	8,072

	15,570		44,451	2,290	7,252	69,563

At 31 December 2008
Trading assets
Debt securities ................................	-		-	35	4	39

Financial assets designated at fair value	10,263		7,990	52	1,970	20,275
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

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

Available-for-sale ...............................	-		14,617	690	2,066	17,373
- 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

Derivatives .........................................	173		204	-	24	401
Other financial assets⁶¹ .......................	843		4,752	1,106	2,110	8,811

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

For footnotes, see page 291.

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 64.4 per cent of financial assets were invested in debt securities at 31 December 2009 (2008: 62.9 per cent) with 22.2 per cent (2008: 19.7 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 22.4 per cent of the total financial assets of HSBC's insurance manufacturing subsidiaries at the end of 2009 (2008: 19.4 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 usually retain exposures to falls in market interest rates as they result in lower available yields on the assets bought to support guaranteed investment returns payable to policyholders.

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 policyholders⁶²

(Audited)

	2009			2008
	Amount of reserve	Investment returns implied by guarantee⁶³	Current yields	Amount of reserve	Investment returns implied by guarantee⁶³	Current yields
	US$m	%	%	US$m	%	%

Annuities in payment .................................	925	0.0 - 7.5	1.3 - 16.7	744	0.0 - 11.5	6.5 - 28.0
Deferred annuities ......................................	943	0.0 - 6.0	0.9 - 15.1	120	0.0 - 6.0	3.9 - 7.4
Immediate annuities ...................................	553	6.0 - 9.0	5.4 - 5.4	576	6.0 - 9.0	5.4 - 5.4
Annual return .............................................	17,147	0.0 - 4.5	0.8 - 6.2	13,717	0.0 - 4.5	2.2 - 4.9
Annual return .............................................	497	4.5 - 6.0	5.1 - 6.5	302	4.5 - 6.0	3.4 - 7.3
Capital .......................................................	15,866	-	2.4 - 4.3	13,346	-	2.0 - 4.3

For footnotes, see page 291.

A certain number of these products have been discontinued, including the US$553 million immediate 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 significant 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 seeks to invest in bonds which produce returns at least equal to the investment returns implied by the guarantees while remaining attentive to the overall portfolio credit quality;

· 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.

The product approval process includes the identification and assessment of the risk embedded in new products.

Group Insurance Head Office includes a Chief Market and Liquidity Risk Officer reporting to the Chief Risk Officer. Each regional insurance unit includes an individual responsible for market and liquidity risk.

As described above, the product approval process includes an identification and assessment of the risk embedded in 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 appropriate risk management procedures are in place. Management reviews certain exposures more frequently when markets demonstrate increased 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. All market risk mandates include management action loss limits designed to control risk.

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 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.

Sensitivity of HSBC's insurance manufacturing subsidiaries to risk factors (Audited)
	2009		2008
	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 .....	68	(82)	94	(13)
- 100 basis points parallel shift in yield curves .....	(69)	92	(82)	24
10 per cent increase in equity prices .....................	19	19	10	10
10 per cent decrease in equity prices ....................	(20)	(20)	(12)	(12)
10 per cent increase in US dollar exchange rate compared to all currencies ................................	20	20	28	29
10 per cent decrease in US dollar exchange rate compared to all currencies ................................	(20)	(20)	(28)	(29)
Sensitivity to credit spread increases ....................	(36)	(91)	(73)	(134)

The above 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.

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$36 million (2008: US$73 million fall). The sensitivity 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. Credit spreads experienced some volatility during 2009 but generally improved from the high level at the end of 2008.

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$40.5 billion (2008: US$33.2 billion) non-linked bond portfolio. The exposure of the income statement to the effect of changes in credit spreads is small (see the table above). Fifty two 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.

The exposure of the income statement to the effect of changes in credit spread is small.

HSBC sells certain unit-linked life insurance contracts which are reinsured with a third party. These insurance contracts include market return guarantees which are underwritten by the third party. 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 improved market conditions in 2009, there has been a reduction in these costs, and hence the Group's counterparty exposure to the guarantees under the reinsurance agreement at 31 December 2009 was lower than at 31 December 2008. The sale of these contracts ceased in 2008, reflecting the adjusted risk appetite of the business.

Group Insurance Head Office includes a Chief Credit Risk Officer reporting to the Chief Risk Officer. Each regional insurance unit includes an individual responsible for credit risk.

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 266 to 269. 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.

A number of tools are used to manage and monitor credit risk. These include 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 five credit quality classifications are included on page 225. 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. 90.9 per cent (2008: 93.7 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 manufacturing subsidiaries

(Audited)

	Neither past due nor impaired
	Strong	Medium- good	Medium- satisfactory		Sub- standard	Impaired⁶⁴	Total
	US$m	US$m		US$m	US$m	US$m	US$m
At 31 December 2009

Supporting liabilities under non-linked insurance and investment contracts
Trading assets - debt securities ..............	8	-		2	-		10

Financial assets designated at fair value .	2,812	80		704	69		3,665
- treasury and other eligible bills .......	174	-		-	-		174
- debt securities ................................	2,638	80		704	69		3,491

Financial investments ...........................	30,126	1,509		130	148	-	31,913
- treasury and other similar bills .......	211	-		-	-	-	211
- other eligible bills ...........................	153	-		-	-	-	153
- debt securities ................................	29,762	1,509		130	148	-	31,549


