FINANCIAL STATEMENTS OF AEGON N.V. 2005 183 Balance sheet 184 Income statement 185 Notes to the financial statements
Report of the Executive Board For the Report of the Executive Board of AEGON N.V. please refer to pages 37-64 of this Annual Report.
Income and shareholders’ equity are expected to be more volatile in the short-term under IFRS than under DAP. Increased volatility is largely accounting driven and is in part a consequence of different valuations of investments and insurance liabilities. However, it is important to take into account that this effect on external reporting does not change the fundamental economic realities or related actual cash flows of AEGON’s business. The way AEGON manages its business will not be altered by these new financial reporting standards.
* AEGON Direct Marketing Services (ADMS) is one of the operating groups of AEGON USA. Please refer to page 67 for more information.
MAIN PRODUCT AREAS Traditional life, life for account of policyholders, accident & health insurance
MAIN DISTRIBUTION CHANNELS Independent advisors, brokers, financial planners, financial institutions www.transamerica.ca
MAIN PRODUCT AREAS Traditional life, life for account of policyholders, pensions, fee business (incl. mutual funds), accident and health insurance, general insurance
AEGON shares are included in a number of the major equity market indices. In addition, AEGON has a variety of debt instruments outstanding in various major currencies.
2. Strategy and governance Pursuing growth and managing our businesses responsibly
contracts during 2005. We expect continued momentum of sales in our group life business, in addition to improved sales to individuals, as a result of new product initiatives.
In the United Kingdom, AEGON UK made considerable progress in growing its independent financial advisor network during 2005. The number of registered individuals affiliated with Positive Solutions has nearly doubled since AEGON’s initial investment in 2002. Further progress was also made in broadening AEGON’s product range in the UK. Growth in annuities, bonds, risk and investment products was encouraging, while AEGON UK’s pension business remained strong. We remain confident about the prospects for continued growth in the evolving UK market.
The Central and Eastern European countries, with a population of over 65 million, where AEGON is now active, offer strong growth potential for life and pension products.
It continues to be our view that pensions represent a key growth driver for our business. Leveraging AEGON’s pension expertise, we formally launched the AEGON Pension Network which has been developed with our French partners at La Mondiale to provide multi-national corporate clients with cross-border solutions. The recent addition of HDI Pensionsmanagement, a leading provider of group pensions in Germany, has added further momentum to this initiative which now covers ten European countries in addition to the United States.
AEGON focuses on the long-term financial protection and asset accumulation needs of its clients, with a primary focus on delivering life insurance, pension, savings and investment products.
AEGON aims to achieve a leading position in its chosen markets in order to realize the benefits of scale.
AEGON pursues organic growth, complemented by growth through selective acquisitions and partnerships, in countries that offer long-term profitable growth opportunities.
companies. Even before reporting our first full set of IFRS results, in addition to comparative 2004 results, we initiated a program to inform our stakeholders about the ramifications of the conversion, and the inevitable volatility that IFRS entails. Throughout the process, we have emphasized the importance of considering other measures in evaluating the underlying performance of AEGON’s businesses around the world.
During the past year, AEGON’s employees around the world again demonstrated their commitment to the communities in which they work and live. The unprecedented tragedies brought about by hurricane disasters in 2005 inspired our employees and agents to respond generously with financial assistance — matched dollar-for-dollar by the AEGON/Transamerica Foundation — and through numerous volunteer efforts. This response followed the support extended by AEGON employees to victims of the Tsunami disaster in early 2005. Contributions were also matched by the AEGON/Transamerica Foundation, as well as by AEGON N.V., and directed to Habitat for Humanity International and the International Red Cross. Once again, AEGON’s employees and our partners made clear their determination to create the possibility of better futures for those most in need.
DONALD J. SHEPARD (1946, American nationality) started his career with Life Investors in 1970. Serving in various management and executive functions with Life Investors, he became executive vicepresident and COO in 1985, a position he held until AEGON consolidated its other United States operations with Life Investors to form AEGON USA in 1989. In 1992, he became a member of the Executive Board of AEGON N.V., and on April 18, 2002, he was appointed chairman of the Executive Board. Mr. Shepard is also a member of the Boards of Directors of Mercantile Bankshares Corp. and CSX Corporation.
RENÉ DAHAN (1941, Dutch nationality) is a retired executive vice-president and director of Exxon Corporation. He was appointed to AEGON’s Supervisory Board in 2004 and his current term will end in 2008. He is also chairman of the Supervisory Board of Royal Ahold N.V., a member of the Supervisory Boards of TNT N.V. and VNU N.V., and a member of the International Advisory Board of the Guggenheim Group. He is currently chairman of the Supervisory Board Compensation Committee and a member of the Supervisory Board Nominating Committee.
TONI REMBE (1936, American nationality) is a retired partner/senior counsel of Pillsbury Winthrop LLP (San Francisco, USA). She was appointed to AEGON’s Supervisory Board in 2000 and her current term will end in 2008. She is also a member of the Board of Directors of AT&T, Inc. (USA). She is currently a member of the Supervisory Board Audit Committee.
AUDIT COMMITTEE Shemaya Levy, chairman Toni Rembe, member Willem F.C. Stevens, member Peter R. Voser, member
COMPENSATION COMMITTEE René Dahan, chairman Willem F.C. Stevens, member Leo M. van Wijk, member
AEGON ANNUAL REPORT 2005 13 2DUDLEY G. EUSTACE O. JOHN OLCAY
Recognizing the increasing importance of economic capital, capital management and effective risk management, the Audit Committee talked about these issues, reviewed the measures that AEGON has implemented, and reported on these to the full Board. The conversion to International Financial Reporting Standards (IFRS) was also examined along with the process initiated by AEGON to ensure compliance starting with the 2005 financial year.
Topics of particular interest to the Supervisory Board included equity lease and ‘Koersplan’ products in the Netherlands as well as regulatory and other legal issues in the USA and in Europe. In accordance with the Sarbanes-Oxley Act (SOX), the Supervisory Board followed the advice of the Audit Committee to adopt the Pre-approval Policy for 2005 that relates to the services of AEGON’s independent auditor, Ernst & Young.
The Supervisory Board relies on its four committees, each made up of members selected from the Supervisory Board, to prepare specific issues for decision-making by the Board. In accordance with its Charter, each Committee reports its findings to the Supervisory Board during a subsequent Supervisory Board meeting.
The Audit Committee held seven regular meetings during 2005, which also were attended by the CFO, the director of Group Finance, and representatives of Ernst & Young. The chairman of the Executive Board, the Group Internal Auditor and the Group Actuary also periodically attended Audit Committee meetings. Discussions regarding the following dominated the meetings permanent agenda: the quarterly results; the annual accounts and the auditing of those by Ernst & Young; actuarial analyses; accounting principles according to IFRS and US-GAAP; financial reports as filed with the SEC; AEGON’s Capital Plan; reports on currency exposure; internal control systems; as well as risk management and Ernst & Young’s reports on independence, their fees and the Audit Plan for 2005. The Audit Committee advised the Supervisory Board to recommend to shareholders that Ernst & Young be reappointed as the independent auditor for the financial year 2005. The Audit Committee also discussed the consequences of SOX and the Dutch Corporate Governance Code, as well as the role of the independent auditors. The Audit Committee confirmed that Mr. Levy and Mr. Voser qualify as financial experts within the meaning of the relevant provisions of SOX and the Dutch Corporate Governance Code. In accordance with legal requirements, the Audit Committee approved and recommended to the Supervisory Board the adoption of the Preapproval Policy for 2005. Two meetings, in March 2005 and September 2005, were devoted to AEGON’s filings with the SEC, the annual report 2004 (Form 20-F), and the results for the first six months 2005 (Form 6-K).
As required by the Audit Committee Charter, the proceedings of the meetings of the Audit Committee were reported to the Supervisory Board, and these minutes were a regular item on the agenda of the Supervisory Board meetings.
The Strategy Committee held two meetings in 2005, which were also attended by the Executive Board members. The purpose of the Strategy Committee is to review the major features of AEGON’s business strategy, in addition to considering alternative strategies and material aspects relating to the implementation of the strategy. The Strategy Committee discussed AEGON’s business strategy and prepared a framework for the agenda for the Supervisory Board meeting held in Cedar Rapids, Iowa, USA, in June 2005.
The Compensation Committee held three meetings in 2005, which were attended by the Executive Board’s chairman. Following the implementation of the Dutch Corporate Governance Code, the Compensation Committee reviewed the employment agreements of the Executive Board members and subsequently advised the Supervisory Board on those. The full text of those employment agreements is available on AEGON’s corporate website. The Compensation Committee also discussed the Executive Board’s Short-term and Long-term Incentive Plans and advised the Supervisory Board on those incentives payable in 2005. Moreover, the Compensation Committee decided to prepare a new Remuneration Policy for the Executive Board during 2006. The proceedings of the Compensation Committee meetings were reported during subsequent Supervisory Board meetings.
In 2005, the four-year terms of office for Messrs. Eustace, Stevens and Tabaksblat expired. The Supervisory Board nominated Messrs. Eustace and Stevens for reappointment for another term, and they were subsequently reappointed by shareholders during the AGM in 2005. In compliance with the Dutch Corporate Governance Code, Mr. Tabaksblat was not eligible for reappointment and stepped down at the end of the AGM in 2005. The Supervisory Board is very grateful for his distinguished fifteen years of membership and five years of chairmanship.
The Supervisory Board appointed Mr. Eustace as chairman (succeeding Mr. Tabaksblat) and Mr. Olcay as vice-chairman (succeeding Mr. Eustace).
In 2006, Mr. Storm’s four-year term of office will expire. He is eligible for reappointment and the Supervisory Board, upon the advice of the Nominating Committee, has decided to nominate him for reappointment for another term by shareholders during the AGM in 2006.
In compliance with the Dutch Corporate Governance Code, the members of the Executive Board are appointed for a term of four years, subject to possible reappointment by the AGM. According to the schedule (which has been posted on AEGON’s corporate website), the terms of office for Messrs. Shepard and Streppel expired in 2005. The Supervisory Board, following the advice of the Nominating Committee, nominated them for reappointment, and they were subsequently reappointed during the AGM in 2005 for another four-year term.
This annual report includes the annual accounts for 2005, which were deliberated upon and proposed by the Audit Committee and the Supervisory Board and subsequently submitted by the Executive Board. The Supervisory Board recommends that shareholders adopt these accounts. A total dividend for 2005 of EUR 0.45 per common share is proposed. This entails a proposed final dividend payment of EUR 0.23 per common share since an interim dividend payment of EUR 0.22 per common share was made in September 2005.
In the United Kingdom, we have strengthened our distribution capability through Positive Solutions, our independent financial advisor network. This past year, we accelerated our 100% acquisition of Positive Solutions to take fuller advantage of the opportunities in the UK market. While maintaining AEGON’s leading position in the UK pensions market is our primary goal, we have also expanded AEGON’s product offering to include annuities, risk and investment products.
In the United States, there is an increasing demand for a broader menu of investment, protection and dissavings products as individuals face the prospect of managing their assets for a longer period of time during retirement. We intend to strengthen AEGON’s leading position in the US retirement market by assisting customers to better manage the drawdown of their accumulated assets over time and even make provisions for wealth transfer to second and third generations. We continue to see opportunity in serving the middle-income market with needspecific life protection and asset accumulation products, and also see good growth potential for our reinsurance business in light of the consolidation that has occurred in recent years. AEGON Direct Marketing Services continues to be a very effective and efficient means for entering new markets. The business model has proven successful in a number of international markets and will, no doubt, provide us further opportunities in the future. Finally, our professional agent channel network is a core strength for AEGON in the US market given the increasing need for valueadded, sound financial advice.
It is for this reason that we have moved to greater centralization in certain areas, such as risk management, our capital management and compliance programs. We have taken these steps not only because they are necessary in today’s environment, but also because they will contribute to ensuring long-term confidence in AEGON’s businesses and the sustained trust of our many stakeholders.
This is the first year that AEGON is reporting under IFRS — what have been the implications for the company and do you expect any further accounting changes? The transition from Dutch accounting principles to IFRS was an accounting change on an unprecedented scale. Fortunately, AEGON was well prepared for this change and through the hard work of everyone involved, the transition at AEGON has been executed successfully. From the very start, we have viewed the adoption of IFRS as a major project that would require proactive communication about the possible implications. We have been informing our investors, analysts and the media of the changes and been as open and transparent as possible in explaining the differences between the old and the new system. As IFRS and the interpretation of rules continue to be refined, we will endeavor to continue to explain the impact on how we report our results. As was visible in the quarterly results that we have published in 2005, IFRS has and will continue to lead to an increase in the volatility of our reported results, but it didn’t change the underlying economics of our business. Until we go to the second phase of insurance accounting under IFRS, which we hope will be finalized before 2009, this is something that we will have to learn to live with. Of course, we will continue to do our best in explaining what is driving our results. Ultimately, we believe that the harmonization of accounting standards can lead to greater comparability of results across companies, which AEGON strongly supports.
