Pension and Other Postretirement Benefits

Defined Benefit Pension Plans Effective January 1, 2005, our previously separate qualified defined benefit pension plan was combined with that of HSBC Finance into a single HSBC North America qualified defined benefit pension plan (either the "HSBC North America Pension Plan" or the "Plan") which facilitates the development of a unified employee benefit policy and unified employee benefit plan administration for HSBC companies operating in the U.S. The following table reflects the portion of pension expense and its related components of the HSBC North America Pension Plan which has been allocated to us and is recorded in our consolidated statement of income (loss).



Year Ended December 31,	2013			2012			2011
	(in millions)
Service cost – benefits earned during the period	$	4		$	15		$	14
Interest cost on projected benefit obligation	71			67			74
Expected return on assets	(83		)	(91		)	(81		)
Amortization of prior service cost (benefit)	—			(5		)	(6		)
Recognized losses	49			46			38
Curtailment benefit recognized	—			(31		)	—
Pension expense	$	41		$	1		$	39

Pension expense in 2012 reflects the recognition of a curtailment benefit associated with the decision in 2012 to cease all future contributions under the Cash Balance formula and freeze the Plan effective January 1, 2013. While participants with existing balances continue to receive interest credits until the account is distributed, they no longer accrue benefits beginning in 2013. Excluding the impact of the curtailment benefit from the prior year, pension expense remained higher in 2013 largely due to lower expected returns on plan assets driven by a lower return assumption due to asset mix.

During December 2011, an amendment was made to the Plan effective January 1, 2011 to amend the benefit formula, thus increasing the benefits associated with services provided by certain employees in past periods. The financial impact is being amortized to pension expense over the remaining life expectancy of the participants. As a result of the decision to cease all future contributions under the Cash Balance formula and freeze the Plan effective January 1, 2013, the remaining unamortized prior service credit was recognized during 2012.

The assumptions used in determining pension expense of the HSBC North America Pension Plan are as follows:



	2013		2012		2011
Discount rate	3.95	%	4.60	%	5.30	%
Salary increase assumption	*		2.75		2.75
Expected long-term rate of return on Plan assets	6.00		7.00		7.25

* As the result of decision to cease all future contributions under the cash balance formula and to freeze the plan effective January 1, 2013, a salary increase assumption no longer applies to the Plan.

Long-term historical rates of return in conjunction with our current outlook of return rates over the term of the pension obligation are considered in determining an appropriate long-term rate of return on Plan assets. In this regard, a "best estimate range" of expected rates of return on Plan assets is established by our actuaries based on a portfolio of passive investments considering asset mix upon which a distribution of compound average returns for such portfolio is calculated over a 20 year horizon. This approach, however, ignores the characteristics and performance of the specific investments the pension plan is invested in, their historical returns and their performance against industry benchmarks. In evaluating the range of potential outcomes, a "best estimate range" is established between the 25th and 75th percentile. In addition to this analysis, we also seek the input of the firm which provides us pension advisory services. This firm performs an analysis similar to that done by our actuaries, but instead uses real investment types and considers historical fund manager performance. In this regard, we also focus on the range of possible outcomes between the 25th and 75th percentile, with a focus on the 50th percentile. The combination of these analyses creates a range of potential long-term rate of return assumptions from which we determine an appropriate rate. Given the Plan’s current allocation of equity and fixed income securities and using investment return assumptions which are based on long term historical data, the long term expected return for plan assets is reasonable.

Investment strategy for Plan Assets The primary objective of the HSBC North America Pension Plan is to provide eligible employees with regular pension benefits. Since the Plan is governed by the Employee Retirement Security Act of 1974 ("ERISA"), ERISA regulations serve as guidance for the management of plan assets. In this regard, an Investment Committee (the "Committee") for the Plan has been established and its members have been appointed by the Chief Executive Officer as authorized by the Board of Directors of HSBC North America. The Committee is responsible for establishing the funding policy and investment objectives supporting the Plan including allocating the assets of the Plan, monitoring the diversification of the Plan’s investments and investment performance, assuring the Plan does not violate any provisions of ERISA and the appointment, removal and monitoring of investment advisers and the trustee. Consistent with prudent standards for preservation of capital and maintenance of liquidity, the goal of the Plan is to earn the highest possible total rate of return consistent with the Plan’s tolerance for risk as periodically determined by the Committee. A key factor shaping the Committee’s attitude towards risk is the generally long term nature of the underlying benefit obligations. The asset allocation decision reflects this long term horizon as well as the ability and willingness to accept some short-term variability in the performance of the portfolio in exchange for the expectation of competitive long-term investment results for its participants.