	32,946	1,589		836	217	-	35,588

Supporting shareholders' funds⁶⁵

Financial assets designated at fair value .	527	506		180	10		1,223
- treasury and other eligible bills .......	3	-		-	-		3
- debt securities ................................	524	506		180	10		1,220

Financial investments ...........................	3,335	312		16	6	-	3,669
- treasury and other similar bills .......	82	-		4	-	-	86
- other eligible bills ...........................	126	-		-	-	-	126
- debt securities ................................	3,127	312		12	6	-	3,457


	3,862	818		196	16	-	4,892

Total⁶⁶
Trading assets - debt securities ..............	8	-		2	-		10

Financial assets designated at fair value .	3,339	586		884	79		4,888
- treasury and other eligible bills .......	177	-		-	-		177
- debt securities ................................	3,162	586		884	79		4,711

Financial investments ...........................	33,461	1,821		146	154	-	35,582
- treasury and other similar bills .......	293	-		4	-	-	297
- other eligible bills ...........................	279	-		-	-	-	279
- debt securities ................................	32,889	1,821		142	154	-	35,006


	36,808	2,407		1,032	233	-	40,480

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

	Neither past due nor impaired
	Strong	Medium- good	Medium- satisfactory		Sub- standard	Impaired⁶⁴	Total
	US$m	US$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	335		319	-		3,358
- treasury and other eligible bills ........	197	-		-	-		197
- debt securities .................................	2,507	335		319	-		3,161

Financial investments ............................	24,881	718		195	45	4	25,843
- treasury and other similar bills ........	404	-		2	-	-	406
- debt securities .................................	24,477	718		193	45	4	25,437


	27,612	1,061		514	45	4	29,236

Supporting shareholders' funds⁶⁵
Trading assets - debt securities ...............	4	-		-	-		4

Financial assets designated at fair value ..	1,502	110		21	-		1,633
- treasury and other eligible bills ........	8	-		-	-		8
- debt securities .................................	1,494	110		21	-		1,625

Financial investments ............................	2,033	174		54	99	-	2,360
- treasury and other similar bills ........	245	-		7	2	-	254
- debt securities .................................	1,788	174		47	97	-	2,106


	3,539	284		75	99	-	3,997

Total⁶⁶
Trading assets - debt securities ...............	31	8		-	-		39

Financial assets designated at fair value ..	4,206	445		340	-		4,991
- treasury and other eligible bills ........	205	-		-	-		205
- debt securities .................................	4,001	445		340	-		4,786

Financial investments ............................	26,914	892		249	144	4	28,203
- treasury and other similar bills ........	649	-		9	2	-	660
- debt securities .................................	26,265	892		240	142	4	27,543


	31,151	1,345		589	144	4	33,233

For footnotes, see page 291.

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

(Audited)

	Treasury bills	Other eligible bills	Debt securities	Total
	US$m	US$m	US$m	US$m
At 31 December 2009
Governments ..................................................................	342	6	8,548	8,896
Local authorities ............................................................	-	-	886	886
Asset-backed securities ...................................................	-	-	54	54
Corporates and other ......................................................	132	273	30,239	30,644

	474	279	39,727	40,480

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

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.

The split of liabilities ceded to reinsurers and outstanding reinsurance recoveries, analysed by credit quality, is shown below. The definitions of the five credit quality classifications are provided on page 225. 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
	Strong	Medium- good	Medium- satisfactory	Sub- standard	but not impaired	Total
	US$m	US$m	US$m	US$m	US$m	US$m

At 31 December 2009
Linked insurance contracts⁶⁷ ..................	27	804	-	-	-	831
Non-linked insurance contracts⁶⁷ ............	1,133	10	90	5	-	1,238

	1,160	814	90	5	-	2,069

Reinsurance debtors ................................	24	2	11	6	17	60

At 31 December 2008
Linked insurance contracts⁶⁷ ..................	9	947	-	-	-	956
Non-linked insurance contracts⁶⁷ ............	1,001	12	50	-	4	1,067

	1,010	959	50	-	4	2,023

Reinsurance debtors ................................	30	-	20	-	10	60

For footnote, see page 291.

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.

There are three aspects considered in liquidity risk. The first of these arises in normal market conditions and is referred to as funding liquidity risk; specifically, the capacity to raise sufficient cash when needed to meet payment obligations. Secondly, market liquidity risk arises when the size of a particular holding may be sufficiently large that a sale cannot be completed around the market price. Finally, there is standby liquidity risk, which refers to the capacity to meet payment terms in abnormal conditions.

HSBC's insurance manufacturing subsidiaries primarily fund cash outflows arising from claim liabilities 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.

Each of these techniques contributes to mitigating the three types of liquidity risk described above.

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 2009. As indicated in the analyses of life and non-life insurance risks on pages 268 to 269, 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 2009 remained comparable with 2008.

Expected maturity of insurance contract liabilities

(Audited)

	Expected cash flows (undiscounted)⁶⁸
	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 2009
Non-life insurance ..............................	1,318	1,277	123	10	2,728
Life insurance (non-linked) ................	2,393	10,098	17,253	18,231	47,975
Life insurance (linked) ........................	522	2,290	4,483	6,899	14,194

	4,233	13,665	21,859	25,140	64,897

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

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

For footnote, see page 291.