How strong is AEGON’s current capital position and has it changed over the past year? AEGON is in a very strong and sound financial position. We started the year with a strong capital base and finished it even stronger. The insurance companies in each of our major markets retained their solid AA financial strength ratios, while the capital ratios at the holding company level improved further. At the end of 2005, shareholders’ equity accounted for 76% of our total capital base, compared to 72% at the end of 2004, while group equity amounted to 89% of total capital at the end of 2005. Under IFRS accounting rules, the composition of reported equity has changed and will be subject to higher volatility. AEGON will monitor its capital ratios under IFRS, and review the definitions to remain consistent with our historical tolerances, to ensure continued strong capitalization. Over the past year, we have completed two successful offerings of perpetual capital securities, which strengthened the capital base in a non-dilutive and cost effective manner. The proceeds of these issues have largely been used to repay senior and perpetual subordinated debt. Our strong capital position and good cash flows have enabled us to raise the total dividend by 7% to EUR 0.45 per share.
In 2005, AEGON The Netherlands has renewed and improved its products and services for the immediate annuity and mortgage markets. We are intent on growing our market share in these markets with renewed efforts and profitable products.
In addition to our focused approach, AEGON’s distinct advantage is the distribution model we have implemented.
AEGON, as a leading pension provider in the United States and Europe, has been able to transfer its knowledge and experience to develop pension businesses in new countries, such as Slovakia. As demographic trends continue, this will prove a distinct competitive advantage for AEGON. We rely on strong partners at the local level, as we have in Spain with our bank partners, to maximize the opportunities that we see. This is an approach that enables us to benefit from a broader range of resources and knowledge to respond more efficiently to the growth opportunity within AEGON’s developing markets.
The AEGON Pension Network will leverage the expertise of AEGON The Netherlands, Scottish Equitable, Diversified Investment Advisors, La Mondiale, and our newest partner, HDI Pensionsmanagement AG in Germany to provide simplification and flexibility to pension systems.
AEGON’s multi-channel distribution strategy is one of the company’s key competitive strengths. What have you done over the past year to strengthen the distribution capabilities further? In 2005, AEGON strengthened its distribution capabilities in both its major and its developing markets. In the United Kingdom, for instance, we accelerated the acquisition of the remaining 40% of Positive Solutions, our independent financial advisor platform that continues to experience a strong increase in the number of registered individuals joining the network. In addition, we are closely connected with a number of the large multi-tie distribution platforms and believe that we are well-positioned to benefit in the new environment following depolarization in the United Kingdom. In the United States, we have strengthened our distribution relationships with a number of key bank partners, continued to recruit new life agents and expand our wholesaling force in the broker-dealer and wirehouse channels.
A good example is our life reinsurance business, which is achieving strong growth as a result of decreasing capacity, increasing rates, tighter underwriting standards and resulting market disruption. We think that life reinsurance will continue to outpace other products for several more years and our returns in that business help offset higher reinsurance costs that we have endured as a direct carrier.
How is AEGON USA positioning itself to service the changing needs of the growing number of people moving into the postretirement phase? AEGON USA formed a new division called Transamerica Retirement Management, which will focus on those individuals nearing or at retirement, and provide those individuals for the rest of their lives. Many of the products needed at this stage of life have already been developed within AEGON USA.
A second example is our pension business, where we have more than USD 60 billion in retirement assets under management and a top five position in pensions among life insurance companies. Demographic trends remain compelling as individuals become increasingly aware that more of the retirement burden is being shifted to the individual and away from government-provided and employer-pay-all plans. As a result we view the retirement market as a key driver of profitable growth.
Given recent developments in the industry, what is the future of the pension business in the United Kingdom? Pensions are assuming a central position in political debate in the United Kingdom. This, of course, leads to an increased awareness on the part of individuals of the need to save more during their working life to help fund their lifestyle in retirement. The Turner report, published in late 2005, heightened the discussion and highlighted many of the key considerations that will be the subject of further debate in 2006.
There are, of course, already very large amounts of accumulated pension assets and we see some exciting opportunities arising from that. For instance, we see continued pressure on companies which provide ‘final salary scheme’ pension arrangements for their employees, thus creating additional opportunities for the insured pension sector.
The distribution landscape in the United Kingdom has changed significantly following depolarization. How is AEGON UK positioned? Regardless of the regulatory landscape, we regard the role of advisers as crucial in the process of assisting customers choose the best products for their retirement needs.
There have been two major impacts of depolarization to date: first, many distributors that were previously tied to a single life insurer have broadened the range of insurers whose products they sell; second, some independent financial advisors (IFAs) have set up multi-tie operations within their business model.
Although there has been much speculation on the impact of multi-tie business models on distributors who were previously IFAs, there has been a limited volume of business transacted through such businesses, most of which has been related to products specific to the mortgage market. We do participate in such arrangements where we think there are clear opportunities to transact profitable business. Of course, this means being vigilant and ready to react if developments in the market necessitate taking a different course.
Diversifying AEGON UK’s product offering has involved establishing our offshore business, building on the risk product expertise which we acquired in the Guardian businesses and, more recently, moving into the annuity and investment product markets. This diversification also allows us to assume different types of risk, while continuing to rely on our strong balance sheet and capital resources of the parent company.
Given the very competitive nature of the UK market, what are the key strengths of AEGON UK to ensure it remains one of the leading players in the industry? Clearly, AEGON UK has a number of strengths which set it apart and ensure its competitive advantage going forward. Our expertise in the corporate and individuals pensions markets is a notable strength. We have taken steps to grow our position in other markets that we believe afford AEGON UK additional and significant profitable opportunities. We have maintained our clear focus on pursuing profitable business, consistent with the strategy for the AEGON Group as a whole. Furthermore, we own one of the largest and most profitable distribution businesses in the UK. We have also taken the lead in developing the use of technology in our manufacturing and distribution businesses.
A General Meeting of Shareholders is held at least once a year to discuss and decide on matters such as the adoption of the annual accounts and the approval of dividends and any appointments to the Executive and Supervisory Boards. Meetings are convened by public notice.
Extraordinary General Meetings of Shareholders may be convened by the Supervisory Board or the Executive Board whenever they are deemed necessary. In accordance with the Articles of Incorporation, requests will generally be honored to add topics to the agenda of a General Meeting of Shareholders when supported by shareholders representing at least 0.1% of the issued common shares.
At the General Meeting of Shareholders, each share is entitled to one vote. However, the holder of preferred shares, Vereniging AEGON, is entitled to cast 2.08 votes per preferred share in the event that Vereniging AEGON, in its sole discretion, has determined that a ‘special cause’ has occurred. Each ‘special cause’ is then limited to a period of six months. Reference to Vereniging AEGON is made on page 193 of this annual report’s financial statements.
At the General Meeting of Shareholders, an absolute majority of the valid votes adopts all resolutions unless a greater majority is required by law or by the Articles of Incorporation.
AEGON endorses the code and the principles of good corporate governance included therein. AEGON has welcomed the guidance given by the Monitoring Committee Corporate Governance.
This chapter is intended to outline AEGON’s compliance with the code as of the end of 2005. The circumstances in which AEGON does not fully comply with the code are explained.
In accordance with AEGON past practice, the Executive Board will submit the company’s operational and financial objectives along with the strategy to achieve stated goals to the Supervisory Board for its consideration and approval. The outlined objectives and strategy will include detailed parameters to be applied in relation to the strategy, such as the company’s financial ratios and capital adequacy levels. A summary of these plans will continue to form part of AEGON’s annual reports.
None of the members of AEGON’s Executive Board is a member of the Supervisory Board of two or more Dutch-listed companies nor is a chairman of the Supervisory Board of a Dutch-listed company. The Executive Board Rules, as posted on AEGON’s website www.aegon.com, provide that any prospective appointment of an AEGON Executive Board member to a supervisory or non-executive director role in another Dutch-listed company is subject to prior approval from AEGON’s Supervisory Board. Moreover, the Executive Board Rules state that Executive Board members intending to accept any other significant professional position will notify the Supervisory Board prior to acceptance of such position.
AEGON’s Remuneration Policy was adopted by the General Meeting of Shareholders on April 22, 2004 and will be in place for a period of three years (2004-2006). The Supervisory Board will propose to extend the duration of the existing Remuneration Policy until the annual General Meeting of Shareholders in 2007. AEGON places a high importance on attracting and retaining qualified directors and personnel, while at the same time safeguarding and promoting the company’s medium and longterm interests. The Remuneration Policy for members of the Executive Board is reflective of these objectives. It was designed to support AEGON’s strategy of value creation and shareholder alignment, in addition to establishing standards for evaluating performance and business results. The Remuneration Policy also offers an incentive for Board members with performance-linked pay, reflecting both individual member and collective Executive Board performance. Moreover, the Remuneration Policy takes into consideration corporate governance guidelines and compensation levels in relevant reference markets.
Any performance shares granted must be retained for a period of at least five years from the date of the grant or at least until the end of employment, if the latter period is shorter.
The Supervisory Board has decided that it will amend the Remuneration Policy with regard to severance payments owed to new members of the Executive Board. Changes will include setting a maximum severance payment in the event of termination, limited to the fixed component of the particular member’s salary for one year, or two years in cases where a maximum of one year’s salary would be manifestly unreasonable for a Board member who is dismissed in his or her first term of office. The Supervisory Board has agreed with the current members of the Executive Board not to amend the existing severance payment arrangements that apply to them in order to respect the existing employment agreements and in consideration of varying employment conditions in the United States and the Netherlands. The employment agreements of the members of the Executive Board can be found on AEGON’s website www.aegon.com.
As consistently disclosed in AEGON’s annual reports, members of the Executive Board of AEGON are entitled to mortgage loans provided by AEGON in the normal course of its business and under the terms applicable to personnel as a whole. Such loans to Board members are subject to the prior approval of the Supervisory Board.
In AEGON’s annual accounts, the value of options and share appreciation rights, if any, granted to the Executive Board and personnel shall be recognized with an indication as to how the value is determined.
AEGON’s Code of Conduct is a code of ethics that addresses conflicts of interest that may occur between AEGON and its employees, including the members of the Executive Board. The Code of Conduct is available on AEGON’s website www.aegon.com.
AEGON has detailed regulations applicable to members of the Executive Board and the Supervisory Board concerning the ownership of and transactions in securities, other than AEGON shares. These regulations are in conformity with the regulations prescribed by the Dutch regulators and have been further refined in light of the more detailed best practice provisions of the Dutch Corporate Governance Code. Compliance with these regulations is supervised by the Group Compliance Officer, who acts alongside compliance officers appointed by country units and the business units. The regulations applicable to members of the Executive Board and the Supervisory Board are posted on AEGON’s website www.aegon.com.
The Supervisory Board shall continue its existing practice of including a detailed account of its activities during the financial year in each annual report. The activity report includes the information prescribed in the Dutch Corporate Governance Code. It also makes reference to the topics discussed within the Supervisory Board meetings during the year.
However, in 2005, the Supervisory Board decided to request that Mr. Olcay complete his current term in office despite the fact that he has served more than the maximum terms allowed by the Code. The Supervisory Board has determined that in the interest of continuity given the high number of vacancies recently filled and yet to be filled, it was prudent to request Mr. Olcay to serve on the Supervisory Board until the end of his current term in office.
Moreover, the Supervisory Board Rules provide that a member of the Supervisory Board shall resign if the Supervisory Board has determined that this member is no longer fit to function due to inadequate performance, fundamental differences of opinion, or other impeding circumstances.
In compliance with the applicable provisions of the United States’ Sarbanes-Oxley Act 2002 and the Dutch Corporate Governance Code, the Supervisory Board maintains four standing committees that are comprised of its members. These committees are: the Audit Committee, the Compensation Committee, the Nominating Committee, and the Strategy Committee. Each Committee reports its findings to the Supervisory Board and these findings are discussed in the plenary meetings of the Supervisory Board.
The Audit Committee is appointed by the Supervisory Board to assist the Supervisory Board in monitoring (1) the integrity of AEGON’s financial statements, (2) the independent auditor’s qualifications and independence, (3) the performance of AEGON’s internal audit performance and that of the independent auditor, (4) AEGON’s compliance with legal and regulatory requirements, and (5) AEGON’s finances and the company’s finance related strategies. The Audit Committee is chaired by Mr. Levy. The Audit Committee has determined that its group, which includes one financial expert, satisfies the criteria of independence specified by the New York Stock Exchange, the provisions of the Dutch Corporate Governance Code, and the United States Sarbanes-Oxley Act. The Executive Board members, the director of Group Finance, the Internal Auditor and the independent auditor periodically attended the meetings of the Audit Committee. In addition, at least once a year, or more often if necessary, the Audit Committee meets with the independent auditor without the presence of the Executive Board members.
The Strategy Committee is responsible for reviewing the major features of the strategy proposed by the Executive Board and preparing the presentation of the strategy for the Supervisory Board. The Strategy Committee also considers strategy options and alternatives in addition to considering the material aspects related to the implementation of the agreed strategy. Finally, the Strategy Committee acts as a consultative body for the Executive Board with its strategy development. The Strategy Committee is chaired by Mr. Eustace.
The remuneration of Supervisory Board members is determined by the General Meeting of Shareholders and is not dependent on AEGON’s profit. The members of the Supervisory Board do not receive any shares or rights to shares by way of remuneration. Members of the Supervisory Board are not eligible to receive any personal loans, guarantees, or similar benefits.
The Supervisory Board and Executive Board welcome increased shareholder participation. At the 2005 annual General Meeting of Shareholders it was an amendment to the Articles of Incorporation that has been adopted require certain Executive Board resolutions to be subject to the approval of the General Meeting of Shareholders, namely those entailing significant changes to the identity or character of AEGON or its business.