The Plan’s investment committee utilizes a proactive approach to managing the Plan’s overall investment strategy. During the past year, this resulted in the Committee conducting four quarterly meetings including two strategic reviews and two in-depth manager performance reviews with the final meeting for 2013 being held in January 2014. These quarterly meetings are supplemented by the pension investment staff tracking actual investment manager performance versus the relevant benchmark and absolute return expectations on a monthly basis. The pension investment staff also monitors adherence to individual investment manager guidelines via a quarterly compliance certification process. A sub-committee consisting of the pension investment staff and three members of the investment committee are delegated responsibility for conducting in-depth reviews of managers performing below expectation. This sub-committee also provides replacement recommendations to the Committee when manager performance fails to meet expectations for an extended period. In 2011, the Committee shifted the Plan's target asset allocation to 40 percent equities, 59 percent fixed income securities and 1 percent cash and maintained this mix through 2013. Should interest rates rise faster than currently anticipated by the Committee, a further shift to a higher percentage of fixed income securities may be made.

In order to achieve the return objectives of the Plan, investment diversification is employed to ensure that adverse results from one security or security class will not have an unduly detrimental effect on the entire portfolio. Diversification is interpreted to include diversification by type, characteristic, and number of investments as well as investment style of investment managers and number of investment managers for a particular investment style. Equity securities are invested in large, mid and small capitalization domestic stocks as well as large and small capitalization international, global and emerging market stocks. Fixed income securities are invested in U.S. Treasuries (including Treasury Inflation Protected Securities), agencies, corporate bonds, and mortgage and other asset backed securities. Without sacrificing returns or increasing risk, the Committee prefers a limited number of investment manager relationships which improves efficiency of administration while providing economies of scale with respect to fees.

An investment consultant is used to provide investment consulting services such as recommendations on the type of funds to be utilized, appropriate fund managers, and the monitoring of the performance of those fund managers. Plan performance is measured against absolute and relative return objectives. Results are reviewed from both a short-term (less than 1 year) and intermediate term (three to five year i.e. a full market cycle) perspective. Separate account fund managers are prohibited from investing in all HSBC Securities, restricted stock (except Rule 144(a) securities which are not prohibited investments), short-sale contracts, non-financial commodities, investments in private companies, leveraged investments and any futures or options (unless used for hedging purposes and approved by the Committee). Commingled account and limited partnership fund managers however are allowed to invest in the preceding to the extent allowed in each of their offering memoranda. As a result of the current low interest rate environment and expectation that interest rates will rise in the future, the Committee mandated the suspension of its previously approved interest rate hedging strategy in June 2009. Outside of the approved interest rate hedging strategy, the use of derivative strategies by investment managers must be explicitly authorized by the Committee. Such derivatives may be used only to hedge an account’s investment risk or to replicate an investment that would otherwise be made directly in the cash market.

The Committee expects total investment performance to exceed the following long-term performance objectives:


•	A long-term return of 6.00 percent;


•	Prior to January 10, 2014, a passive, blended index comprised of 9.5 percent S&P 500, 3 percent Russell 2000, 8 percent EAFE, 3 percent S&P Dev ex-US Small Cap, 11 percent MSCI AC World Free Index, 6 percent MSCI Emerging Markets, 51 percent Barclays Long Gov/Credit, 8 percent Barclays Treasury Inflation Protected Securities and 1 percent 90-day T-Bills;


•	From January 10, 2014, a passive, blended index comprised of 9.5 percent S&P 500, 3 percent Russell 2000, 8 percent EAFE, 3 percent S&P Dev ex-US Small Cap, 11 percent MSCI AC World. 5.5 percent MSCI Emerging Markets, 59 percent Barclays Long Gov/Credit and 1 percent 90-day T-Bills; and


•	Above median performance of peer corporate pension plans.

