Transcript

Transcript

IFRS 17 Investor and Analyst Seminar

9 March 2023, 8.00 am GMT

RICHARD O'CONNOR, GLOBAL HEAD OF INVESTOR RELATIONS: Good morning and good afternoon, everyone. Welcome to the HSBC Insurance and IFRS 17 event. There'll be around a 30-minute presentation with slides shown on screen, then, hopefully, plenty of time for Q&A. As you can see, we have a live audience here in London and also in Hong Kong, and currently about 45 participants on Zoom. So with that, I'll hand over to Greg Hingston in Hong Kong to start the presentation.

GREG HINGSTON, CEO, GLOBAL INSURANCE AND PARTNERSHIPS: Excellent. Thank you. Good afternoon, good morning and welcome to the IFRS 17 teach-in. I'm Greg Hingston, CEO for HSBC Global Insurance and Partnerships, and I'm joined by Alistair Chamberlain, Chief Financial Officer for Global Wealth and Insurance, and members of our senior leadership from HSBC Life. The purpose of this session is primarily to provide you with an understanding of what the IFRS 17 accounting change means for our business and to answer any questions you may have in this regard.

But before we go there, I'd like to provide a brief overview of HSBC Life and our strategic focus. So who are we? So HSBC Life manufactures life and health insurance products in 10 markets. Our core market participation is Hong Kong, where we operate two entities; Macau, mainland China, Singapore and India, where we participate as a 26% shareholder in a joint venture; and the UK and Mexico.

Our participation in Asia is focused on Hong Kong and Singapore, as they represent the leading Asia financial centres and offshore hubs, and mainland China and India representing the largest domestic growth opportunities, large protection gaps, low insurance penetration and fast-growingmiddle-class populations. Beyond Asia, the UK and Mexico are HSBC's scale markets, with 11 million retail customers across HSBC Bank and first direct in the UK, and over five million retail customers in Mexico, with both businesses also having large corporate banking bases.

In our manufacturing markets, we serve mass retail right the way through to private bank, and, on the corporate side, business banking through to large corporate clients. And we distribute through a mix of HSBC channels and platforms and external channels. In markets where we don't manufacture, we partner with life and general insurers, and we have distribution partnerships in 30 markets. Most recently, you probably will have seen, in 2022, we extended our partnership with Allianz in six Asian markets for 15 years.

Life insurance plays an important role in our total wealth management philosophy. It's an integral part of our Wealth strategy and our focus on growing fee income contribution. As you can see from the slide, HSBC Life is a meaningful contributor to Wealth and Personal Banking and a consistently strong payer of dividends up to the Group.

Life insurance plays a key role across the universe of customer needs. As an integrated financial services provider, life insurance is a very natural conduit for us for deepening long- term and intergenerational customer relationships, both at the individual and the family-unit level. And the fundamental demand for life insurance solutions is also being shaped by broad emerging trends that we are observing - so ageing populations and the associated longevity risk; inflation and rising healthcare costs widening the potential protection gap; growing awareness amongst customers of healthier living; the need for protection and the crossover to wealth; and, unsurprisingly, the growing use of digital to both access insurance information and to consume services.

Our strategic focus is bringing holistic health and wealth wellbeing solutions to our customers when we combine our capabilities as both a bank and a life insurer, and we strongly believe that, as a bank and an insurer model, we benefit from a number of key attributes - so access

to the bank's installed retail and corporate customer bases; a higher frequency and quality of engagement with customers through that integrated model; the richness of data that we have across both the bank and the insurance business that we can apply, for example in things like pre-underwriting; the use of data to support customer lifecycle management and propensities; the application of integrated customer loyalty and rewards programmes; the ability to create integrated customer journeys and embed product adjacencies; and internalisation of value through things like product innovation, where we can leverage HSBC cross-line-of-business solutions.

Our health and wealth model goes beyond just the preventative, physical healthcare focus that you often see from insurers, to something that really encompasses overall physical and financial wellbeing. This is something that we have led on in Hong Kong, with our Well+ and Benefits+ propositions, and these are capabilities that we are taking to other main businesses.

We also believe HSBC Life can be an effective distribution channel in its own right, so where we can scale new-to-health and wealth and, ultimately, new-to-bank customers - so for example, in our Pinnacle model in mainland China, our tied agency in Singapore, our employee benefits platform solution.