Currently, Vereniging AEGON holds 23,850,000 preferred shares class B, representing approximately 1.3% of voting shares under normal circumstances. The 1983 Merger Agreement (as amended) provides that additional preferred shares class B are to be issued by AEGON to Vereniging AEGON at the option of Vereniging AEGON in order to prevent Vereniging AEGON’s voting power from being diluted as a result of issuances of common shares. In addition, AEGON and Vereniging AEGON have entered into a preferred shares voting rights agreement. Pursuant to this agreement, voting power attached to the preferred shares classes A and B is, under normal circumstances, limited to one vote per share. The preferred shares voting rights agreement allows Vereniging AEGON to exercise the full voting power on its preferred shares (approximately 2.08 votes per preferred share) in the event of a special cause (as defined in the preferred shares voting rights agreement) for up to six months.
As a result of the foregoing and certain qualified majorities specified in AEGON’s Articles of Incorporation, in the event of a special cause (as referred to above), for a period of six months Vereniging AEGON may effectively be in a position to temporarily block any unfriendly actions by a hostile bidder or others. The Supervisory and Executive Boards take the view that this arrangement is in accordance with the principles that the Dutch Corporate Governance Committee has recommended to the legislature and which should be taken into consideration when drafting a law on anti-takeover measures.
AEGON’s Articles of Incorporation provide that the General Meeting of Shareholders may cancel the binding character of binding nominations for the appointment of new members to the Supervisory Board and the Executive Board with a majority of two-thirds of the votes cast representing at least one-half of the issued capital. In addition, members of the Executive Board and members of the Supervisory Board can only be dismissed by the General Meeting of Shareholders with the same qualified majority (except if proposed by the Supervisory Board). These provisions were included at the time of the overall review of AEGON’s corporate governance and were adopted at the extraordinary General Meeting of Shareholders on May 9, 2003. This qualified majority requirement was included in order to give AEGON a temporary protection against unfriendly actions by a hostile bidder, for example. Effectively, these provisions provide Vereniging AEGON a period of six months during which time it can block any unfriendly attempts to replace the Supervisory Board and the Executive Board.
Release from liability of the members of the Executive Board for their management and of the members of the Supervisory Board for their supervision will be separately voted upon in the annual General Meeting of Shareholders.
All communications and filings are supervised by the Disclosure Committee instituted by AEGON in compliance with the United States’ Sarbanes-Oxley legislation. These communications and filings are made available on AEGON’s website www.aegon.com.
AEGON refrains from any actions that may jeopardize the independence of analysts in relation to the company. Other than factually, analysts’ reports and valuations (including earnings estimates) are not assessed, commented upon or corrected by
As a general rule, the report of the General Meeting of Shareholders shall be made available, upon request, to the shareholders no later than three months after the meeting. Shareholders are given three months to react to the report prior to its adoption in accordance with the Articles of Incorporation. Such reaction is channeled through the chairman of the General Meeting of Shareholders and the secretary appointed by the chairman for that purpose. The report is posted on AEGON’s website www.aegon.com.
In addition to AEGON’s responsibility to its shareholders and other stakeholders, the company also is an institutional investor. As such, in deciding whether to exercise its rights as a shareholder of other listed companies, AEGON acts primarily in the interest of its policyholders and other ultimate beneficiaries of its products while also honoring the responsibility to the ultimate beneficiaries and investors in the companies in which it has invested.
AEGON, on a ongoing basis, reviews its internal procedures relating to the composition, preparation, and publication of its financial reporting. The Executive Board has instituted procedures aimed at ensuring that major financial information is delivered to the Executive Board in an orderly and timely fashion. The Executive Board receives the financial information from the country units directly. The Supervisory Board, acting primarily through the Audit Committee, supervises the compliance with these internal procedures and the external information. Specific regulations dealing with the internal control function have been documented in the Audit Committee Charter and accompanying attachments.
The independent auditor is appointed annually by the shareholders at the annual General Meeting of Shareholders. The shareholders will be given the opportunity to question the independent auditor at the General Meeting of Shareholders in relation to his or her statement on the fairness of the annual accounts.
At least every four years the Audit Committee and the Supervisory Board conduct a thorough assessment of the functioning of the independent auditor. The findings of this assessment will be shared with the General Meeting of Shareholders for the purposes of its deliberations on the annual appointment of the independent auditor.
AEGON has an internal auditor on Group level who reports directly to the Executive Board. This is in addition to the internal auditors that have been appointed on the level of AEGON’s country units. The work schedule for the Group Internal Auditor was determined with the involvement of the Audit Committee and the independent auditor. The findings of the internal auditor are made available to the Executive Board, the Audit Committee as well as the independent auditor.
The Supervisory Board meets with the independent auditor at least once a year on the occasion of the discussion of the annual accounts that are to be submitted for adoption to the General Meeting of Shareholders. As part of standing procedures, the independent auditor receives the information underlying the annual accounts and the quarterly figures and is given ample opportunity to respond to all information.
From the foregoing it follows that AEGON complies with the principles of the Dutch Corporate Governance Code. Moreover, AEGON generally also applies the best practice provisions of the Code. Where AEGON does not apply the best practice provisions, the reasons have been stated at the appropriate places. In those limited cases where AEGON does not apply the best practice provisions, AEGON follows the spirit of the Dutch Corporate Governance Code as much as possible. In summary: • II.2.7: this best practice provision provides that the maximum remuneration in the event of dismissal is one-year’s salary. AEGON will apply this best practice provision to any future appointments to the Executive Board. The existing employment agreements with the current members of the Executive Board, and more in particular the severance arrangements to which current members of the Executive Board are entitled, are not in line with this best practice provision.
• III.3.5: this best practice provision provides that a person may be appointed to the Supervisory Board for a maximum of three four-year terms. The Supervisory Board has asked Mr. Olcay to complete his current term, thus exceeding the maximum stated in the code;.
At AEGON, Corporate Responsibility (CR) is an integral part of the work culture. It ensures that AEGON is operating its business according to its core values of respect, quality, transparency, and trust as defined in its Code of Conduct. CR also makes sure that AEGON is responsible for the benefit of all of its stakeholders: customers, employees, shareholders, business partners, and communities.
AEGON’s Executive Board recognizes the importance of CR. Johan van der Werf, as a member of the AEGON N.V. Executive Board and CEO of AEGON The Netherlands, is responsible for CR at the Group level, including all social and environmental issues.
AEGON ensures its CR activities are aligned to its business strategy and to the issues most relevant to its business. Therefore, in addition to living its core values, AEGON will increasingly focus on matters like corporate governance, risk management, compliance, and workplace issues like ‘health and safety’ and ‘training and development’. Moreover, AEGON takes into account some of the most commonly accepted CR measurements including Global Reporting Indicators (GRI).
The Compensation Committee, one of the four committees of the Supervisory Board, is responsible for the design, development, implementation, and review of the Remuneration Policy. This policy outlines the terms and conditions of Executive Board member employment and the remuneration of Supervisory Board members. The Compensation Committee makes its recommendations to the Supervisory Board.
The remuneration of the members of the Supervisory Board is made up of a base compensation and a compensation relating to committee membership and meetings. The members of the Supervisory Board do not receive any performance or equityrelated compensation and do not accrue any pension rights with AEGON. The compensation of Supervisory Board members is reviewed every three years. Any change in the compensation will be submitted to the shareholders for adoption.
Mr. Streppel would be entitled to compensation according to the ‘Zwartkruis formula’, which means that the severance payment would be calculated on the basis of and depending on age, years of service, functional level, and the probability of finding an equivalent position. Messrs. Van der Werf and Wynaendts would be entitled to three years’ fixed salary, only in the case of termination in connection with a merger or takeover.
The remuneration of Executive Board members comprises the following components: a base salary, variable compensation in the form of a Short-term Incentive Plan (STI Plan) and a Longterm Incentive Plan (LTI Plan), pension arrangements and other arrangements.
Base salary levels are set to reflect the requirements and responsibilities of an Executive Board position. The Compensation Committee will ensure that base salary levels are realistic and competitive, taking into account individual roles and responsibilities of the Executive Board members and considering benchmark information provided by independent external advisors.
Members of the Executive Board are eligible to participate in the Short-term Incentive (STI) Plan that provides for an annual cash bonus for the achievement of previously determined targets that reflect their respective individual responsibilities.
The achievable STI bonus levels vary between the members of the Executive Board due to differences in their responsibilities and base salary. Whilst the base salary of Messrs. Van der Werf and Wynaendts is lower than that of Mr. Streppel, their achievable bonuses are higher, reflecting their role as value drivers for AEGON.
Actual OE equals or is higher than 150% of target OE Actual OE equals (maximum STI target OE Plan bonus)
The STI Plan determines that a bonus will be paid only if a positive value of new business (VNB), as publicly disclosed, is realized. This measure was chosen because it reflects AEGON’s commitment towards profitable growth. A specific area of responsibility has been determined for which VNB will be taken into account for each member of the Executive Board.
Shepard Group: determines 100% of STI bonus Streppel Group: determines 100% of STI bonus Van der Werf Group: determines 40% of STI bonus country unit(s) under his responsibility: determine 60% of STI bonus
Wynaendts Group: determines 40% of STI bonus country unit(s) under his responsibility: determine 60% of STI bonus
Additionally, Mr. Shepard is entitled to a cash bonus equal to 0.1% of AEGON’s net income for the corresponding year.
Each year, the value (amount) of the grant is determined and the related number of shares and options are granted. After three financial years, starting with the grant year, vesting of the granted shares and options is subject to AEGON’s TSR performance relative to that of a select peer group. This peer group comprises companies that are comparable in type of business, size, geographical presence, and that are generally recognized as the most appropriate reference group. The group consists of Allianz, Aviva, AXA, Fortis, Generali, ING, JeffersonPilot, John Hancock Life Insurance, Lincoln National, Nationwide FS Inc., and Prudential PLC.
During the three-year grant period, the TSR data are compiled by the Compensation Committee based on information from an independent outside advisor (Towers Perrin). After the grant period, the Compensation Committee will advise the Supervisory Board on the percentage of the LTI grant to be vested.
Pension arrangements are based on a retirement age of 62. Mr. Shepard’s benefits would be based on 55% of his ‘final average earnings’ calculation (his five highest complete and consecutive calendar years of pensionable earnings). For Messrs. Streppel, Van der Werf and Wynaendts, their benefits are 70% of their final salary, provided 37 years of service.
Chairman 60,000 Vice-chairman 50,000 Member 40,000 2. FEE PER ANNUM FOR MEMBERSHIP OF A COMMITTEE
The base salaries of the Executive Board members were not changed in 2005, save the adaptation in accordance with the general salary rounds applicable to AEGON employees in the Netherlands, as stipulated in the employment contracts with the Dutch Executive Board members.
Shepard USD 1,000,000 Streppel EUR 679,000 Van der Werf EUR 575,000 Wynaendts EUR 575,000 1 Base salary including increase due to Dutch collective labor agreement, the customary employee profit sharing bonus as well as a tax deferred employee savings scheme.
Van der Werf 109% 98% 552,237 1 OE per area of responsibility has been established as explained in the Remuneration
The STI bonuses for the 2005 Plan, as well as Mr. Shepard’s additional STI bonus, will be paid in 2006, after adoption of the 2005 annual accounts by shareholders.
Target LTI value (% of Number of Number base pay) EUR shares of options 1 LTI target bonus amounts have been calculated from base salaries as per 2 Calculation example Mr. Shepard: Vesting of these rights will take place after three years, in accordance with the aforementioned LTI vesting schedule. The announcement of two mergers caused the Compensation Committee to review the LTI peer group in 2005. The Compensation Committee proposed, and the Supervisory Board subsequently approved, that John Hancock Life Insurance and Jefferson-Pilot be replaced by Prudential Financial Inc. and Metlife Inc. This change is expected to have a minor impact on the probability of AEGON reaching a certain ranking within the peer group.
Due to new regulations in the Netherlands, additional arrangements were required to ensure that existing agreements would not be affected. The Compensation Committee suggested, and the Supervisory Board agreed to harmonize the individual pension agreements for Messrs. Van der Werf and Wynaendts with the new Dutch VPL law (Wet Vut Prepensioen en Levensloop), and to also reconcile the pension plan for Dutch Executive Board members with these regulations as from January 2006. Mr. Shepard is exempted from these new regulations since he is under an AEGON USA Pension Plan. As the new law allows to exempt employees who have reached the age of 56 or above as per December 31, 2005, Mr. Streppel will also not be affected.
As from August 2005, Mr. Wynaendts has been seconded temporarily to AEGON USA. In determining the specific provisions of the secondment, AEGON has engaged independent advisors to advise that the arrangements are customary. The Compensation Committee has reviewed and approved these provisions.
The Remuneration Policy and Report 2005 will be posted on the company website, www.aegon.com.
3. Report of the Executive Board A comprehensive account of AEGON’s performance in 2005.
Institutional guaranteed products 280 367 (24) Fee — off balance sheet products 33 36 (8)
REVENUES GEOGRAPHICALLY 2005 Holdings, other The United Other activities and in million EUR Americas Netherlands Kingdom countries eliminations Total
Total life insurance gross premiums 6,629 3,021 5,152 1,277 — 16,079 Accident and health insurance premiums 1,972 191 — 67 — 2,230 General insurance premiums — 443 — 130 — 573
In the Netherlands, the improved organization reported a 64% increase in operating earnings for the year. Leveraging its leading position in the group pension market, AEGON The Netherlands was successful in capturing several large contracts. The Dutch organization focused on maximizing opportunities. For instance, to date, AEGON The Netherlands signed approximately 775 life cycle (Levensloop) contracts with employers and 2,250 group disability contracts. Looking ahead, AEGON The Netherlands expects continued momentum of sales in the group business, as well as improved sales to individuals driven by new product initiatives in the intermediary channel.