HSBC North America’s overall investment strategy for Plan assets is to achieve a mix of at least 95 percent of investments for long-term growth and up to 5 percent for near-term benefit payments with a wide diversification of asset types, fund strategies, and fund managers. The target sector allocations of Plan assets at December 31, 2013 are as follows:



	Percentage of Plan Assets at December 31, 2013
Domestic Large/Mid-Cap Equity	9.9	%
Domestic Small Cap Equity	3.3
International Large Cap Equity	8.1
International Small Cap Equity	3.2
Global Equity	11.4
Emerging Market Equity	5.4
Fixed Income Securities	58.7
Cash or Cash Equivalents	—
Total	100.0	%

Plan Assets A reconciliation of beginning and ending balances of the fair value of net assets associated with the HSBC North America Pension Plan is shown below.



Year Ended December 31,	2013			2012
	(in millions)
Fair value of net Plan assets at beginning of year	$	3,485		$	3,130
Cash contributions by HSBC North America	131			181
Actual return on Plan assets	(8		)	383
Benefits paid	(173		)	(209		)
Fair value of net Plan assets at end of year	$	3,435		$	3,485

The fair value of Plan assets decreased approximately 1.4 percent compared with December 31, 2012 due primarily to significantly increasing Treasury yields which negatively impacted fixed income assets and swaps during 2013, partially offset by an improvement in equities and a $131 million cash contribution to the Plan.

The Pension Protection Act of 2006 requires companies to meet certain pension funding requirements. As a result, during 2009, the Committee revised the Pension Funding Policy to better reflect current marketplace conditions and ensure the Plan’s ability to continue to make lump sum payments to retiring participants. Until the Plan is fully funded, the revised Pension Funding Policy requires HSBC North America to annually contribute the greater of:


•	The minimum contribution required under ERISA guidelines;


•	An amount necessary to ensure the adjusted funding target attainment percentage for the Plan Year is equal to or greater than 90 percent; or


•	Pension expense for the year as determined under current accounting guidance.

Because the Plan was frozen effective January 1, 2013 and Plan participants no longer accrue benefits, the actuarial present value of benefits is $3.1 billion.

As a result, during 2013 HSBC North America made a contribution to the Plan of $131 million. Additional contributions during 2014 are anticipated.

Accounting principles related to fair value measurements provide a framework for measuring fair value and focuses on an exit price in the principal (or alternatively, the most advantageous) market accessible in an orderly transaction between willing market participants (the "Fair Value Framework"). The Fair Value Framework establishes a three-tiered fair value hierarchy with Level 1 representing quoted prices (unadjusted) in active markets for identical assets or liabilities. Fair values determined by Level 2 inputs are inputs that are observable for the identical asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are inactive, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability and include situations where there is little, if any, market activity for the asset or liability. Transfers between leveling categories are recognized at the end of each reporting period. The following table presents the fair values associated with the major categories of Plan assets and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair values as of December 31, 2013 and 2012.



	Fair Value Measurement at December 31, 2013
	Total			(Level 1)			(Level 2)			(Level 3)
	(in millions)
Investments at Fair Value:
Cash and short term investments	$	106		$	106		$	—		$	—
Equity Securities
U.S. Large-cap⁽¹⁾	303			303			—			—
U.S. Small-cap⁽²⁾	104			104			—			—
International Large-cap⁽³⁾	310			28			282			—
Global	387			65			322			—
Emerging Market	206			—			206			—
U.S. Treasury	716			716			—			—
U.S. Government agency issued or guaranteed	83			9			74			—
Obligations of U.S. states and political subdivisions	70			—			70			—
Asset-backed securities	31			—			11			20
U.S. corporate debt securities⁽⁴⁾	827			—			827			—
Foreign debt securities	279			—			268			11
Other investments	114			—			114			—
Accrued interest	23			6			17			—
Total investments	3,559			1,337			2,191			31
Receivables:
Receivables from sale of investments in process of settlement	106			106			—			—
Derivative financial assets	5			—			5			—
Total receivables	111			106			5			—
Total Assets	3,670			1,443			2,196			31
Derivative financial liabilities	(137		)	(13		)	(124		)	—
Other liabilities	(98		)	(98		)	—			—
Total Liabilities	(235		)	(111		)	(124		)	—
Total Net Assets	$	3,435		$	1,332		$	2,072		$	31