Remaining contractual maturity of investment contract liabilities

(Audited)

	Liabilities under investment contracts by insurance manufacturing subsidiaries⁶⁹
	Linked investment contracts	Other investment contracts	Investment contracts with DPF	Total
	US$m	US$m	US$m	US$m
At 31 December 2009
Remaining contractual maturity:
- due within 1 year .....................................................	477	443	14	934
- due between 1 and 5 years ........................................	904	-	20	924
- due between 5 and 10 years ......................................	693	-	-	693
- due after 10 years ....................................................	2,093	-	-	2,093
- undated⁷⁰ .................................................................	3,180	3,492	20,980	27,652

	7,347	3,935	21,014	32,296

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
- undated⁷⁰ .................................................................	3,093	3,147	17,732	23,972

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

For footnotes, see page 291.

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 2009 was US$2.8 billion (2008: 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
	2009	2008
	US$m	US$m

+ 100 basis point shift in risk-free rate ...........	212	179
- 100 basis point shift in risk-free rate ...........	(145)	(100)
+ 100 basis point shift in risk discount rate ....	(140)	(109)
- 100 basis point shift in risk discount rate ....	162	122

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)

	2009			2008
		Total equity	PVIF included in total equity	Total equity	PVIF included in total equity
		US$m	US$m	US$m	US$m

At 1 January ....................................................................		7,577	2,033	8,430	1,965
Value of new business written during the year⁷¹ ................		600	600	452	452
Movements arising from in-force business:
- expected return .........................................................		(123)	(123)	(186)	(186)
- experience variances⁷² ..............................................		(44)	(44)	(36)	(36)
- change in operating assumptions ...............................		48	48	(7)	(7)
Investment return variances ............................................		16	16	(94)	(94)
Changes in investment assumptions .................................		19	19	12	12
Return on net assets ........................................................		522	-	(310)	-
Exchange differences and other .......................................		(83)	231	(93)	(73)
Capital transactions .........................................................		48	-	(591)	-

At 31 December ..............................................................		8,580	2,780	7,577	2,033

For footnotes, see page 291.

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 2009 to reasonably possible changes in these non-economic assumptions at that date across all insurance manufacturing subsidiaries, with comparatives for 2008.

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, Latin America and Bermuda.

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, the UK and the US.

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, the UK and the US 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

2009
20% increase in claims costs ........................	-	(191)	(191)	-	(191)	(191)
20% decrease in claims costs .......................	-	190	190	-	190	190
10% increase in mortality and/or morbidity rates ........................................................	(51)	-	(51)	(51)	-	(51)
10% decrease in mortality and/or morbidity rates ........................................................	62	-	62	62	-	62
50% increase in lapse rates ..........................	(162)	-	(162)	(162)	-	(162)
50% decrease in lapse rates ..........................	408	-	408	408	-	408
10% increase in expense rates .....................	(52)	(11)	(63)	(52)	(11)	(63)
10% decrease in expense rates .....................	52	11	63	52	11	63

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

Capital management and allocation

Capital management

(Audited)

HSBC's capital management approach is driven by its strategic and organisational requirements, taking into account the regulatory, economic and commercial environment in which it operates.

It is HSBC's objective to maintain a strong capital base to support the development of its business and to meet regulatory capital requirements at all times. To achieve this, 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.

The Group's policy is underpinned by the Capital Management Framework, which enables HSBC to manage its capital in a consistent and aligned manner. The framework, which is approved by GMB, incorporates a number of different capital measures including market capitalisation, invested capital, economic capital and regulatory capital, defined by HSBC as follows:

· market capitalisation is the stock market value of the company;

· invested capital is the equity capital invested in HSBC by its shareholders;

· economic capital is the internally calculated capital requirement which is deemed necessary by HSBC to support the risks to which it is exposed at a confidence level consistent with a target credit rating of AA; and

· regulatory capital is the capital which HSBC is required to hold in accordance with the rules established by the FSA for the consolidated Group and by HSBC's local regulators for individual Group companies.

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 these risks pose a significantly greater challenge in a severe economic downturn and management's response to these risks has, correspondingly, been intensified in the current conditions.

Stress testing is incorporated into the Capital Management Framework and is used as an important mechanism in understanding the sensitivities of the core assumptions in the Group's capital plans to the adverse effect of extreme, but plausible, events. Stress testing allows senior management to formulate its response in advance of conditions starting to exhibit the stress scenarios identified. The actual market stresses which occurred throughout the financial system during the past two years have been used to inform the capital planning process and further develop the stress scenarios employed by the Group.

The responsibility for global capital allocation principles and decisions rests with GMB. Through its structured internal governance processes, HSBC maintains discipline over its investment and capital allocation decisions and seeking to ensure that returns on investment are adequate after taking account of capital costs. HSBC's strategy is to allocate capital to businesses on the basis of their economic profit generation, regulatory and economic capital requirements and cost of capital.