AEGON UK had a good year with a 32% increase in operating earnings before costs associated with the accelerated acquisition of Positive Solutions, AEGON UK’s independent financial advisor network, in 2005. AEGON UK has successfully introduced a broader range of non-pension products in the UK market, which resulted in over 30% of new business coming from annuities, bonds and protection products in 2005. Moreover, AEGON UK is in a good position to both drive and benefit from developments in the distribution market. The number of registered individuals affiliated with Positive Solutions has more than doubled since the initial investment in the company in late 2002. AEGON UK regards this as key to ensuring its position in the UK market as further reforms are implemented and the distribution environment becomes more competitive.
Elsewhere in Europe, AEGON divested its general insurance business in Spain and focused its efforts on establishing life insurance partnerships with savings banks. The partnership with Caja de Ahorros del Mediterráneo achieved a 27% increase in recurring premiums during the year. AEGON established also two new bancassurance joint ventures in 2005 with Caja de Badajoz and Caja Navarra. AEGON Spain’s life products will soon be sold in over 1,500 branches across the country. AEGON Spain will be looking at opportunities to expand this network given the dominant role of banks in the Spanish life and pensions market.
AEGON continues to see pensions as a key growth driver for its business. Leveraging AEGON’s pension expertise, AEGON formally launched the AEGON Pension Network, which has been developed with its French partners at La Mondiale to provide multinational corporate clients cross-border solutions. The recent addition of HDI Pensionsmanagement, a leading provider of group pensions in Germany, has added further momentum to this initiative, which now covers ten European countries as well as the United States
Finally, AEGON’s operations in Asia also grew during 2005. In Taiwan, new life sales increased 58% following especially strong sales in the first half of the year. Although recurring traditional life business continued to be the main driver of growth, increased efforts to sell unit-linked products led to encouraging results in the fourth quarter.
AEGON continues to benefit from strong capitalization in all its country units. The year 2005 was especially good in terms of capital formation and cash flows. Shareholders’ equity at December 3 1, 2005 was EUR 1 9.3 billion, an increase of 30% compared to year end 2004. In 2005, AEGON further strengthened the quality of its capital base by replacing senior debt and perpetual subordinated bonds with perpetual capital securities. Group equity, which includes shareholders’ equity and other equity instruments, represented 89% of the total capital base at the end of December. Due to AEGON’s strengthened capital position and good cash flows, AEGON has raised the final dividend by 10% to EUR 0.23 per common share, bringing the total 2005 dividend to EUR 0.45 per common share, a 7% increase over 2004.
Non-operating earnings, which includes gains/(losses) on investments, impairment charges and other non-operating income/(charges), increased from EUR 998 million in 2004 to EUR 1,448 million in 2005. Net gains on investments were 4% lower in 2005 compared to 2004. Included in other nonoperating income/(charges) in 2005 is the gain on the sale of the general insurance business in Spain for a pre-tax amount of EUR 176 million. Included in 2004 in other non-operating income/(charges) is the gain on the sale of Transamerica Finance Corporation businesses for an amount of EUR 154 million.
Total commissions and operating expenses amounted to EUR 5,522 million over 2005 compared to EUR 5,784 million in 2004, a decrease of EUR 262 million or 5%. The sale of most of Transamerica Finance Corporation’s businesses in 2004, the sale of the general insurance business in Spain, as well as expense savings in AEGON UK, all contributed to lower operating expenses.
Revenue generating investments amounted to EUR 358 billion on December 31, 2005. This represents an increase of 17% compared to year end 2004.
Life for account of policyholders 108 107 1 87 86 1
Traditional life Traditional life operating earnings before tax of USD 674 million increased by USD 35 million or 5% compared to 2004. Continued growth of the in-force business contributed to the earnings increase during 2005 in addition to the increase in earnings from volatile items. The valuation of certain financial assets carried at fair value contributed USD 58 million to traditional life operating earnings before tax in 2005 compared to USD 38 million in 2004. Excluding this volatile item, operating earnings before tax increased USD 15 million or 2%. Significant positive items include USD 15 million increase in Canada traditional life earnings upon an update to the valuation software and refinement of reinsurance reserve credits in the third quarter of 2005 and a USD 15 million favorable adjustment of premium tax rates in addition to growth in both the United States and Canada. These were partially offset by USD 10 million of non-recurring expenses incurred in Canada in the second quarter of 2005.
Life for account of policyholders Life for account of policyholders operating earnings before tax of USD 108 million remained at approximately the same level as the results for 2004. Earnings increased due to growth of the in force business and a positive DPAC adjustment in the bankowned life insurance and company-owned life insurance (BOLI/COLI) business in the first quarter of 2005. This was largely offset by lower expense deferrals due to an updated expense study.
Variable annuities Variable annuity operating earnings before tax of USD 162 million decreased USD 58 million or 26% in 2005 compared to 2004, primarily as a result of a decline in the earnings before tax of Canadian segregated funds of USD 48 million. Excluding the Canadian segregated funds pre-tax operating income decreased USD 10 million or 6%. A negative DPAC adjustment of USD 25 million occurred in the second quarter of 2005 related to updating a trail commission modeling assumption, while 2004 results included a positive USD 17 million DPAC adjustment. The remaining increase was primarily due to higher fees from growth in assets under management due to continued favorable persistency and strong equity market growth.
During the second and third quarters of 2005, changes were made to the valuation of the maturity guarantees in the Canadian segregated funds. During the third quarter, best estimate assumptions for the risk free rate used in the calculation of the fair value of the guarantee reserve were updated to better coincide with the liability pattern for this guarantee. However, separate from the change discussed above, interest rates rose during the third and fourth quarters, reducing the liability. During the year, AEGON Canada updated its best estimates for lapse assumptions and equity market volatility, which had a negative impact of USD 74 million.
Fee — off balance sheet products Fee — off balance sheet products operating earnings before tax of USD 67 million increased USD 68 million compared to the results for 2004. Included in the 2005 results is a USD 20 million one-time accrual release from a long-term deferred compensation plan as conditions for payment from the plan were not fulfilled during 2005. The remaining increase reflects higher fees from growth in assets under management from the recent strong equity market performance and lower expenses.
Reinsurance Reinsurance operating earnings before tax of USD 131 million increased USD 240 million compared to a loss of USD 109 million in 2004. The 2004 results were negatively impacted by loss recognition of USD 118 million related to value of business acquired (VOBA) recoverability. Reserve increases and other
Total return annuity — The total return annuity product provides customers with a pass-through of the total return on an underlying portfolio of investment securities (typically a mix of corporate and convertible bonds) subject to a cumulative minimum guarantee. Both the assets and liabilities are carried at fair value, however, due to the minimum guarantee not all of the asset market value changes will be offset in the liability valuation. This product exists in both the fixed annuity and reinsurance lines of business and in both cases represents closed blocks. Product balances as of December 31, 2005 were USD 2.2 billion in fixed annuities and USD 0.6 billion in reinsurance. This item generated a loss of USD 46 million in 2004 operating earnings before tax, compared to earnings of USD 35 million in 2005.
Segregated funds maturity guarantees — Segregated funds sold in Canada and reported in the variable annuity line of business contain ten-year maturity guarantees that are carried at fair value using market-based risk neutral scenario techniques. The operating earnings impact from these guarantees is generally positive for higher equity market returns and higher interest rates, and conversely negative for lower equity market returns and lower interest rates. As of December 31, 2005, segregated fund balances with maturity guarantees total USD 4.3 billion. This product contributed positive USD 12 million to operating earnings before tax in 2005 compared to positive USD 60 million in 2004. The decline during 2005 was primarily due to changes in best estimate modeling assumptions for volatility, lapse rates and the Canadian risk free interest rate.
Accident and health insurance Accident and health operating earnings before tax of USD 345 million decreased USD 16 million or 4% compared to 2004. The long-term care business earnings increased USD 14 million in 2005 due to favorable lapse and claim experience compared to a reserve strengthening in 2004 and higher investment income. Favorable premium tax rate adjustments in 2005 increased earnings by USD 18 million and other one-time expense items reduced earnings. The 2005 earnings were also reduced by USD 30 million due to reserve strengthening and increased claims mostly related to closed blocks of business. The 2004 results included a one-time benefit of USD 15 million due to reserve refinements upon conversion to a new reserve valuation system.
The effective tax rate for 2005 was 26% compared to 21% for 2004. The primary reasons for the increase are higher pre-tax earnings in 2005 (taxed at the 35% US marginal tax rate), a onetime benefit in 2004 from favorable treatment of dividend repatriations from foreign subsidiaries pursuant to a provision of the American Jobs Creation Act of 2004 and a decrease in 2005 benefits from non-taxable distributions from pre-1984 tax accounts of certain US life insurance company members of the Group. These increases in tax were offset in part by increases in 2005 in tax credits and certain tax preferred investment income.
Revenues of USD 18,503 million increased 4% in 2005 compared to those in 2004. Life insurance gross premiums of USD 8,257 million increased 1%, accident and health insurance premiums remained stable at USD 2,456 million, investment income of USD 6,705 million increased 7%, and fees and commissions of USD 1,085 million increased 7%.
Life for account of policyholders single premiums of USD 611 million decreased 6% in 2005 due to a large case that closed in the fourth quarter of 2004. Life for account of policyholders recurring premiums of USD 1,156 million decreased 2%.
Deposits into fixed and variable annuity contracts and institutional spread based products (GICs and funding agreements) were recorded directly to the balance sheet as a deposit liability and not reported in revenues.
The increase in fees and commission revenues is primarily attributable to increased investment management fees earned as a result of higher asset balances. Fees were lower on certain membership products as direct marketing sales declined throughout 2004 and in 2005 due to FCC and FTC regulations including the national ‘Do Not Call’ list.
Standardized new premium production of USD 1,166 million was 7% higher than in 2004. Retail standardized production of USD 800 million was USD 20 million or 3% higher than last year’s as continued strong traditional and universal life sales in the Agency channel were partially offset by lower single premium via the bank channel sales. BOLI/COLI standardized production of USD 107 million was USD 22 million or 17% lower than last year’s due to a large BOLI case that closed in the fourth quarter of 2004. Reinsurance standardized production of USD 259 million was USD 82 million or 46% higher than last year’s due to continued strong international and domestic sales.
In May 2005, AEGON The Netherlands announced that it would improve the terms of its ‘spaarkas’ products. In 2005, the improvements involved an amount of approximately EUR 100 million. Part of these costs are offset by a release of a previously established provision. The effect of the improvements on future earnings will also amount to approximately EUR 100 million and will be spread over many years.
Traditional life operating earnings before tax of EUR 270 million increased EUR 230 million because of higher investment income stemming primarily from the release of profit-sharing provisions of EUR 57 million (compared to an addition of EUR 50 million in 2004), the positive effect of volatile items of EUR 50 million, the returns on swaps used to extend duration of EUR 31 million, dividend receipts of EUR 20 million and EUR 33 million related to the deferred purchase price receivable of the mortgage securitization programs.
Accident and health insurance operating earnings before tax of EUR 45 million increased by EUR 18 million or 67% compared to the results over 2004. The accident and health business benefited from the positive claim experience on disability and sick leave coverage products.
General insurance operating earnings before tax of EUR 30 million decreased by EUR 4 million in comparison to 2004 mainly due to additional provisioning for personal liability insurance. Fire and transport have performed well.
Banking operating earnings before tax of EUR 15 million decreased by EUR 9 million mainly reflecting additional settlements of client disputes regarding ‘Sprintplan’ and ‘Vliegwiel’, a decline in the lease portfolio due to expiration, a decline in savings accounts balances following the release of company savings accounts and lower interest spreads.
Net income, which includes net realized gains and losses on investments and impairment charges, increased by EUR 94 million or 10% to EUR 1,014 million in 2005. The increase in the non-operating component of earnings is driven by improving equities markets and a declining yield curve. The decision to lengthen the duration of the pension portfolio in the second quarter of 2004 had a significant impact on the results in both 2004 and 2005. Derivatives used to extend the duration contributed EUR 307 million to the non-operating result in 2005.
of the organization and higher compliance and regulatory costs. Deferred expenses were slightly lower in 2005 compared to 2004 as a significant portion of commissions relates to the sale of single premium products, which are not deferred. DPAC amortization declined in comparison to 2004 as a consequence of accelerated DPAC amortization charges in 2004.
Single premium production increased by 4% compared to 2004. This increase was mainly due to the conclusion of a number of institutional pension contracts in the life for account of policyholder business line. These contracts are very significant but tend to be incidental and therefore production is less predictable. The recurring premium production has remained stable compared to 2004. Whereas 2004 benefited from the effect of changes in pension legislation causing strong production in the second quarter of 2004 of ‘Streefregelingen’, 2005 included several large new contracts. Moneymaxx Germany production in 2005 amounted to EUR 3 million (2004: EUR 15 million) reflecting the sale of this business in the first quarter of 2005. Excluding Moneymaxx Germany, the total standardized new premium production life increased by 8%.