	Fair Value Measurement at December 31, 2012
	Total			(Level 1)			(Level 2)		(Level 3)
	(in millions)
Investments at Fair Value:
Cash and short term investments	$	74		$	74		$	—	$	—
Equity Securities
U.S. Large-cap⁽¹⁾	378			374			4		—
U.S. Small-cap⁽²⁾	109			109			—		—
International Large-Cap⁽³⁾	401			150			251		—
Global	189			53			136		—
Emerging Market	207			—			207		—
U.S. Treasury	829			829			—		—
U.S. Government agency issued or guaranteed	82			7			75		—
Obligations of U.S. states and political subdivisions	70			—			70		—
Asset-backed securities	44			—			1		43
U.S. corporate debt securities⁽⁴⁾	754			—			752		2
Corporate stocks – preferred	4			4			—		—
Foreign debt securities	211			4			186		21
Other investments	103			—			103		—
Accrued interest	20			6			14		—
Total investments	3,475			1,610			1,799		66
Receivables:
Receivables from sale of investments in process of settlement	89			89			—		—
Derivative financial assets	7			—			7		—
Total receivables	96			89			7		—
Total Assets	3,571			1,699			1,806		66
Liabilities	(86		)	(86		)	—		—
Total Net Assets	$	3,485		$	1,613		$	1,806	$	66


⁽¹⁾	This category comprises actively managed enhanced index investments that track the S&P 500 and actively managed U.S. investments that track the Russell 1000.


⁽²⁾	This category comprises actively managed U.S. investments that track the Russell 2000.

⁽³⁾

This category comprises actively managed equity investments in non-U.S. and Canada developed markets that generally track the MSCI EAFE index. MSCI EAFE is an equity market index of 21 developed market countries in Europe, Australia, Asia and the Far East including Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.


⁽⁴⁾	This category represents predominantly investment grade bonds of U.S. issuers from diverse industries.

The following table provides additional detail regarding the rating of our U.S. corporate debt securities at December 31, 2013:



	Level 2		Level 3		Total
	(in millions)
AAA to AA⁽¹⁾	$	104	$	—	$	104
A+ to A-⁽¹⁾	299		—		299
BBB+ to Unrated⁽¹⁾	424		—		424
Total	$	827	$	—	$	827


⁽¹⁾	We obtain ratings on U.S. corporate debt securities from both Moody’s Investor Services and Standard and Poor’s Corporation. In the event the ratings obtained from these agencies differ, the lower of the two ratings is utilized.

Significant Transfers Into/Out of Levels 1 and 2 for Plan Assets There were no significant transfers between Levels 1 and 2 during 2013.

Information on Level 3 Assets and Liabilities The following table summarizes additional information about changes in the fair value of Level 3 assets during 2013 and 2012.



			Total Gains and (Losses) Included in																	Current Period Unrealized Gains (Losses)
	Jan 1, 2013		Income		Other Comp. Income			Purchases		Settlement			Transfers Into Level 3		Transfers Out of Level 3			Dec. 31, 2013		Current Period Unrealized Gains (Losses)
	(in millions)
Asset-backed securities	43		—		(1		)	—		(21		)	—		(1		)	20		4
U.S. corporate debt securities	2		—		—			—		(2		)	—		—			—		—
Foreign debt securities	21		—		—			5		(10		)	—		(5		)	11		—
Total assets	$	66	$	—	$	(1	)	$	5	$	(33	)	$	—	$	(6	)	$	31	$	4



			Total Gains and (Losses) Included in																	Current Period UnrealizedGains (Losses)
	Jan 1, 2012		Income		Other Comp. Income			Purchases		Settlement			Transfers Into Level 3		Transfers Out of Level 3			Dec. 31, 2012		Current Period UnrealizedGains (Losses)
	(in millions)
Obligations of U.S. states and political subdivisions	$	8	$	—	$	—		$	—	$	(1	)	$	—	$	(7	)	$	—	$	—
Asset-backed securities	36		—		3			9		(5		)	—		—			43		4
U.S. corporate debt securities	$	—	$	—	$	—		$	2	$	—		$	—	$	—		$	2	$	—
Foreign debt securities	8		—		(2		)	17		—			—		(2		)	21		1
Total assets	$	52	$	—	$	1		$	28	$	(6	)	$	—	$	(9	)	$	66	$	5

Valuation techniques for Plan Assets Following is a description of valuation methodologies used for significant categories of Plan assets recorded at fair value.