HSBC's capital management process is articulated in an annual Group capital plan which is approved by the Board. The plan is drawn up with the objective of maintaining both the appropriate amount of capital and the optimal mix between the different components of capital. When HSBC Holdings and its major subsidiaries raise non-equity tier 1 capital and subordinated debt, this is done 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 to support its planned business growth and meet its local regulatory requirements within the context of the approved annual Group capital plan. In accordance with HSBC's Capital Management Framework, capital generated by subsidiaries 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 and these investments are substantially funded by HSBC Holdings' own capital issuance and profit retention. As part of its capital management process, HSBC Holdings seeks to maintain a prudent balance between the composition of its capital and that of its investment in subsidiaries.

During 2009, the Group targeted a tier 1 ratio within the range 7.5 to 10.0 per cent for the purposes of its long-term capital planning. This was an increase on the 2008 range of 7.5 to 9.0 per cent, and reflected revised market expectations on capital strength and the higher volatility of capital requirements which resulted from pro-cyclicality embedded within the Basel II rules. The tier 1 ratio increased to 10.8 per cent at 31 December 2009 (2008: 8.3 per cent) and notwithstanding that this lies outside the target range noted above, HSBC is satisfied that, in light of the current evolution of the regulatory framework, this is appropriate.

Capital measurement and allocation

The FSA supervises HSBC on a consolidated basis and therefore receives information on the capital adequacy of, and sets capital requirements for, the Group as a whole. Individual banking subsidiaries are directly regulated by their local banking supervisors, who set and monitor their capital adequacy requirements.

HSBC calculates capital at a Group level using the Basel II framework of the Basel Committee on Banking Supervision; 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.

Basel II is structured around three 'pillars': minimum capital requirements, supervisory review process and market discipline. The Capital Requirements Directive ('CRD') implemented Basel II in the EU and the FSA then gave effect to the CRD by including the requirements of the CRD in its own rulebooks.

Capital

HSBC's capital is divided into two tiers:

· tier 1 capital is divided into core tier 1 and other tier 1 capital. Core tier 1 capital comprises shareholders' equity and related minority interests. The book values of goodwill and intangible assets are deducted from core tier 1 capital and other regulatory adjustments are made for items reflected in shareholders' equity which are treated differently for the purposes of capital adequacy. Qualifying hybrid capital instruments such as non-cumulative perpetual preference shares and innovative tier 1 securities are included in other tier 1 capital;

· tier 2 capital comprises qualifying subordinated loan capital, related minority interests, allowable collective impairment allowances 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.

To ensure the overall quality of the capital base, the FSA's rules set limits on the amount of hybrid capital instruments that can be included in tier 1 capital relative to core tier 1 capital, and also limits overall tier 2 capital to no more than tier 1 capital.

The basis of consolidation for financial accounting purposes is described on page 367 and differs from that used for regulatory purposes. Investments in banking associates, which are equity accounted in the financial accounting consolidation, are proportionally consolidated for regulatory purposes. Subsidiaries and associates engaged in insurance and non-financial activities are excluded from the regulatory consolidation and are deducted from regulatory capital. The regulatory consolidation does not include SPEs where significant risk has been transferred to third parties. Exposures to these SPEs are risk-weighted as securitisation positions for regulatory purposes.

Pillar 1

Pillar 1 covers the capital resources requirements for credit risk, market risk and operational risk. Credit risk also covers both counterparty credit risk and securitisation requirements. All these requirements are expressed in terms of risk-weighted assets ('RWA's).

Credit risk

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 group other counterparties into broad categories and apply 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 subjects their quantified estimates of exposure at default ('EAD') and loss given default ('LGD') to standard supervisory parameters. Finally, the IRB advanced approach allows banks to use their own internal assessment in both determining PD and quantifying EAD and LGD.

The capital resources requirement, which is intended to cover unexpected losses, is derived from a formula specified in the regulatory rules, which incorporates these factors and other variables such as maturity and correlation. Expected losses under the IRB approaches are calculated by multiplying PD by EAD and LGD. Expected losses are deducted from capital to the extent that they exceed accounting impairment allowances.

For credit risk, with the FSA's approval, HSBC has adopted the IRB advanced approach for the majority of its business, 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. Under the Group's Basel II rollout plans, a number of Group companies are in transition to advanced IRB approaches. At December 2009, corporate portfolios in France, Hong Kong and Rest of Asia- Pacific completed the transition from foundation to advanced IRB approaches. Other Group companies and portfolios remain on the standardised or foundation approaches under Basel II, pending definition of local regulations or model approval, or under exemptions from IRB treatment.

Counterparty credit risk

Counterparty credit risk in both the trading and non-trading books is the risk that the counterparty to a transaction may default before completing the satisfactory settlement of the transaction. Three approaches to calculating counterparty credit risk and determining exposure values are defined by Basel II: standardised, mark-to-market and internal model method. These exposure values are used to determine capital requirements under one of the credit risk approaches; standardised, IRB foundation and IRB advanced.

HSBC uses the mark-to-market and internal model method approaches for counterparty credit risk. Its longer-term aim is to migrate more positions from the mark-to-market to the internal model method approach.

Securitisation

Basel II specifies two methods for calculating credit risk requirements for securitisation positions in the non-trading book, being the standardised and IRB approaches. Both approaches rely on the mapping of rating agency credit ratings to risk weights, which range between 7 per cent and 1,250 per cent. Positions that would otherwise be weighted at 1,250 per cent are deducted from capital. Within the IRB approach, HSBC uses the Ratings Based Method for the majority of its non-trading book securitisation positions, and the Internal Assessment Approach for unrated liquidity facilities and programme wide enhancements for asset-backed securitisations.