Off balance sheet production increased by 10% to EUR 864 million, reflecting growth in asset-only group pension contracts and good performance at TKP Pensioen.
The sale of shares in 2005 resulted in the realization of gains amounting to EUR 348 million, the sale of bonds EUR 154 million and mortgages EUR 32 million. Changes in the market value of real estate contributed a further EUR 144 million to nonoperating income.
Impairment charges in 2005 amounted to a total of EUR 25 million compared to EUR 19 million in 2004, comprised of EUR 25 million in respect of AEGON Germany which was sold in April 2005, impairments on loans of EUR 3 million, impairments of shares of EUR 14 million and offset by the release of provisions on lease products (EUR 17 million) due to increases in the value of investments coupled with the lease products.
Life general account premiums of EUR 893 million decreased by 23% compared to 2004, mainly due to the decrease in single premiums. Recurring premiums have remained stable compared to 2004.
Life for account of policyholders premiums of EUR 2,128 million increased by 17% compared to 2004 as a result of several large new contracts in the single premium-segment that closed in 2005. In addition, a catch-up effect for a large co-insurance pension contract in the recurring segment was booked in the first quarter of 2005.
Accident and health insurance premiums increased by 2% in 2005 compared to 2004 as a consequence of the privatization of disability for self employed (WAZ). General insurance revenues remained flat compared to last year.
Investment income amounted to EUR 2,184 million and increased 8% as a consequence of higher volumes of both investments and derivative instruments in 2005, partly offset by lower investment income from banking activities due to a shrinking block of business (run-off of the ‘Sprintplan’ product and withdrawal of company savings plans).
Fee and commission income of EUR 325 million was 9% higher than in 2004 due to strong growth (55%) in the service centers, 17% growth for TKP Pensioen and a 22% increase for AEGON Asset Management.
Total commissions and operating expenses increased by 7% to EUR 1,09 1 million in comparison to 2004.
Operating expenses increased by EUR 162 million or 27% to EUR 752 million. Operating expenses in 2005 included the addition to the provision for spaarkas products (EUR 42 million), partially offset by releases of the provisions for lease products (EUR 8 million). In 2004, operating expenses included the release of the provision related to the sale of real estate in 2000 (EUR 56 million) and the receipt of fraud compensation (EUR 16 million). When one-time items are excluded, operating expenses increased by EUR 25 million or 4% mainly due to additional employee expenses reflecting the focus on improving the quality
in million in million in million in million INCOME BY PRODUCT SEGMENT GBP GBP % EUR EUR %
Life for account of policyholders 139 114 22 203 168 21
Income tax attributable to policyholder return (71) (40) 78 (104) (58) 79 INCOME BEFORE INCOME TAX
1 Includes a GBP 33 million charge in 2005 for incentive pay related to Positive Solutions. 2 Other non-operating income/(charges) is currently used to report charges made to policyholders in respect of income tax. There is an equal and opposite tax charge which is reported in the line Income tax attributable to policyholder return.
Operating earnings before tax of GBP 111 million in 2005 increased by 2% compared to 2004. The increase primarily reflects the positive effect of the higher equity and bond markets on policy fee income offset by a GBP 33 million charge for the incentive plan for registered individuals and staff related to the acquisition of the remaining 40% of Positive Solutions (GBP 23 million in the third quarter of 2005 and GBP 10 million in the fourth quarter of 2005). A further charge of GBP 7 million is expected in the first quarter of 2006. AEGON UK has accelerated the incentive plan for Positive Solutions registered individuals and staff on the back of the acquisition of the remaining 40% of Positive Solutions.
The FTSE level was on average 15% higher in 2005 than in 2004 and results in 2004 included a GBP 10 million restructuring charge.
Operating earnings before tax in the traditional life product segment were a loss of GBP 1 million in 2005 compared to a loss of GBP 8 million in 2004. The increase reflects a restructuring charge of GBP 10 million in 2004.
Operating earnings before tax in the life for account of policyholders line of business was GBP 139 million for 2005, an increase of 22% compared to 2004. The increase mainly reflects the impact of the higher equity and bond market on policyholders fee income.
Other non-operating earnings before tax represent charges made to policyholders in respect of corporation tax and are offset by an equal and opposite amount included in the line income tax attributable to policyholders return.
Net income for 2005 of GBP 98 million increased by 20% compared to 2004. The effective tax rate decreased from 25% in 2004 to 15% in 2005, largely due to non-recurring tax charges in 2004 increased volume of protection business in 2005 giving additional expense relief and an increase in profits in AEGON UK’s life business lines (these are taxed at a lower rate than pensions business).
The increase in fee and commission revenues of 28% to GBP 153 million is due to growth in income from our distribution companies. In particular there was strong growth in Positive Solutions income during the year.
Commission and operating expenses increased 20% to GBP 518 million and included the GBP 33 million incentive cost related to Positive Solutions, and the growth in the distribution businesses, leading to an increase of GBP 38 million in paid-out commissions. Operating expenses increased GBP 2 million to GBP 346 million.
In asset management, AEGON UK had a strong performance in retail and institutional sales, attributable to the continued stock market improvement that encouraged investors back into the market as well as to the continued strong performance of AEGON UK Asset Management’s fixed income team. Total off balance sheet products sales amounted to GBP 1,032 million compared to GBP 143 million in 2004.
Non-life operating earnings increased by HUF 1.6 billion, mainly due to lower claims ratio in household and motor and improving expense results.
Life premiums amounted to HUF 39.3 billion and increased by HUF 1.7 billion compared to 2004 due to higher universal life recurring sales while traditional life premiums decreased due to mature portfolios. Non-life premiums increased by 12% in 2005 compared to 2004. Higher deposits resulted in a HUF 0.8 billion higher fee and commission income despite falling fee rates due to increasing competition in the market.
Off balance sheet production increased by HUF 25 billion or 49% to HUF 76 billion, reflecting increased pension fund deposits. Although competition in the pension fund management business intensified, pension fund membership increased by 32,500 to 456,000 members. Off balance sheet investments grew by 44% to HUF 282 billion compared to the 2004 year end level.
Operating earnings before tax amounted to a loss of SKK 463 million in 2005 compared to a loss of SKK 325 million in 2004. Premium income increased from SKK 76 million to SKK 105 million. Standardized new premium production decreased from SKK 100 million to SKK 77 million, reflecting the focus on the sale of pension plans, but increased in the second half of 2005 due to new agreements with brokers.
Net income for 2005 amounted to EUR 161 million and included the gain on the sale of the general insurance business of EUR 150 million (pre-tax EUR 176 million) and EUR 11 million related to AEGON’s share in the net result of the partnership with CAM (49.99% interest), which became operational in June 2004 (EUR 4 million in 2004).
Life premiums increased by 3%, partly due to premiums from the acquired Reale Vida portfolio. Life recurring premiums decreased by 3%, but single premiums increased by 32%. The cancellation of a distribution agreement with a large agent had a negative effect on life premium growth. Accident and health premiums increased 6% compared to 2004.
Standardized new premium production was 32% lower than in 2004. This reflects the cancellation of a distribution agreement with a large agent and the slow down in sales in the first half of 2005 from general agents as a consequence of the sale of the general insurance activities.
A 50/50 partnership agreement was signed in November 2005 with Caja Navarra. The acquisition of 50% of Seguros Navarra S.A. took place in two tranches. In the fourth quarter of 2005 15% was acquired and in February 2006 another 35% stake has been acquired. No results have been recognized in the 2005 financial statements as the acquisition is subject to approval by the insurance authorities and approval was not received by year end.
Net income decreased from NTD 249 million in 2004 to NTD 176 million in 2005. Net gains on investments were NTD 155 million for the year 2005, lower than the NTD 193 million reported for 2004, mainly attributable to lower realized capital gains on USD fixed income instruments in 2005. In 2005 there was no impairment charge versus default losses on convertible bonds of NTD 94 million in 2004.
Investment income rose from NTD 935 million in 2004 to NTD 1,964 million in 2005, mainly due to an increase in the asset base. Investment assets increased from NTD 41 billion as of December 31, 2004 to NTD 70 billion as of December 31, 2005.
Commissions and operating expenses were NTD 4,495 million for the year 2005 compared to NTD 3,462 million reported for the same period last year, mainly due to higher first year commissions as a result of higher new business production.
Gross premiums (AEGON’s 50% share) increased from CNY 27 million to CNY 134 million and standardized new premium production increased from CNY 10 million to CNY 23 million in 2005, reflecting the extension of sales channels and the opening of new branches in Beijing and Nanjing in 2005.
AEGON increased its share in La Mondiale Participations from 20% to 35% on December 31, 2004. AEGON’s share in the net result of La Mondiale Participations increased from EUR 5 million in 2004 to EUR 6 million in 2005.
As an insurance company, AEGON is in the ‘risk’ business and as a result is exposed to a variety of risks. Below a description of the risk management and control systems is given on the basis of the identified important risks for AEGON. Some risks, such as currency translation risk, are related to the international nature of AEGON’s business. Other risks include insurance related risks, such as changes in mortality and morbidity. However, AEGON’s largest exposures are to changes in financial markets (e.g.
AEGON manages risk at the local level where business is transacted, based on principles and policies established at Group level. AEGON’s integrated approach to risk management involves common measurement of risk and scope of risk coverage to allow for aggregation of the Group’s risk position. In addition, this integrated framework facilitates the sharing of best practices and the latest research on methodologies. The risk management functions are applied locally and are tied to the speed of business with corporate oversight, while remaining independent of the business activity providing oversight and peer review.
Results of AEGON’s sensitivity analyses are presented throughout this section to show the estimated sensitivity of net income and shareholders’ equity to various scenarios. These sensitivity analyses are presented according to IFRS. These scenario results do not consider the actions that might be taken to mitigate losses inherent in AEGON’s risk management processes. As financial markets fluctuate, these actions may involve selling investments, changing investment portfolio allocation and adjusting interest rates or bonuses credited to policyholders. Also, the results do not take into account correlation between factors and assume unchanged conditions for all other assets and liabilities. Results of the analyses also cannot be extrapolated for wider variations since effects do not tend to be linear. No risk management process can clearly predict future results.
AEGON bears interest rate risk with many of its products. In cases where cash flows are highly predictable, investing in assets that closely match the liabilities can mitigate this risk. For some AEGON country units local capital markets are not well developed, which prevents the complete matching of assets and liabilities for those businesses. For some products, cash flows are less predictable as a result of policyholder actions that can be affected by the level of interest rates.
Premiums in flexible premium policies may decrease as policyholders seek investments with higher perceived returns. This activity may result in cash payments requiring the sale of invested assets at a time when the prices of those assets are adversely affected by the increase in market interest rates; this may result in realized investment losses. These cash payments to policyholders result in a decrease in total invested assets and a decrease in net income. Among other things, early withdrawals may also require AEGON to accelerate amortization of DPAC, which in turn reduces net income.
SENSITIVITY ANALYSIS OF NET INCOME AND SHAREHOLDERS’ EQUITY TO CURRENCY EXCHANGE RATE MARKETS 1,2
1 Basic assumptions: no correlation between markets and risks; unchanged conditions for all other assets and liabilities; limited management actions taken. All percentage changes are relative to net income and shareholders’ equity. Effects do not tend to be linear and therefore cannot be extrapolated for larger increases or decreases.
The sensitivity analysis in table 5 shows an estimate of interest rate movements on net income and shareholders’ equity.
Shift up 100 basis points (563) (840) Shift up 200 basis points (1,088) (1,642) Shift down 100 basis points 554 628 Shift down 200 basis points 1,095 1,183 1 Basic assumptions: no correlation between markets and risks; unchanged conditions for all other assets and liabilities; limited management actions taken. All changes are relative to net income and shareholders’ equity. Effects do not tend to be linear and therefore cannot be extrapolated for larger increases or decreases.
2 The effect of interest rate movements is reflected as the effect of a one-time parallel shift up or down of all relevant yield curves on December 31, 2005.
CCC or lower 341 — — — 341 1 Includes investments of holding and other activities.
58 AEGON ANNUAL REPORT 2005 shareholders’ equity. As a result under IFRS, the impact of interest rate changes on net income and shareholders’ equity can give an incomplete and even incorrect impression of the true risk exposure of the company. In fact, the company is at risk if rates decline as the investments are currently shorter in duration than the liabilities and as a result of minimum guarantees present in some products. Similarly when interest rates rise, the company is currently better off since the investments are currently shorter in duration than the liabilities. When interest rates rise sharply, this benefit would be partially offset in the short term due to a likely sudden rise in lapse rates on fixed annuity products in AEGON USA.
As premiums and deposits are received, these funds are invested to pay for future policyholder obligations. For general account products, AEGON typically bears the risk for investment performance equaling the return of principal and interest. AEGON is exposed to credit risk on its general account fixed income portfolio (bonds, mortgages and private placements), over-thecounter derivatives and reinsurance contracts. Some issuers have defaulted on their financial obligations for various reasons, including bankruptcy, lack of liquidity, downturns in the economy or downturns in real estate values, operational failure and fraud. In the past, poor economic and investment climates in AEGON’s major markets resulted in significant investment impairments on AEGON’s investment assets due to defaults and overall declines in the securities markets. Although credit default rates were benign in 2005, a reversion to excessive defaults, or other reductions in the value of these securities and loans, could have a material adverse effect on AEGON’s business, results of operations and financial condition.