Securities: Fair value of securities is generally determined by a third party valuation source. The pricing services generally source fair value measurements from quoted market prices and if not available, the security is valued based on quotes from similar securities using broker quotes and other information obtained from dealers and market participants. For securities which do not trade in active markets, such as fixed income securities, the pricing services generally utilize various pricing applications, including models, to measure fair value. The pricing applications are based on market convention and use inputs that are derived principally from or corroborated by observable market data by correlation or other means. The following summarizes the valuation methodology used for the major security types of our pension plan assets:

•

Equity securities – Since most of our securities are transacted in active markets, fair value measurements are determined based on quoted prices for the identical security. Equity securities and derivative contracts that are non-exchange traded are primarily investments in common stock funds. The funds permit investors to redeem the ownership interests back to the issuer at end-of-day for the net asset value ("NAV") per share and there are no significant redemption restrictions. Thus the end-of-day NAV is considered observable.


•	U.S. Treasury, U.S. government agency issued or guaranteed and Obligations of U.S. States and political subdivisions – As these securities transact in an active market, the pricing services source fair value measurements from quoted prices for the identical security or quoted prices for similar securities with adjustments as necessary made using observable inputs which are market corroborated.

•

U.S. government sponsored enterprises – For certain government sponsored mortgage-backed securities which transact in an active market, the pricing services source fair value measurements from quoted prices for the identical security or quoted prices for similar securities with adjustments as necessary made using observable inputs which are market corroborated. For government sponsored mortgage-backed securities which do not transact in an active market, fair value is determined using discounted cash flow models and inputs related to interest rates, prepayment speeds, loss curves and market discount rates that would be required by investors in the current market given the specific characteristics and inherent credit risk of the underlying collateral.


•	Asset-backed securities – Fair value is determined using discounted cash flow models and inputs related to interest rates, prepayment speeds, loss curves and market discount rates that would be required by investors in the current market given the specific characteristics and inherent credit risk of the underlying collateral.

•

U.S. corporate and foreign debt securities – For non-callable corporate securities, a credit spread scale is created for each issuer. These spreads are then added to the equivalent maturity U.S. Treasury yield to determine current pricing. Credit spreads are obtained from the new issue market, secondary trading levels and dealer quotes. For securities with early redemption features, an option adjusted spread ("OAS") model is incorporated to adjust the spreads determined above. Additionally, the pricing services will survey the broker/dealer community to obtain relevant trade data including benchmark quotes and updated spreads.


•	Corporate stocks – preferred – In general, fair value for preferred securities is calculated using an appropriate spread over a comparable U.S. Treasury security for each issue. These spreads represent the additional yield required to account for risk including credit, refunding and liquidity. The inputs are derived principally from or corroborated by observable market data.

•

Derivatives – Derivatives are recorded at fair value. Derivatives traded on an exchange are valued using quoted prices. OTC derivatives, which comprise a majority of derivative contract positions, are valued using valuation techniques. The fair value for the majority of our derivative instruments are determined based on internally developed models that utilize independently-sourced market parameters, including interest rate yield curves, option volatilities, and currency rates. For complex or long-dated derivative products where market data is not available, fair value may be affected by the choice of valuation model and the underlying assumptions about, among other things, the timing of cash flows and credit spreads. The fair values of certain structured derivative products are sensitive to unobservable inputs such as default correlations and volatilities. These estimates are susceptible to significant change in future periods as market conditions change.

Projected benefit obligation A reconciliation of beginning and ending balances of the projected benefit obligation of the defined benefit pension plan is shown below and reflects the projected benefit obligation of the merged HSBC North American plan.