HSBC uses the IRB approach for the majority of its non-trading book securitisation positions, while those in the trading book are treated like other market risk positions.

Market risk

Market risk is the risk that movements in market risk factors, including foreign exchange, commodity prices, interest rates, credit spread and equity prices will reduce HSBC's income or the value of its portfolios. Market risk is measured, with FSA permission, using Value at Risk ('VAR') models, or the standard rules prescribed by the FSA.

HSBC uses both VAR and standard rules approaches for market risk. Its longer-term aim is to migrate more positions from standard rules to VAR.

Operational risk

Basel II includes capital requirements for operational risk, again utilising 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 in determining its Group operational risk capital requirements.

Pillar 2

The second pillar of Basel II (Supervisory Review and Evaluation Process) 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 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 is set as a capital resources requirement higher than that required under pillar 1.

Pillar 3

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. HSBC published its first full set of pillar 3 disclosures for 31 December 2008, including quantitative tables, on 11 May 2009. Pillar 3 Disclosures 2009 is published as a separate document on the Group Investor Relations website.

Future developments

The regulation and supervision of financial institutions is currently undergoing a period of significant change in response to the global financial crisis. Increased capital requirements for market risk and securitisations have already been announced by the Basel Committee and are due for implementation in the EU in 2011. The Basel Committee issued further proposals in a Consultative Document 'Strengthening the resilience of the banking sector' on 17 December 2009. The Committee's proposals are part of global initiatives to strengthen the financial regulatory system, and have been endorsed by the Financial Stability Board and the G20 leaders. A comprehensive impact assessment will be carried out on the proposals in the first half of 2010, with the aim of developing a fully calibrated set of standards by the end of 2010. The proposals will be phased in as financial conditions improve and the economic recovery is assured, with the aim of implementation by the end of 2012. Within this context, the Basel Committee will also consider appropriate transition and grandfathering arrangements. The consultation period for these proposals closes on 16 April 2010.

Capital structure at 31 December

	2009	2008
	US$m	US$m
Composition of regulatory capital
(Audited)
Tier 1 capital
Shareholders' equity ............................................................................................................	135,252	106,301
Shareholders' equity per balance sheet⁷³ ..........................................................................	128,299	93,591
Preference share premium ...............................................................................................	(1,405)	(1,405)
Other equity instruments .................................................................................................	(2,133)	(2,133)
Deconsolidation of special purpose entities⁷⁴ ...................................................................	10,491	16,248

Minority interests ...............................................................................................................	3,932	3,616
Minority interests per balance sheet ................................................................................	7,362	6,638
Preference share minority interests .................................................................................	(2,395)	(2,110)
Minority interest transferred to tier 2 capital ..................................................................	(678)	(626)
Minority interest in deconsolidated subsidiaries ................................................................	(357)	(286)

Regulatory adjustments to the accounting basis ...................................................................	164	349
Unrealised losses on available-for-sale debt securities⁷⁵.....................................................	906	5,191
Own credit spread ............................................................................................................	(1,050)	(5,744)
Defined benefit pension fund adjustment⁷⁶ .......................................................................	2,508	1,822
Reserves arising from revaluation of property and unrealised gains on available-for-sale equities .............................................................................................	(2,226)	(1,726)
Cash flow hedging reserve ................................................................................................	26	806

Deductions ..........................................................................................................................	(33,088)	(29,994)
Goodwill capitalised and intangible assets .........................................................................	(28,680)	(26,861)
50% of securitisation positions.........................................................................................	(1,579)	(989)
50% of tax credit adjustment for expected losses..............................................................	546	516
50% of excess of expected losses over impairment allowances ........................................	(3,375)	(2,660)

Core tier 1 capital ...........................................................................................................	106,260	80,272

Other tier 1 capital before deductions ..................................................................................	15,798	14,926
Preference share premium ...............................................................................................	1,405	1,405
Preference share minority interests .................................................................................	2,395	2,110
Innovative tier 1 securities ..............................................................................................	11,998	11,411

Deductions ..........................................................................................................................	99	138
Unconsolidated investments⁷⁷ .........................................................................................	(447)	(378)
50% of tax credit adjustment for expected losses .............................................................	546	516

Tier 1 capital ....................................................................................................................	122,157	95,336

Tier 2 capital
Total qualifying tier 2 capital before deductions ..................................................................	50,075	49,394
Reserves arising from revaluation of property and unrealised gains on available-for-sale equities .............................................................................................	2,226	1,726
Collective impairment allowances⁷⁸ .................................................................................	4,120	3,168
Perpetual subordinated debt .............................................................................................	2,987	2,996
Term subordinated debt ...................................................................................................	40,442	41,204
Minority interest in tier 2 capital ....................................................................................	300	300

Total deductions other than from tier 1 capital ...................................................................	(16,503)	(13,270)
Unconsolidated investments⁷⁷ .........................................................................................	(11,547)	(9,613)
50% of securitisation positions ........................................................................................	(1,579)	(989)
50% of excess of expected losses over impairment allowances ........................................	(3,375)	(2,660)
Other deductions .............................................................................................................	(2)	(8)


Total regulatory capital ..................................................................................................	155,729	131,460

Risk-weighted assets
(Unaudited)
Credit risk ...........................................................................................................................	903,518	882,597
Counterparty credit risk ......................................................................................................	51,892	73,999
Market risk .........................................................................................................................	51,860	70,264
Operational risk ..................................................................................................................	125,898	121,114

Total ..................................................................................................................................	1,133,168	1,147,974

For footnotes, see page 291.