AEGON actively manages its credit risk exposure by individual counterparty, sector and asset class. It may mitigates credit risk in derivative contracts by entering in collateral agreements where practical and in International Swaps and Derivatives Association (ISDA) master netting agreements for each of AEGON’s legal entities to facilitate AEGON’s right to offset credit risk exposure. AEGON may also mitigates credit risk in reinsurance contracts where possible by retaining ownership of assets required to support liabilities ceded or by requiring the reinsurer to hold assets in trust. For the resulting net credit risk exposure, AEGON employs deterministic and stochastic credit risk modeling in order to assess AEGON’s credit risk profile, associated earnings and capital implications due to various credit loss scenarios.
The ratings distribution of general account portfolios of AEGON’s major country units are presented in table 6 on page 57 and are organized by rating category.
CCC or lower 50 1 The fixed income issuer rating is used when applying the credit counterparty limit exposure policy.
volatility in returns and investment performance risk. Significant terrorist actions, as well as general economic conditions, have led to and may again result in significant decreases in the value of AEGON’s equity investments.
Sensitivity analysis of net income and shareholders’ equity to equity and real estate markets is presented in table 10 on page 60.
The sensitivity of shareholders’ equity and net income to changes in equity and real estate markets reflects changes in the market value of AEGON’s portfolio, changes in DPAC amortization, contributions to pension plans for AEGON’s employees and the strengthening of the guaranteed minimum benefits, when applicable. The main reason for the non-linearity of results in the equity portion of the sensitivity is that more severe scenarios could cause accelerated DPAC amortization and guaranteed minimum benefits provisioning, while moderate scenarios may not.
ASSETS (IN USD) (IN EUR) (IN GBP) (IN EUR) (IN EUR) (IN EUR)
AEGON’s inability to manage risks successfully through derivatives or a counterparty’s failure to honor its obligations could have a material adverse effect on AEGON’s business, results of operations and financial condition.
Illiquid assets, consisting of general account investments in real estate, loans and unlisted bonds and shares, amounted to EUR 39 billion or 26% of general account investments at the end of 2005 (EUR 33 billion or 26% in 2004).
AEGON monitors and manages its underwriting risk by each underwriting risk type. Attribution analysis is performed on earnings and reserve movements in order to understand the source of any material variation in actual results from what was expected. AEGON’s units also perform experience studies for underwriting risk assumptions, comparing AEGON’s experience to
1 Basic assumptions: no correlation between markets and risks, unchanged conditions for all other assets and liabilities and limited management actions taken. All changes are relative to net income and shareholders’ equity. Effects do not tend to be linear and therefore cannot be extrapolated for larger increases or decreases.
2 The effect of movements in equity and real estate markets is reflected as a one-time increase or decrease of worldwide equity and real estate markets on December 31, 2005.
Sensitivity analysis of net income and shareholders’ equity to various underwriting risks is shown in table 11.
AEGON may face claims from customers and adverse negative publicity if its products result in losses or fail to result in expected gains, regardless of the suitability of products for customers or the adequacy of the disclosure provided to customers by AEGON and by the intermediaries who distribute AEGON’s products. New products that are less understood and that have less of a historical performance track record may be more likely to be the subject of such claims. Any such claims could have a material adverse effect on AEGON’s results of operation, corporate reputation and financial condition.
Claims paying ability and financial strength ratings are factors in establishing the competitive position of insurers. A rating downgrade (or the potential for such a downgrade) of AEGON or any of its rated insurance subsidiaries may, among other things, materially increase the number of policy surrenders and withdrawals by policyholders of cash values from their policies. The outcome of this may be cash payments requiring the sale of invested assets, including illiquid assets, at a price that may result in realized investment losses. These cash payments to policyholders result in a decrease in total invested assets and a decrease in net income. Among other things, early withdrawals may also cause AEGON to accelerate amortization of policy acquisition costs, reducing net income.
SENSITIVITY ANALYSIS OF NET INCOME AND SHAREHOLDERS’ EQUITY TO VARIOUS UNDERWRITING RISKS 1,2 (in EUR millions)
2 The mortality/morbidity sensitivities assume that mortality/morbidity increases or decreases for all products regardless of whether one product produces a gain or loss on the directional change.
Furthermore, natural disasters, terrorism and fires could disrupt AEGON’s operations and result in significant loss of property, key personnel and information about AEGON’s clients and AEGON. If AEGON’s business continuity plans have not included effective contingencies for such events, they could adversely affect AEGON’s business, results of operations, corporate reputation and financial condition for a substantial period of time.
AEGON’s insurance business is subject to comprehensive regulation and supervision in all countries in which AEGON operates. The primary purpose of such regulation is to protect policyholders, not holders of securities. Changes in existing insurance laws and regulations may affect the way in which to conduct business and the products offered. Changes in pension and employee benefit regulation, social security regulation, financial services regulation, taxation and the regulation of securities products and transactions may adversely affect AEGON’s ability to sell new policies or claims exposure on existing policies. Additionally, the insurance laws or regulations adopted or amended from time to time may be more restrictive or may result in higher costs than current requirements.
For the first time in 2005, AEGON’s financial statements have been prepared and presented in accordance with IFRS. Any future change in these accounting principles may have a significant impact on AEGON’s reported results, financial condition and shareholders’ equity. This includes the level and volatility of reported results and shareholders’ equity.
On the basis hereof, the Executive Board declares the following regarding AEGON’s financial reporting risks: 1. the risk management and control systems provide reasonable assurance that the financial reporting does not contain any material inaccuracies; 2. the risk management and control systems have worked properly in 2005; 3. there are no indications that the risk management and control systems will not work properly in 2006.
Since the internal control systems throughout the whole organization are currently under review in view of the future obligations pursuant to SOX 404, the above statement does not imply an assessment as required by SOX 404.
AEGON manages capital adequacy at the level of its country units and their operating companies. AEGON seeks to support its internal capital adequacy levels at the higher of local regulatory requirements, 165% of the relevant local Standard & Poor’s capital adequacy models or internally imposed requirements. During 2005, the capital adequacy of AEGON’s operating units continued to be strong. All of AEGON’s units were capitalized within these tolerances. In the United States, at December 3 1, 2005, AEGON held approximately 383% of the minimum capital required by the National Association of Insurance Commissioners.
During 2005, AEGON N.V. issued USD 1,750 million junior perpetual capital securities to refinance maturing debt and perpetual cumulative subordinated bonds. This further improved the quality of the capital base and reduced refinancing risk.
Shareholders’ equity was EUR 19,276 million at December 31, 2005, compared to EUR 14,875 million at December 31, 2004. The increase of EUR 4,401 million is largely due to the net income of EUR 2,732 million and currency translation gains of EUR 1,515 million offset in part by cash dividends of EUR 272 million.
AEGON’s funding strategy continues to be based on assuring excellent access to international capital markets at low costs. As part of this strategy, AEGON aims to offer institutionally targeted debt securities in amounts that are eligible for benchmark inclusion and to support the maintenance of liquid secondary markets in these securities. AEGON also aims to maintain excellent access to retail investors, as witnessed by the successful issuance of Junior Perpetual Capital Securities in 2004 and 2005. AEGON’s focus on the fixed income investor base will continue to be supported by an active investor relations program to keep investors well informed on AEGON’s strategy and results. Most of AEGON’s external debt is issued by the parent company, AEGON N.V., as well as a limited number of other AEGON Group companies whose securities are guaranteed by AEGON N.V. AEGON N.V. has employed its regular access to the capital markets through private placements issued under its USD 6 billion Euro Medium Term Notes Program and under a separate US shelf registration. AEGON’s USD 2 billion Euro Commercial Paper Program and AEGON Funding Corp.’s USD 4.5 billion Euro Commercial Paper Program (guaranteed by AEGON N.V.) facilitate access to international and domestic money markets, when required. Additionally, AEGON N.V. utilizes a USD 300 million Euro Commercial Paper Program.
Internal distributions may be subject to (local) regulatory requirements. Each business unit further controls its liquidity by closely managing the liquidity of its investment portfolio. The duration profile of AEGON’s capital debt and interest rate structure is managed in line with the duration of surplus assets related to its investments in its subsidiaries, subject to liquidity needs, capital, and other requirements. Of AEGON’s total capital debt and hybrid securities at December 31, 2005, approximately EUR 1.0 billion matures within three years. EUR 0.4 billion between three and five years. EUR 4.8 billion is perpetual or matures after five years. AEGON believes its working capital, backed by the external funding programs and facilities, is amply sufficient for the group’s present requirements.
The Hague, March 8, 2006 The Executive Board 64 AEGON ANNUAL REPORT 2005
AEGON’s operations in the Americas comprise AEGON USA Inc. and AEGON Canada Inc., which are collectively referred to as AEGON Americas. The companies operating in the United States are collectively referred to as AEGON USA. Reference to AEGON USA in this report refers individually or collectively to the corresponding operating companies. The companies operating in Canada are collectively referred to as AEGON Canada..
AEGON USA Inc., the principal holding company of AEGON USA, was formed in 1989 when AEGON consolidated its holding companies in the United States under one financial services holding company. Business operations are conducted through life insurance subsidiaries of AEGON USA Inc. and Commonwealth General, with licenses in every state of the United States, the District of Columbia, Puerto Rico, the Virgin Islands, and Guam.
AEGON USA’s principal offices are located in Baltimore, Maryland; Cedar Rapids, Iowa; Charlotte, North Carolina; Frazer, Pennsylvania; Little Rock, Arkansas, Los Angeles, California; Louisville, Kentucky; Kansas City, Missouri; Plano, Texas; Purchase, New York; and St Petersburg, Florida.
AEGON’s subsidiary companies in the United States contain five operating groups acting through one or more of the AEGON USA life insurance companies: Agency, Direct Marketing Services, Financial Markets, Institutional Products and Services, and Pension. The group structure enables AEGON USA to manage the organization more efficiently, to identify business synergies, to pursue cross-selling opportunities, and to improve operating efficiencies. Coordinated support services complement operations by providing expertise in systems technology, investment management, regulatory compliance, and various corporate functions. Products are offered and distributed through one or more of the AEGON USA licensed insurance or brokerage subsidiary companies. The divisions referenced below are part of those subsidiary companies.
The Agency Group divisions offer a wide range of insurance products through agents dedicated to selling AEGON products as well as independent agents, registered representatives, financial advisors, and specialized marketing organizations. The Agency Group targets distinct market segments ranging from lowerincome clients to the advanced market with higher net-worth customers that it serves by providing various tax and estate planning products. The Agency Group consists of the following: • Life Investors Career Agents/Independent Marketing Organizations
• Intersecurities, Inc. • Transamerica Insurance & Investment Group • World Financial Group • Monumental Division • Long Term Care Division • Worksite Marketing The Life Investors Agency Group/Independent Marketing Organizations target the middle to upper-income markets, selling primarily interest-sensitive and ordinary life insurance. Life Investors offers support to agencies and provides agents with quality products, technology tools, and a high-level of home office training and support. During the past few years, the Independent Marketing Organizations group has seen growth in both recruiting and sales. This unit focuses on developing relationships with independent marketing organizations and managing general agents throughout the United States.
Transamerica Insurance & Investment Group (TIIG), the marketing unit for Transamerica Occidental Life Insurance Company (TOLIC) and its affiliates, distributes term, fixed, and variable universal life insurance and fixed annuity products. In the United States, TIIG focuses on the upper-middle and affluent markets, in addition to a number of niche markets that include small to mid-sized businesses and various ethnic groups. TIIG also targets the upper-middle and affluent markets in the Pacific Rim, with particular emphasis on asset management and wealth transfer. TIIG has a branch in Hong Kong and, in 2005, TOLIC became the first outside insurer in fourteen years to be granted a license to operate in Singapore as a direct insurer.
TIIG’s primary distribution channel is a network of independent general agencies and agents. Sales of TIIG’s variable products are supported by its broker-dealer affiliate, Transamerica Financial Advisors, Inc. TIIG also has a National Accounts channel through which it provides life insurance products to customers via the broker-dealer community. In 2006, TIIG will celebrate the 100th anniversary of the founding of the original Transamerica life company, Occidental Life Insurance Company.
World Financial Group (WFG) targets the middle-income market, selling variable universal life insurance, variable annuities, mutual funds, equity indexed universal life insurance, universal life insurance, and term life insurance. WFG offers its associates the opportunity to build financial services and insurance businesses on their own terms. Associates can offer securities-related products and services by becoming registered representatives of WFG’s affiliated broker-dealer, World Group Securities, Inc.
Transamerica Worksite Marketing offers a wide range of voluntary payroll deduction life and supplemental health insurance products for groups ranging in size from as few as five employees to more than 100,000 employees. Products marketed to employees at their workplace are designed to supplement benefit plans that they may already have, both through their employers and on their own.
Additionally, ADMS has applied its direct marketing expertise internationally and is now doing business in Europe, Asia, Australia, and Latin America. ADMS has developed strategic relationships with major business partners in these regions and uses their endorsement to market products via telemarketing and direct mail.
Transamerica Investment Management is a registered investment advisor that provides investment management services to mutual funds, institutional accounts, pension funds, variable annuity, and variable life insurance company separate accounts.
The Institutional Products and Services Group includes AEGON Institutional Markets and Transamerica Reinsurance Group.