	2013			2012
	(in millions)
Projected benefit obligation at beginning of year	$	4,374		$	3,923
Service cost	11			39
Interest cost	176			168
Actuarial losses (gains)	(496		)	453
Benefits paid	(173		)	(209		)
Projected benefit obligation at end of year	$	3,892		$	4,374

The accumulated benefit obligation for the HSBC North America Pension Plan was $3.9 billion and $4.4 billion at December 31, 2013 and 2012, respectively. As the projected benefit obligation and the accumulated benefit obligation relate to the HSBC North America Pension Plan, only a portion of this deficit should be considered our responsibility.

The assumptions used in determining the projected benefit obligation of the HSBC North America Pension Plan at December 31 are as follows:



	2013		2012		2011
Discount rate	4.80	%	3.95	%	4.60	%
Salary increase assumption	*		2.75		2.75

Estimated future benefit payments for the HSBC North America Pension Plan are as follows:



	HSBC North America
	(in millions)
2014	$	179
2015	182
2016	185
2017	188
2018	190
2019-2022	1,007

Defined Contribution Plans We maintain a 401(k) plan covering substantially all employees. Employer contributions to the plan are based on employee contributions. Total expense recognized for this plan was approximately $30 million, $30 million and $32 million in 2013, 2012 and 2011, respectively.

Certain employees are participants in various defined contribution and other non-qualified supplemental retirement plans all of which have been frozen. Total expense recognized for these plans was less than $3 million in each of 2013, 2012 and 2011.

Postretirement Plans Other Than Pensions Our employees also participate in plans which provide medical and life insurance benefits to retirees and eligible dependents. These plans cover substantially all employees who meet certain age and vested service requirements. We have instituted dollar limits on payments under the plans to control the cost of future medical benefits. The following table reflects the components of the net periodic postretirement benefit cost:



Year Ended December 31,	2013		2012		2011
	(in millions)
Service cost – benefits earned during the period	$	1	$	1	$	1
Interest cost	$	2	$	3	4
Amortization of transition obligation	—		2		2
Net periodic postretirement benefit cost	$	3	$	6	$	7

The assumptions used in determining the net periodic postretirement benefit cost for our postretirement benefit plans are as follows:



	2013		2012		2011
Discount rate	3.35	%	4.25	%	4.95	%
Salary increase assumption	2.75		2.75		2.75

A reconciliation of the beginning and ending balances of the accumulated postretirement benefit obligation is as follows:



	2013			2012
	(in millions)
Accumulated benefit obligation at beginning of year	$	70		$	85
Service cost	1			1
Interest cost	2			3
Actuarial losses (gains)	(8		)	(2		)
Plan curtailments	—			(8		)
Benefits paid	(6		)	(9		)
Accumulated benefit obligation at end of year	$	59		$	70

Our postretirement benefit plans are funded on a pay-as-you-go basis. We currently estimate that we will pay benefits of approximately $6 million relating to our postretirement benefit plans in 2014. The funded status of our postretirement benefit plans was a liability of $59 million at December 31, 2013.

Estimated future benefit payments for our postretirement benefit plans are summarized in the following table.



	(in millions)
2014	$	6
2015	6
2016	6
2017	6
2018	6
2019-2022	28

The assumptions used in determining the benefit obligation of our postretirement benefit plans at December 31 are as follows:



	2013		2012
Discount rate	4.35	%	3.35	%
Salary increase assumption	2.75		2.75

For measurement purposes, 7.2 percent (pre-65) and 6.8 percent (post-65) annual rates of increase in the per capita costs of covered health care benefits were assumed for 2013. These rates are assumed to decrease gradually reaching the ultimate rate of 4.5 percent in 2027, and remain at that level thereafter.

Assumed health care cost trend rates have an effect on the amounts reported for health care plans. A one-percentage point change in assumed health care cost trend rates would increase (decrease) service and interest costs and the postretirement benefit obligation as follows:



	One Percent Increase		One Percent Decrease
	(in millions)
Effect on total of service and interest cost components	$	—	$	—
Effect on accumulated postretirement benefit obligation	1		(1		)