	2009	2008
	%	%
Capital ratios
(Unaudited)
Core tier 1 ratio ..................................................................................................................	9.4	7.0
Tier 1 ratio .........................................................................................................................	10.8	8.3
Total capital ratio ...............................................................................................................	13.7	11.4

Source and application of tier 1 capital

	2009 US$m	2008 US$m
Movement in tier 1 capital
(Audited)
Opening tier 1 capital⁷⁹........................................................................................................	95,336	101,685
Contribution to tier 1 capital from profit for the year .....................................................	10,247	11,682
Consolidated profits attributable to shareholders of the parent company .........................	5,834	5,728
Removal of own credit spread net of tax .........................................................................	4,413	(4,610)
Goodwill write-offs ..........................................................................................................	-	10,564

Net dividends ......................................................................................................................	(3,969)	(7,708)
Dividends ........................................................................................................................	(5,639)	(11,301)
Add back: shares issued in lieu of dividends .......................................................................	1,670	3,593

Decrease/(increase) in goodwill and intangible assets deducted ..............................................	(1,819)	1,430
Ordinary shares issued .........................................................................................................	18,399	470
Rights issue (net of expenses)⁸⁰ .......................................................................................	18,326	-
Other ..............................................................................................................................	73	470
Innovative tier 1 securities issued ........................................................................................	-	2,133
Foreign currency translation differences ..............................................................................	4,837	(11,980)
Other⁷⁹ ...............................................................................................................................	(874)	(2,376)

Closing tier 1 capital ...........................................................................................................	122,157	95,336

Movement in risk-weighted assets
(Unaudited)
At 1 January⁷⁹.....................................................................................................................	1,147,974	1,164,649
Movements .........................................................................................................................	(14,806)	(16,675)

At 31 December ..................................................................................................................	1,133,168	1,147,974

For footnotes, see page 291.

Movement in tier 1 capital

(Audited)

HSBC complied with the FSA's capital adequacy requirements throughout 2009 and 2008. The rights issue increased tier 1 capital by US$17.8 billion. Profits attributable to shareholders of the parent company of US$5.8 billion included losses of US$4.4 billion from own credit spread, net of tax, which do not impact regulatory capital. The resulting contribution to tier 1 capital was therefore US$10.2 billion less net dividends of US$4.0 billion after taking account of shares issued in lieu of dividends. The weakening US dollar caused foreign currency translation differences to increase tier 1 capital by US$4.8 billion.

Movement in risk-weighted assets

(Unaudited)

Total risk-weighted assets decreased by US$14.8 billion, or 1.3 per cent. Foreign currency translation effects are estimated to have increased RWAs by US$40 billion, mainly as a result of the weakening of the US dollar, particularly against sterling and the Brazilian real, resulting in an estimated underlying decrease of US$55 billion in RWAs. Of this underlying decrease, US$19 billion was due to credit risk RWAs, reflecting decreases in Europe and North America being offset by increases in Asia. Market risk and counterparty credit risk RWAs decreased by US$41 billion, primarily due to reduced market volatility and active exposure management. Operational risk RWAs increased by US$4.8 billion because the three-year averaging of gross revenues used in the calculation now includes revenues for 2009 in place of 2006.

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 RWAs by principal subsidiary. The RWAs are calculated using FSA rules and exclude intra-HSBC items.

Risk-weighted assets by principal subsidiary (Unaudited)
	2009 US$m	2008 US$m

The Hongkong and Shanghai Banking Corporation ...........................................................	288,225	247,626
Hang Seng Bank ............................................................................................................	60,991	44,211
HSBC Bank Malaysia⁸¹ ..................................................................................................	8,606	-
The Hongkong and Shanghai Banking Corporation and other subsidiaries ......................	218,628	203,415

HSBC Bank .......................................................................................................................	318,570	379,695
HSBC Private Banking Holdings (Suisse) .......................................................................	20,200	20,422
HSBC France .................................................................................................................	50,462	65,557
HSBC Bank and other subsidiaries ..................................................................................	247,908	293,716

HSBC North America .......................................................................................................	363,622	373,955
HSBC Finance ...............................................................................................................	174,595	187,660
HSBC Bank Canada .......................................................................................................	34,831	35,336
HSBC Bank USA and other subsidiaries ..........................................................................	154,196	150,959

HSBC Mexico ...................................................................................................................	22,624	21,037
HSBC Bank Middle East ....................................................................................................	33,773	35,217
HSBC Bank Malaysia ........................................................................................................	-	11,182
HSBC Brazil ......................................................................................................................	41,782	30,851
HSBC Bank Panama .........................................................................................................	9,142	9,498
Bank of Bermuda ..............................................................................................................	4,663	4,759
Other ................................................................................................................................	50,767	34,154

	1,133,168	1,147,974

For footnote, see below.