For more than 30 years, Transamerica Reinsurance has worked closely with life insurance and financial services companies to provide mortality risk and capital management solutions for individual life insurance and annuity products. These direct relationships result in a more complete understanding of the risks being assumed and provide valuable insights into the needs of clients and trends within the marketplace
In the United States, Transamerica Reinsurance provides traditional life reinsurance solutions for term life, universal life, variable universal life and whole life products. Reinsurance products include coinsurance, yearly renewable term (YRT) and modified coinsurance agreements. In recent years, most clients seeking reinsurance of term life insurance contracts are opting for coinsurance reinsurance agreements to achieve both mortality risk transfer and reserve financing.
Over the past five years, Transamerica Reinsurance has initiated programs to expand and diversify geographically. Offices have been established in Taiwan, South Korea, Hong Kong, Japan, Mexico, Chile, and Brazil. Transamerica Reinsurance brings value internationally through customized solutions including coinsurance financing, product development and related quota share programs, and traditional life reinsurance.
Diversified Investment Advisors (Diversified) is a registered investment advisory firm dedicated to retirement plan management. Diversified provides a customized approach to retirement plans, which includes comprehensive investment, administrative, and technical services for 401(k), 403(b), defined benefit, profit sharing, money purchase, NQDC, and 457(b) plan types. Diversified provides retirement products and services for the mid to large-sized pension market, which generally includes companies with between 250 and 100,000 employees and with between USD 5 million and USD 1 billion pension assets. These products and services are sold through a variety of intermediaries, including benefit consulting firms, broker-dealers, and brokers.
AEGON USA reinsures portions of its life insurance exposure with unaffiliated insurance companies under traditional indemnity, quota share reinsurance contracts, and, in some instances, excess loss reinsurance. Such reinsurance arrangements are in accordance with standard reinsurance practices within the industry. AEGON USA enters into these arrangements to assist in diversifying its risks and to limit the maximum loss on risks that exceed policy retention limits. The maximum retention limit on any one life varies by product and risk classification, and is generally between USD 300,000 and USD 3,000,000.
TLC’s life products business unit provides life insurance products for individuals and companies across Canada. The portfolio includes universal life and traditional life insurance, predominantly term life and permanent life insurance, as well as accidental death and out-of-the-country medical insurance.
Reinsurance ceded does not discharge AEGON Canada's liability as the primary insurer. Failure of reinsurers to honour their obligations could result in losses to AEGON Canada. Consequently, AEGON Canada evaluates the financial condition of its reinsurers and monitors their credit risk to minimize its exposure to losses from reinsurer insolvency. AEGON Canada only contracts business with reinsurers who are registered with the Office of the Superintendent of Financial Institutions Canada.
AEGON The Netherlands primary operational subsidiaries in the Netherlands are: • AEGON Levensverzekering N.V. • AEGON Schadeverzekering N.V. • AEGON NabestaandenZorg N.V. • AEGON Spaarkas N.V. • AEGON Bank N.V.
• Spaarbeleg Kas N.V. • Axent AEGON Sparen • Meeùs Groep B.V.
AEGON The Netherlands is involved in both the life and non-life insurance business and provides banking, financial and asset management services.
As of January 1, 2004, AEGON The Netherlands implemented a new organizational structure with five service centers and four marketing and sales organizations. Prior to this reorganization, a business unit structure was in place. The five service centers that focus on customer service and the administration of the five main product lines are as follows: • Service center pensions • Service center life insurance • Service center non-life insurance • Service center banking • Service center asset management During 2005, AEGON The Netherlands continued the restructuring process, transferring marketing activities from each of the three organizations to a central marketing unit for the Netherlands. This reorganization has energized the development of new product propositions and has made the integration of IT systems possible, a task which will be completed in 2006.
The SO’s are: • Corporate & Institutional Clients (C&IC) — focuses on large companies, company pension funds, and industry pension funds.
• Intermediair — which includes the Meeùs Groep since the third quarter of 2005, focuses on retail and institutional clients and independent brokers.
The main pension products are: • Products for account of policyholders with guarantees (separate investment guaranteed contracts)
• Products for account of policyholders without guarantees (separate investment capital contracts)
End 2004, AEGON The Netherlands introduced AEGON Persoonlijk Pensioen Plan, an individual pension product based on defined contribution, which targets employees that fall outside a collective pension plan and directors who own a company. Clients can choose from several investment options including two options with limited guarantees. The insurance cover is client-specific, which means the client can select the retirement date and the type of pension.
Fund plan and savings plan products. Fund plan and savings plan products are mainly endowment and savings type products, both single premium and recurring premiums with profit sharing based on the selected fund performance. A customer may choose from a wide variety of AEGON funds. AEGON The Netherlands has issued a guarantee of 3% for investments in the Mix Fund and the Fixed Income Fund (4% on policies sold before the end of 1999) at the maturity date if the policyholder has paid the premium for a consecutive period of at least ten years or on death of the insured.
End 2004, AEGON The Netherlands introduced AEGON LevenHypotheek, a universal life-based mortgage investment product. The loan is repaid in full or in part at the redemption date with the proceeds from a savings policy. If the insured dies during the contract period, the benefit payment is used to repay the mortgage loan. The customer can choose from six funds in which to invest the savings premiums; two of these six funds offer limited guaranteed benefit payments on maturity date. The actual amount available at the maturity date will vary depending on the performance of the underlying funds.
Non-life insurance products are mainly sold by the sales organization Intermediary (including Meeùs). Non-life products consist primarily of accident and health and property and casualty.
Reinsurance takes place through a profit-sharing contract between AEGON Levensverzekering N.V. and Swiss Re. The contract includes retentions of EUR 900,000 per policy with respect to death risk and EUR 25,000 annually for disability risk.
In the fire insurance business, an excess of loss reinsurance strategy is in place with a retention of EUR 5.0 million per risk and EUR 21.0 million per event. The motor business is also reinsured on an excess-of-loss basis with a retention of EUR 2.5 million per event.
AEGON UK is a leading manufacturer, fund manager, and distributor of pension, protection, and investment products. The principal holding company within the AEGON UK group of companies is AEGON UK plc (AEGON UK). It is a company limited by shares, incorporated on December 1, 1998. The principal offices of AEGON UK are Edinburgh (Scotland), London (England), Lytham (England), and Dublin (Ireland).
Changes to many aspects of UK pension legislation and taxation continue to impact the industry. The most significant change relates to the introduction of a simpler and unified tax regime, which will apply to all types of pension arrangements. This will be implemented in April 2006 and will impact all pension providers in the United Kingdom. Reviews of product ranges and supporting infrastructure are underway to ensure that AEGON UK capitalizes on the opportunities presented by these changes.
Offshore Bonds. Offshore bonds are sophisticated, packaged investment products with tax advantages for clients in the United Kingdom and overseas. The products meet the needs of high net-worth individuals looking for investment choice and flexibility, inheritance tax planning (in conjunction with trust arrangements), and general tax planning. They are also recommended for investing corporate money.
AEGON Individual Protection (AIP) operates in the individual protection market under the brand name of Scottish Equitable Protect. Launched in 2001, Scottish Equitable Protect offers menu-based products targeted at meeting the needs of both individual and business customers.
New electronic business services have been increasingly embraced by advisors in 2005, improving productivity and efficiency for advisors and product providers. The importance of electronic transaction services within the overall proposition will continue to increase, and development of new electronic business services will be a focus throughout 2006. Moreover, the pension reforms in April 2006 will revitalize the pension term assurance market and open up a new potential market for AIP.
AEGON Corporate offers a range of corporate risk products exclusively through financial advisors to suit the needs of all employers and their employees. AEGON UK’s core product lines include group life, group income protection, and group critical illness. Each can be bought on a stand-alone basis or together in the form of a tailored employee benefits package, either on a core or flexible benefits basis. A product called the Employee Protection Menu, aimed specifically at small to medium enterprises, is also offered through intermediaries. This product is purchased by the employer at a predefined cost and allows each individual employee to select appropriate levels of protection to suit their individual needs.
In 2002 and 2003, AEGON UK acquired six independent financial advisors in the United Kingdom. Five of these businesses were merged in 2004 to form a new company called Origen, which became fully operational on March 1, 2005. Origen delivers advice relating to the financial needs of both individual and corporate customers. Origen uses a range of distribution methods, primarily face to face contact but also media and worksite marketing, and distribution agreements with closed book life offices. The sixth acquired firm, Positive Solutions, provides management services to self-employed independent financial advisors that use sophisticated technology platforms.
AEGON Hungary Composite Insurance Company Limited by Shares (AEGON Hungary) is a member of the AEGON Group since 1992. The legal predecessor of the company was the state-owned ÁB, which was incorporated in the 1940’s. The company operates in Hungary and has its head office in Budapest.
On September 5, 2005, AEGON Hungary Financial Services Company Limited by Shares merged into AEGON Hungary Composite Insurance Company.
These products consist of individual life policies that were issued before AEGON Hungary became part of the AEGON Group. The premium income and the profit margin from these policies are very low. Traditional general account products also include indexed life products that are not unit-linked but have guaranteed interest. AEGON Hungary no longer offers these products.
Unit-linked products are AEGON Hungary’s most important products and make up the largest part of AEGON Hungary’s new sales. Unit-linked premiums are invested in various asset funds.
AEGON Hungary also provides asset management services through its subsidiary, AEGON Hungary Investment Fund Management Company. It offers six mutual funds to the public: domestic bond, domestic equity, international bond, international equity, money market, and a mixed fund. AEGON Hungary Investment Fund Management Company manages the assets in the general account portfolio of AEGON Hungary, the unit-linked portfolios and AEGON Hungary Pension Funds. It also provides asset management services to third parties. AEGON Hungary Investment Fund Management Company is responsible for all the investment activities in Hungary and the Central Eastern European region.
The AEGON Hungary Pension Fund Management Company is responsible for the operation and management of voluntary and mandatory pension funds. Its two main sources of revenue are fees for asset management and administrative services.
AEGON Hungary’s distribution channels comprise a composite network that sells both life and non-life products. Distribution also depends on a specialized team that targets the Budapest market and other independent agents and brokers.
The composite network and the specialized team work with agents. AEGON Hungary also uses alternative channels and partners to increase sales. This approach enabled AEGON Hungary to keep a strong fourth position in the pension fund and life insurance market in 2005 (source: www.pszaf.hu and www.mabisz.hu).
The renewed, integrated direct sales and direct marketing operation focuses on core portfolio protection and the sale of standardized products.
AEGON Hungary also fosters relationships with banks. AEGON Hungary’s current partner banks offer mortgage products, simple savings products and units of AEGON Hungary Investment Fund Management Company’s mutual funds to the public.
AEGON Hungary’s reinsurance partners are all large reinsurers in the European markets with a minimum Standard & Poor’s rating of A. The three most important reinsurance programs in force in the last ten years are the Catastrophe Excess of Loss Treaty, the Motor Third Party Liability Excess of Loss Treaty, and the Property per Risk Excess of Loss Treaty. AEGON Hungary’s catastrophe cover, which protects private homeowners, is popular in the Hungarian market. Additionally, AEGON Hungary has smaller treaties for other business lines such as General Third Party Liability, Marine Cargo, and Life & Group Life Business. The majority of AEGON Hungary’s programs are non-proportional Excess of Loss programs, which is in line with AEGON Hungary’s strategy to cede only the higher risks or involve the reinsurers in high losses.
In addition, AEGON Czech Republic offered the following five riders: • Accidental death • Accidental disability • Children’s accidental disability • Diseases • Waiver of premium (for regular premium products) Distribution in the Czech Republic consists of an internal distribution network (IDN), an external distribution network (EDN), and alliance partner key account managers and distribution networks. IDN is comprised of tied agents who are associated to ten regional offices. EDN includes brokers. The key account managers are responsible for corporate business.
AEGON Czech Republic’s reinsurance partner is Munich Re, with a Standard and Poor’s rating of A+. Mortality risk and risk of disability are reinsured. The retention on any one life is CZK 600.
AEGON Poland has been a member of the AEGON Group since October 4, 2005. The company was incorporated on December 24, 1999. AEGON Poland is a joint stock company. It operates in Poland and is headquartered in Warsaw. AEGON Poland operates in the life insurance business. AEGON Poland operations are organized by sales channels and functional areas.
AEGON Poland’s distribution channels are comprised of tied agent networks, external agency networks (e.g., brokers), and the bank channels. In all networks, AEGON Poland is the provider of life insurance investment programs. Additionally, in the bank channel, AEGON Poland provides credit life protection to mortgages.
There are two AEGON operating units in Slovakia: • AEGON Life Insurance — the life insurance operations were started up on September 2, 2003 as a branch office of AEGON Levensverzekering N.V. At the end of October 2004, AEGON Life insurance Slovakia started its own operations. The branch office is in the process of being converted into a local company.
AEGON Life Insurance Slovakia offers the following products: • Universal life and unit-linked endowment, fixed term, whole life insurance, and endowments for children
• Mortgage (packaged endowment product) • Group life The Pension Asset Management company offers products for the second pillar retirement market (mandatory pension fund market).
In 2005, AEGON operated in Spain through two insurance companies: AEGON Seguros Salud and AEGON Seguros de Vida, subsidiaries of a holding company, AEGON España S.A. Administrative and operational services to all companies in Spain, including joint ventures with third parties, are provided by a separate legal entity: AEGON Administración y Servicios A.I.E.
In 2004, AEGON Spain set up a strategic partnership with Caja de Ahorros del Mediterráneo (CAM). This partnership combines CAM’s significant customer reach through its banking network with AEGON’s expertise in life insurance and pensions.