Life insurance has been a high-growth business for HSBC, and our future strategy is focused on further optimising our integrated health and wealth platform advantages and further diversifying our geographic, product and distribution mix - so doubling down on growth in our core Asian markets and scale market positions in the UK and Mexico; increasing penetration of the bank's installed customer base across segments in those key markets; expanding our distribution capabilities, including scaling up our mobile wealth advisory channel - Pinnacle in China and our tied agency in Singapore; and expanding our health and wellbeing platforms and further scaling our digital and data analytics capabilities to grow the mix of high-margin health and protection products in our portfolio.

We have a highly productive, market-leading business in Hong Kong, where we have made consistent market share gains and significant progress in evolving our integrated health and wealth platform. Our business proved incredibly resilient through the pandemic period, demonstrated by the fact that our value of new business in 2022 was 10% higher than pre-pandemic levels, and that period was when the border with mainland China was always open. We have improved our capital efficiency and we'll continue to enhance this, and we foresee significant, ongoing growth potential in Hong Kong, Macau and the rest of the Greater Bay Area.

The opportunity for us in our other scale markets of the UK and Mexico is to further develop propositions to meet the demands from the sociodemographic trends that we're seeing, whilst also extending those capabilities I talked about earlier to fundamentally improve our penetration rates.

In our other key markets, we continue to grow and scale our businesses. In Singapore, we completed the acquisition of AXA, taking our market position from number 10 to currently number seven on life insurance and number four in health insurance. In mainland China, we increased our ownership of HSBC Life China from 50% to 100%. We've expanded our presence to 10 cities and we've recently acquired a distribution broker to support further acceleration of our geographic expansion. The joint venture in India has shown a significant value of new business growth over the past few years, and India continues to represent a burgeoning market opportunity, given the acceleration of wealth creation and the unpenetrated scale of our JV partner customer base.

So just to reiterate, HSBC Life is a business that continues to create value, so sustained embedded value growth up $2.3 billion over just the past two years. In the same period, our VNB grew 31% CAGR, both a factor of the underlying momentum that we've created in the business and margin improvements, so VNB margin uplift from 38% in 2021 to 56% in '22. And we have been and will continue to fund our own growth. We're cash-generative and a consistently strong payer of dividends up to the Group.

So in summary, we have a clear strategy, we're investing for growth and we're very focused on extending our track record of shareholder value creation. With that, I'll hand over to Alistair, our CFO, who will take you through the IFRS accounting change update.

ALISTAIR CHAMBERLAIN, CFO, GLOBAL WEALTH AND INSURANCE: Thank you, Greg. We included the key impacts of IFRS 17 on our opening balance sheet, together with H1 2022

comparative numbers during the Group's year-end results announcement. Let me take you through the detail in the following slides.

IFRS 17 is an accounting standard. It does not change the economics of our insurance business. Group RoTE will be more stable, as the market impact volatility that we reported in our IFRS 4 income statement is almost fully absorbed by the contractual service margin under IFRS 17. There is no expected impact on our regulatory capital, our solvency, cash, dividend generation, or in the total profit we report over the life of the contracts that we sell.

When applying IFRS 17 in H1 2022, the HSBC Group PBT reduces by $0.4 billion, with revenue down by $0.7 billion, offset by $0.3 billion of lower costs. Based on actual investment conditions, reported PBT of our insurance manufacturing business reduces by around 50% from $0.6 billion under IFRS 4 to $0.3 billion on an IFRS 17 basis.

IFRS 17 impacts HSBC Insurance more than you might see for other insurers, due to the legacy IFRS 4 PVIF accounting model, which applies to UK banking groups with insurance operations, in conjunction with our strong new business growth. On transition, our Group total equity reduces by $10.5 billion, and our Group tangible equity reduces by $2.4 billion. The reduction in equity is mainly due to the elimination of the PVIF asset and the creation of the CSM liability. Insurance equity plus CSM amounts to $14.7 billion and represents a measure of the net asset value plus the future earnings from our in-force business. We'll update you on the impact to the Group targets and guidance later in this presentation.

On the next slide, let me recap on what I explained during our Q3 2021 announcement on why IFRS 17 is such a significant change for HSBC and what the implications of that are when it comes to things like predictability and volatility of our earnings. We adopt IFRS 17 in 2023, with a requirement for one year of comparatives, so 1 January 2022 is our opening balance sheet date. The main changes that affect our equity at that date are the elimination of the PVIF intangible asset and the establishment of the CSM liability in respect of our in-force business. From the graph on the right, you can see that the profits over the life of the contract will be the same, albeit, under IFRS 17, the profits will emerge later than under IFRS 4.

Under IFRS 17, revenue is no longer booked upfront but is recognised as services are provided to customers. This is different from our PVIF accounting model under IFRS 4, where our revenues were predominantly recognised at the point of sale. This significant conceptual change will make our insurance earnings more predictable, as revenues in a given year will be predominantly generated by the amortisation of the CSM from the in-force business.