Footnotes to Risk

Credit risk

1 The amount of the loan commitments reflects, where relevant, the expected level of take-up of pre-approved loan offers made by mailshots to personal customers. In addition to those amounts, there is a further maximum possible exposure to credit risk of US$62,286 million (2008: US$35,849 million), reflecting the full take-up of such irrevocable loan commitments. The take-up of such offers is generally at modest levels.

2 As discussed further under 'Write-off of loans and advances', there was a change in the write-off period in North America during 2009. The effect of this change was an acceleration of write-offs which reduced residential mortgages by US$1,924 million, other personal loans by US$1,340 million and total personal lending by US$3,264 million, with a corresponding reduction in impairment allowances. There was no significant effect on net loans and advances or loan impairment charges.

3 Residential mortgages include Hong Kong Government Home Ownership Scheme loans of US$3,456 million at 31 December 2009 (2008: US$3,882 million). Where disclosed, earlier comparatives were 2007: US$3,942 million; 2006: US$4,078 million; 2005: US$4,680 million.

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

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

6 Included within 'Gross loans and advances to customers' is credit card lending of US$68,289 million (2008: US$75,266 million). Where disclosed, earlier comparatives were 2007: US$82,854 million; 2006: US$74,518 million; 2005: US$66,020 million.

7 The Middle East is disclosed as a separate geographical region with effect from 1 January 2009. Previously, it formed part of Rest of Asia-Pacific. Comparative data have been restated accordingly.

8 As discussed further under 'Write-off of loans and advances', there was a change in the write-off period in North America during 2009. The effect of this change was an acceleration of write-offs which reduced gross loans and advances to customers and loans classified as impaired by US$3,264 million, with a corresponding reduction in impairment allowances. There was no significant effect on net customer loans and advances or loan impairment charges.

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

10 Comprising Hong Kong, Rest of Asia-Pacific, Middle East and Latin America.

11 As discussed further under 'Write-off of loans and advances', there was a change in the write-off period in North America during 2009. The effect of this change was an acceleration of write-offs which reduced residential mortgages by US$1,924 million, second lien mortgages by US$425 million and total mortgage lending by US$2,349 million, with a corresponding reduction in impairment allowances. There was no significant effect on net loans and advances or loan impairment charges.

12 Negative equity arises when the value of the loan exceeds the value of available equity, generally based on values at origination date.

13 Loan-to-value ratios are generally based on values at the balance sheet date. The comparative data for the UK and the US are restated accordingly (previously these ratios were presented based on origination date).

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

15 As discussed further under 'Write-off of loans and advances' on page 205, there was a change in the write-off policy in North America during 2009. The effect of this change was a one-off acceleration of write-offs. Excluding this, HSBC Finance mortgage lending at 31 December 2009 totalled US$63,724 million, of which US$52,914 million was fixed rate, US$9,537 million was adjustable rate and US$1,274 million was interest only. Of the total, US$55,625 million was first lien and US$8,098 million was second lien.

16 Stated income lending forms a subset of total mortgage services lending across all categories.

17 By states which individually account for 5 per cent or more of HSBC Finance's US customer loan portfolio.

18 Percentages are expressed as a function of the relevant loans and receivables balance.

19 The average loss on sale of foreclosed properties is calculated as cash proceeds after deducting selling costs and commissions, minus the book value of the property when it was moved to 'Real estate owned', divided by the book value of the property when it was moved to 'Real estate owned'.

20 The average total loss on foreclosed properties sold during each quarter includes both the loss on sale and the cumulative write-downs recognised on the loans up to and upon classification as 'Real estate owned'. This average total loss on foreclosed properties is expressed as a percentage of the book value of the property prior to its transfer to 'Real estate owners'.

21 HSBC observes the disclosure convention that, in addition to those classified as EL9 to EL10, retail accounts classified EL1 to EL8 that are delinquent by 90 days or more are considered impaired, unless individually they have been assessed as not impaired (see page 229, 'Past due but not impaired financial instruments').

22 The EL percentage is derived through a combination of PD and LGD, and may exceed 100 per cent in circumstances where the LGD is above 100 per cent reflecting the cost of recoveries.

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

24 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, all such balances are reported under 'Neither past due nor impaired'.

25 Includes asset-backed securities that have been externally rated as strong (2009: US$5,707 million; 2008: US$7,991 million), medium-good (2009: US$881 million; 2008: nil), medium-satisfactory (2009: US$311 million; 2008: nil), sub-standard (2009: US$468 million; 2008: nil) and impaired (2009: US$460 million; 2008: nil).

26 The balances reported at 31 December 2008 for individually and collectively assessed impaired loans and advances to customers have been restated by US$1.0 billion as a result of a reclassification, for disclosure purposes, of an element of a mortgage portfolio. There has been no change to total impaired loans or total impairment allowances.

27 Impaired loans and advances are those classified as CRR 9, CRR 10, EL 9 or EL 10 and all retail loans 90 days or more past due, unless individually they have been assessed as not impaired (see page 229, 'Past due but not impaired financial instruments').

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

29 Collectively assessed loans and advances not impaired are those classified as CRR1 to CRR8 and EL1 to EL8 but excluding retail loans 90 days past due.

30 The impairment allowances on loans and advances to banks relate to the geographical regions, Europe and Middle East.

31 Net of reverse repo transactions, settlement accounts and stock borrowings.

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

33 Includes movement in impairment allowances against banks.

34 See table below 'Net loan impairment charge to the income statement by geographical region'.

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

36 Ratio excludes trading loans classified as in default.

Liquidity and funding

37 This comprises the Group's other main banking subsidiaries and, as such, includes businesses spread across a range of locations, in many of which HSBC may require a higher ratio of net liquid assets to customer liabilities to reflect local market conditions.

38 Unused committed sources of secured funding for which eligible assets were held.

39 Client-originated asset exposures relate to consolidated multi-seller conduits (see page 191). These vehicles provide funding to Group customers by issuing debt secured by a diversified pool of customer-originated assets.

40 HSBC-managed asset exposures relate to consolidated securities investment conduits, primarily Solitaire and Mazarin (see page 191). These vehicles issue debt secured by ABSs which are managed by HSBC. Of the total contingent liquidity risk under this category, US$18.7 billion was already funded on-balance sheet at 31 December 2009 (2008: US$25.3 billion) leaving a net contingent exposure of US$10.4 billion (2008: US$9.5 billion).

41 Other conduit exposures relate to third-party sponsored conduits (see page 194).

42 The five largest committed liquidity facilities provided to customers other than those facilities to conduits.

43 The total of all committed liquidity facilities provided to the largest market sector, other than those facilities to conduits.

Market risk

44 The structural foreign exchange risk is monitored using sensitivity analysis (see page 455). The reporting of commodity risk is consolidated with foreign exchange risk and is not applicable to non-trading portfolios.

45 The interest rate risk on the fixed-rate securities issued by HSBC Holdings is not included in the Group VAR. The management of this risk is described on page 258.

46 Credit spread sensitivity is reported separately for insurance operations (see page 277).

47 The effect of any month-end adjustments, not attributable to a specific daily market move, is spread evenly over the days in the month in question.

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

Risk management of insurance operations

49 HSBC has no insurance manufacturing subsidiaries in the Middle East.

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

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

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

53 Term assurance includes credit life insurance.

54 Other assets comprise shareholder assets.

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

56 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.

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

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

59 Comprises non-life insurance contracts.

60 Does not include financial assets of associated insurance company, Ping An Insurance, or joint venture insurance companies, Hana Life and Canara HSBC Oriental Bank if Commerce Life Insurance Company Limited.

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

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

63 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.

64 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'.

65 Shareholders' funds comprise solvency and unencumbered assets.

66 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.

67 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.

68 Do 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.

69 Do 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.

70 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.

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

72 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.

Capital management and allocation

73 Includes externally verified profits for the year to 31 December 2009.

74 Mainly comprises unrealised losses on available-for-sale debt securities within special purpose entities which are excluded from the regulatory consolidation.

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

76 Under FSA rules, the defined benefit liability may be substituted with the additional funding that will be paid into the relevant schemes over the following five year period.

77 Mainly comprise investments in insurance entities.

78 Under FSA rules, collective impairment allowances on loan portfolios on the standardised approach are included in tier 2 capital.

79 Opening capital items as at 1 January 2008 are pro forma and unaudited.

80 Rights issue excludes US$493 million of losses arising on derivative contracts and certain fees, which are recognised in the income statement.

81 HSBC Bank Malaysia was transferred within the Group to the ownership of The Hongkong and Shanghai Banking Corporation with effect from 2 January 2009.

This information is provided by RNS

The company news service from the London Stock Exchange

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Annual Financial Report - 20

(Audited)

Life insurance business

(Audited)

(Audited)

Insurance risk

Europe

Hong Kong

Rest of Asia- Pacific

North America

Latin America

Total

US$m

Investment contracts with DPF50,51..............

Investment contracts with DPF50,51 .............

Analysis of non-life insurance risk - net written insurance premiums49,52

Europe

Hong Kong

Rest of Asia- Pacific

North America

Latin America

Total

US$m

Unit-

Other

US$m

US$m

Total assets ....................

Total liabilities ...............

Unit-

Other

US$m

US$m

Total assets ....................

Total liabilities ...............

Hong Kong

Rest of Asia- Pacific

North America

Latin America

Total

US$m

Life linked

Trading assets

Financial assets designated at fair value..............................................

Financial investments

Held-to-maturity:

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

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

Other financial assets61 .......................

Trading assets

Financial assets designated at fair value

Financial investments

Held-to-maturity:

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

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

Other financial assets61 .......................

Credit risk

Credit quality

Neither past due nor impaired

Neither past due nor impaired

Treasury

Debt

securities

Total

Liquidity risk

(Audited)

Within 1 year

At 31 December 2009

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

At 31 December 2008

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

2009

2008

Total

PVIF included in total equity

Total

equity

PVIF included in total equity

Capital management and allocation

Capital management

North
America

Latin
America

Investment contracts with DPF^50,51..............

Investment contracts with DPF^50,51 .............

Analysis of non-life insurance risk - net written insurance premiums^49,52

North
America

Latin
America

Hong
Kong

Rest of
Asia- Pacific

North
America

Latin
America

Other financial assets⁶¹ .......................

Other financial assets⁶¹ .......................

PVIF
included in
total equity

PVIF
included in
total equity