IFRS 17 will also lead to a different way of reporting our expenses, with attributable expenses included in the CSM and, therefore, recognised within the insurance service result revenue line. Non-attributable expenses will continue to be reported in the operating expense line. Importantly, our earnings will be less volatile. This is because more than 90% of our business will be accounted under the variable fee approach, which I will cover in the next slide.

I will briefly cover the conceptual foundations of IFRS 17 and what those mean to HSBC. The measurement of insurance contract liabilities under IFRS 17 is done through a so-called building block approach. This approach is based on best-estimate cashflows using assumptions at the reporting date that best reflect our assessment of the future.

The chart on the left shows the different components of the building block approach. The future cashflows are the best estimates of all future cashflows expected over the life of the contract, including the attributable expenses.

We discount all those cashflows to reflect the time value of money. We do this at an IFRS 17 discount rate that reflects the risks and liquidity profile of those cashflows, but not all asset spreads such as equity or credit risk premiums. Therefore, the realisation of those asset spreads over time is an additional source of earnings.

Building block three is the risk adjustment to address the risk of uncertainty in our best-estimate cashflows. If the amount and timing of the discounted cashflows occur in line with our best estimate, the risk margin will be released into profit over time.

The last of the four building blocks is the CSM - the contractual service margin. This is the estimated future profit of contracts that we sell and is the net amount of building blocks one, two and three. If the sum of those parts is negative, the total expected loss will be recognised

in full in profit and loss immediately. I'll talk about our CSM numbers a bit later in this presentation.

On the right-hand side, you can see an illustration of the types of products that fall under each of our two measurement models. The main difference between VFA and GMM is that, under VFA, all market volatility, whether it's positive or negative, will be absorbed in the CSM, while, for GMM, this will be reported in our income statement as it happens.

With 90% of our business falling into the VFA category, the volatility in our earnings year on year will be significantly reduced compared to IFRS 4. The difference between the two measurement models is not one of choice. Under IFRS 17, when you fulfil the requirements for VFA, then the use of the VFA model is mandatory.

On transition, insurance manufacturing total equity reduces by $10.1 billion, and insurance manufacturing tangible equity reduces by $2.3 billion. HSBC Group tangible equity reduces by $2.4 billion, which is 1.5%. The first change is the removal of the PVIF asset, which is eliminated under IFRS 17. You only see this change in total equity, as PVIF is not part of tangible equity. Approximately $60 billion of financial assets were remeasured from amortised cost to fair value through P&L on transition. As a consequence, you will see there is a resulting reduction in net interest income of $1.1 billion in the Group P&L at H1 2022. The change in the fair value of the redesignated assets, along with the corresponding liability movement, is presented in the other income line under IFRS 17.

The overall impact of remeasuring our insurance and reinsurance assets and liabilities leads to an increase in equity of $6.8 billion. The amount of CSM that is calculated on transition is $9.6 billion for insurance manufacturing and $10 billion at HSBC Group level. This amount represents expected future profit of business in force at the transition date, which is yet to be recognised in our income statement.

The additional $0.4 billion of CSM at Group level recognises the additional CSM from distribution activities as we apply IFRS 17 to the entire value chain for all insurance policies across the Group. This includes the effect of eliminating intragroup fees between insurance manufacturing and other Group entities. On transition, we have equity plus CSM net of tax of $14.7 billion, representing the net asset value plus the estimated future earnings from the in-force business.

Value of new business is an important new business growth metric that is part of our IFRS 4 reporting, but, under IFRS 17, will no longer be recognised as revenue on day one. Conceptually, new business CSM can be thought of as the IFRS 17 equivalent of VNB and represents the expected future profit on new business written in the reporting period. At H1 '22, we have added new-business CSM of $0.6 billion to the total CSM balance.

The technical difference between new business CSM and VNB is principally driven by two components. To make new business CSM more similar to VNB, we deduct the non-attributable costs. Secondly, the long-term asset spreads are not part of our new-business CSM but are part of VNB calculations. Therefore, we add expected future investment spreads to impute a number that is more similar to VNB, with a corresponding change to the discount rate.

Both new-business CSM and the IFRS 17-derived VNB will play an important role in our business performance management and decision-making going forward. We will, therefore, provide both of these metrics in our reporting and investor communications going forward, starting from H1 2023.

The second key IFRS 17 performance metric is the CSM balance. From our opening CSM on 1 January 2022 of $9.6 billion, the main movements are the effect of writing new business in H1 2022. Secondly, the effect of market and non-economic movements. Under IFRS 17, the CSM acts as a buffer that will reduce income statement volatility. Thirdly, we add in the CSM for our inorganic acquisition of AXA Singapore that occurred in H1 2022. And lastly, the CSM recognised in the P&L is the amount of CSM that is amortised to the income statement as revenue to reflect the services provided in that reporting period.

There are two points I would like to highlight here. Firstly, the amount of new business CSM in the period is around 1.5 times larger than the amount of CSM amortised to the income statement. That means that, market volatility aside, we're growing the amount of CSM as we continue to grow our business. Secondly, you can see here an example of when the market

volatility is absorbed in the CSM rather than coming directly through the P&L, which was the case under IFRS 4, with H1 2022 being a clear example.

On the next slide, let me now tuto the income statement. I mentioned earlier that the H1 2022 PBT of insurance manufacturing dropped from about $0.6 billion to around $0.3 billion. The numbers that you see on this page illustrate the main drivers of our IFRS 4 and IFRS 17 PBT. Our H1 IFRS 4 numbers contain a large number in respect of market impacts. This amount gets largely absorbed by the CSM under IFRS 17. Our H1 IFRS 4 revenue numbers included a $0.3 billion gain following a pricing update. This is also absorbed within the CSM under IFRS 17 and will be recognised as earnings over time.

IFRS 4 PBT, after adjusting for these two, separately disclosed items, is around $1 billion. Compared to this number, the drop to our IFRS 17 PBT is around the two-thirds range, consistent with the impact that we first indicated back in Q3 2021. Under IFRS 17, the most significant is the CSM unwind of $0.4 billion. On an annualised basis, this translates to around 8% of opening CSM. For H1 2022, we reported some onerous contracts, largely caused by the effect of market movements on a number of cohorts where the CSM turned negative, and the net loss has been accounted for in the H1 2022 income statement.

The net investment revenue relates to products accounted for under the GMM model and assets-backing shareholder equity. IFRS 17 requires attributed costs to be recognised in the CSM. You can see that this causes reported operating expenses to reduce by $0.2 billion compared to IFRS 4. Outside of insurance manufacturing, there is an adjustment to eliminate intragroup items that leads to a $0.1 billion reduction in the Group's PBT. Lastly, we illustrate here that, based on a continuing strong new business growth rate of around 20%, we would retuto current IFRS 4 profit levels by 2027 to 2030.

We've set out in this slide the basis of the insurance cash and capital consolidation into the Group's capital basis. If you read through the logic, you can see that there is no change due to IFRS 17, as, although the insurance equity is changing, it's all above a deduction limit. Therefore, there is no impact on either the cash generation of the insurance business, which is largely driven by regulatory and economic capital considerations, or on the bank's capital.

On the right-hand side of the page, we've illustrated how much dividend our insurance manufacturing entities have paid to their parent companies in prior years. We expect that our insurance business will continue to pay meaningful dividends to the Group. The CET1 injections that you can see in 2021 and 2022 are mainly related to supporting our investment in Pinnacle in China. For the avoidance of doubt, the capital flows presented here do not include the inorganic strategic investments into China or Singapore.

This page shows the comparison between IFRS 4 and IFRS 17 in our Group income statement. The main visible difference is in our net interest income. This results from the reclassification of $60 billion of debt securities from amortised cost to fair value through P&L. We've done this to align the measurement of these assets to the corresponding liabilities under IFRS 17.

Under IFRS 4, the NII from the debt securities which backed policyholder liabilities was offset by a corresponding liability movement in the insurance claims line within other income. Under IFRS 17, the change in the fair value of these assets, along with the corresponding change in the measurement of the insurance contract liabilities, will both be reported in the other income lines. The remaining $0.2 billion of NII represents retufrom shareholder assets.

Our fee income increases by $0.2 billion under IFRS 17, as we defer some fee expense into the CSM. Within the other income lines, IFRS 4 revenue such as net insurance premium, net insurance claims, benefits paid, movement in liabilities to policyholders and PVIF movements will disappear. Instead, new IFRS 17 lines are added, such as the release of CSM, the effect of onerous contracts and other IFRS 17 revenue. As mentioned earlier, the total operating expense line reduces as the attributable expenses are no longer reported on this line.

Overall, Group PBT reduces by $0.4 billion, and then, factoring in $0.1 billion of tax credit, you get a profit attributable to ordinary shareholders impact of negative $0.3 billion. We'll provide more detailed disclosures when we publish the transition document around the time of the Q1 2023 results announcement.

I'd like to conclude this section by reemphasising the following: the change to IFRS 17 is an accounting change that does not impact the fundamental economics of our business and, as