In July 2005, AEGON Spain entered into a strategic partnership agreement with Caja de Badajoz (CB) aiming at setting up a new insurance company, which will sell AEGON Spain’s life insurance, accident and pension products through the CB network. AEGON Spain will provide the back office services for this joint venture company. The agreement is subject to regulatory approval, and the transaction is expected to be completed in the first quarter of 2006.
Over the past several years, AEGON Spain has focused on the life insurance business for portfolio growth. By marketing unit-linked variable life products through multiple distribution channels significant inroads were made into a market traditionally dominated by banks.
AEGON Spain focuses on the individual consumer segment. AEGON Spain’s principal lines of business are traditional life and unit-linked insurance products. These products are distributed exclusively through the agency channel, using a network of agents and brokers.
At the end of 2001, AEGON Taiwan acquired a block of business comprised of 57,000 policies of National Mutual Life Association of Australia, AXA’s Taiwan life operation.
Over the past three years, distribution through brokerage and bancassurance has resulted in substantial growth in new accounts and business volume for the majority of AEGON Taiwan’s total new business premiums.
AEGON Taiwan has its mortality and morbidity risks reinsured by local and international reinsurers. Other than the local Central Reinsurance Company, which is going through a privatization, all reinsurers carry a current rating of A+ or higher. The reinsurance covers both excess surplus risks and catastrophic concentration risks.
Since its inception in 2003, AEGON-CNOOC has successfully established multiple distribution channels, including the agency, the bancassurance, direct marketing, and telemarketing channels. In addition, AEGON-CNOOC’s brokerage channel started to perform well since the Jiangsu branch began its business in September 2005.
The agency channel portfolio consists primarily of universal life and traditional life products including level whole life, coupon whole life, endowment life, and term life, as well as short-term accident and long-term health products. The most important product for the bancassurance channel is a single premium short-term universal life product. AEGON-CNOOC is also planning to gradually sell more regular premium products through the bancassurance channel. The major product for the telemarketing channel is a yearly-renewable personal accident product. The primary products sold through the brokerage channel are universal life and traditional life products as well as short-term accident and long-term health products.
In addition, AEGON-CNOOC entered into several commercial reinsurance arrangements to achieve a diversification of risks and to limit the maximum loss on risks that exceed policy retention limits. AEGON-CNOOC entered into reinsurance programs with Munich Re, Swiss Re, and General Re. The maximum amount retention limit on any one individual life is generally CNY 200,000.
These products are sold through a highly diversified distribution network. Similar types of products are grouped together and reported on in a certain line of business. For example: whole life, term life and universal life insurance products are grouped together in the traditional life line of business. The table on this page provides a broad overview of the lines of business for each country unit. The section ‘AEGON Around the world’ (page 65-79) provides more detail on the specific products sold in each country unit and in the financial statements information about products is also included.
Traditional life 823 566 Life for account of policyholders 243 304 Fixed annuities 425 284 Variable annuities 130 177 Institutional guaranteed products 280 367 Fee — off balance sheet products 33 36
United Czech GENERAL ACCOUNT United States Canada Netherlands Kingdom Hungary Republic Poland Slovakia Spain Taiwan China
Banking • Accident and health insurance • • • • • • • • • General insurance • • * Also distributed internationally from the United States
5. Financial information AEGON is committed to providing transparent information and quality services to existing and potential shareholders.
CONSOLIDATED BALANCE SHEET OF AEGON GROUP AS AT DECEMBER 31, 2005 Amounts in millions 82 AEGON ANNUAL REPORT 2005
2.03 1.72 Basic earnings per share (cents per share)1 45 1.63 1.38 2.03 1.72 Diluted earnings per share (cents per share)1 45 1.63 1.38
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY OF AEGON GROUP FOR THE YEAR ENDED DECEMBER 31, 2005 Amounts in EUR millions 84 AEGON ANNUAL REPORT 2005
1Issued capital and reserves attributable to equity holders of AEGON N.V.
Other Issued Share Retained Revaluation Other equity capital and Minority capital earnings reserves reserves instruments reserves1 interest Total
Gains/(losses) transferred to income statement on disposal and impairment — — (23) — — (23) — (23) Equity movements of associates — — — 59 — 59 — 59 Foreign currency translation differences — — (77) — — (77) — (77) Movements in foreign currency translation and net foreign investment hedging reserves — — — (755) — (755) — (755) Aggregate tax effect of items recognized directly in equity — (29) (329) — — (358) — (358)
(301) (136) Purchase of investments in real estate and real estate held for own use (242) (109)
Proceeds from sale and maturity of financial assets, 68,517 74,176 excluding fair value option assets and derivatives 55,007 59,646 326 305 Proceeds from sale of investments in real estate and real estate held for own use 262 245
2 1 Proceeds from issue of share capital 2 1 1,815 1,681 Proceeds from issue of perpetuals 1,457 1,352 1,293 710 Proceeds from borrowings and amounts due to banks 1,038 571 139 123 Proceeds from issue of treasury shares 112 99 (1,183) — Repayments of perpetuals (950) —
— (228) Repayments of capital securities and subordinated borrowings — (183) (1,959) (4,232) Repayments of borrowings and amounts due to banks (1,573) (3,403)
(1,799) 4,584 NET INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS (1,444) 3,686 9,268 4,500 Net cash and cash equivalents at the beginning of the year 6,804 3,563 (311) 184 Effects of exchange rate changes on cash and cash equivalents 708 (445)
7,158 9,268 NET CASH AND CASH EQUIVALENTS AT THE END OF THE YEAR 6,068 6,804
The consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS), as adopted by the European Union (EU).
The adoption of the amendments to IAS 19 has resulted in more extensive disclosures on the Group’s post-employment benefit plans. The option provided by the amendment to IAS 19 to recognize actuarial gains and losses immediately outside income has not been adopted. In accordance with the transitional provisions to the amendments, the amounts included in disclosures that require comparatives for four previous years will be determined for each annual period prospectively from 2005 onwards.
As allowed by IFRS 4 Insurance Contracts, the Group values its insurance contracts in accordance with the accounting principles that were applied prior to the transition to IFRS. The assets and liabilities relating to insurance contracts issued in the United States and Canada are accounted for in accordance with United States Generally Accepted Accounting Principles (US GAAP). On September 19, 2005, the Financial Accounting Services Board (FASB) released SOP 05-1 Accounting by Insurance Enterprises for Deferred Acquisition Costs
The Group will adopt SOP 05-1 for insurance contracts issued in the United States and Canada effective January 1, 2007. The Group is currently investigating the effect of SOP 05-1 on its accounting.
The excess of the cost of acquisition, comprising the consideration paid to acquire the interest and the directly related costs, over the Group’s share in the net fair value of assets, liabilities and contingent liabilities acquired is recognized as goodwill. Negative amounts are recognized directly in the income statement. If the fair value of the assets, liabilities and contingent liabilities acquired in the business combination has been determined provisionally, adjustments to these values resulting from the emergence of new evidence within twelve months after the acquisition date are made against goodwill. Also, goodwill is adjusted for changes in the estimated value of contingent considerations given in the business combination when they arise.
Subsidiaries are deconsolidated when control ceases. Any difference between the net proceeds and the carrying amount of the subsidiary is recognized in the income statement.
On consolidation of an investment fund, a liability is recognized to the extent that the Group is legally obliged to buy back participations held by third parties. Where this is not the case, other participations held by third parties are presented as minority interests in equity. The assets allocated to participations held by third parties or by the Group on behalf of policyholders are presented in the consolidated financial statements as investments for account of policyholders.
Equity instruments issued by the Group that are held by the investment funds are eliminated on consolidation. However, the elimination is not reflected in the measurement of the related financial liabilities towards policyholders or other third parties.
b. Jointly controlled entities Joint ventures are contractual agreements whereby the Group undertakes an economic activity with other parties that is subject to joint control.
At the balance sheet date monetary assets and monetary liabilities are translated at the prevailing exchange rate. Non-monetary items carried at cost are translated using the exchange rate at the date of the transaction, whilst assets carried at fair value are translated at the exchange rate when the fair value was determined.
On transition to IFRS on January 1, 2004, the foreign currency translation reserve was reset to nil. The US dollar information provided in the consolidated financial statements for comparative purposes is translated from euro by translating balance sheet items at the closing rate on the balance sheet date and income statement items at the average exchange rate.
a. Goodwill Goodwill is recognized as an intangible asset for interests in subsidiaries and joint ventures acquired after January 1, 2004 and is measured as the positive difference between the acquisition cost and the Group’s interest in the net fair value of the entity’s identifiable assets, liabilities and contingent liabilities. Subsequently, goodwill is carried at cost less accumulated impairment charges. It is derecognized when the interest in the subsidiary or joint venture is disposed of.
d. Other intangible assets Other intangible assets are recognized to the extent that the assets can be identified, are controlled by the Group, are expected to provide future economic benefits and can be measured reliably. The Group does not recognize internally generated intangible assets arising from research or internally generated goodwill, brands, customer lists and similar items.
a. Financial assets Financial assets are recognized on the trade date when the Group becomes a party to the contractual provisions of the instrument and are classified for accounting purposes depending on the characteristics of the instruments and the purpose for which they were purchased.
Classification The following financial assets are measured at fair value through profit or loss: financial assets held for trading, financial assets managed on a fair value basis in accordance with the Group’s risk management and investment strategy and financial assets containing an embedded derivative that is not closely related and that cannot be reliably bifurcated. In addition, the Group designates financial assets to this category when by doing so a potential accounting mismatch in the financial statements is eliminated or significantly reduced.
Measurement Financial assets are initially recognized at fair value excluding interest accrued to date plus, in the case of a financial asset not at fair value through profit or loss, any directly attributable incremental transaction costs.
Loans and assets held-to-maturity are subsequently carried at amortized cost using the effective interest rate method. Financial assets at fair value through profit or loss are measured at fair value with all changes in fair value recognized in the income statement as incurred. Available-for-sale assets are recorded at fair value with unrealized changes in fair value recognized directly in equity. Financial assets that are designated as hedged items are measured in accordance with the hedge accounting requirements.
The fair value of an asset is the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction. For quoted financial assets for which there is an active market, the fair value is the bid price at the balance sheet date. In the absence of an active market, fair value is estimated by using present value or other valuation techniques. Where discounting techniques are applied the discount rate is based on current market rates applicable to financial instruments with similar characteristics.
On derecognition the difference between the disposal proceeds and the carrying amount is recognized in the income statement as a realized gain or loss. Any cumulative unrealized gain or loss previously recognized in equity is also recognized in the income statement.
b. Real estate Property that is occupied by the Group and that is not intended to be sold in the near future is classified as real estate held for own use. Investments in real estate is property held to earn rentals or for capital appreciation, or both. Considering the Group’s asset liability management policies, under which both categories of property can be allocated to liabilities resulting from insurance and investment contracts, both are classified as investments.
Property is initially recognized at cost. Subsequently, investments in real estate are measured at fair value with the changes in fair value recognized in the income statement. Real estate held for own use is carried at its revalued amount, which is the fair value at the date of revaluation less any subsequent accumulated depreciation and impairment losses. Depreciation is calculated on a straight line basis over the useful life of a building. Land is not depreciated. On revaluation the accumulated depreciation is eliminated against the gross carrying amount of the asset and the net amount is restated to the revalued amount. Increases in the net carrying amount are recognized in the related revaluation reserve in equity and are released to retained earnings over the remaining useful life of the property.
Property under construction The Group develops property itself with the intention to hold it as investments in real estate. During the construction phase both the land and the building are presented as real estate held for own use, are held at cost, including directly attributable borrowing costs, and are not depreciated. When the construction phase is completed, the property is transferred to investments in real estate and revalued at fair value. Any resulting gain or loss is recognized in the income statement.
Maintenance costs and other subsequent expenditure Expenditure incurred after initial recognition of the asset is capitalized to the extent that the level of future economic benefits of the asset is increased. Costs that restore or maintain the level of future economic benefits are recognized in the income statement as incurred.
Investments held for account of policyholders consist of investments in financial assets, excluding derivatives, as well as investments in real estate and real estate held for own use. Investment return on these assets is passed on to the policyholder. Also included are the assets held by consolidated investment funds that are backing liabilities towards third parties. The accounting principles are consistent with those applicable to general account investments with the same classification, as described in note 2.7.
Assets and liabilities held by the Group may include derivative-like terms and conditions. With the exception of features embedded in contracts held at fair value through profit or loss, embedded derivatives that are not considered closely related to the host contract are bifurcated, carried at fair value and presented as derivatives. In assessing whether a derivative-like feature is closely related to the contract in which it is embedded, the Group considers the similarity of the characteristics of the embedded derivative and the host contract. Embedded derivatives that transfer significant insurance risk are accounted for as insurance contracts.
Derivatives with positive values are reported as assets and derivatives with negative values are reported as liabilities. Derivatives for which the contractual obligation can only be settled by exchanging a fixed amount of cash for a fixed amount of AEGON N.V. equity instruments are accounted for as equity and are therefore discussed in the notes on equity.
b. Measurement All derivatives are recognized on the balance sheet at fair value. All changes in fair value are recognized in the income statement, unless the derivative has been designated as a hedging instrument in a cash flow hedge or a hedge of a net foreign investment.
To qualify for hedge accounting, the hedge relationship is designated and formally documented at inception, detailing the particular risk management objective and strategy for the hedge (which includes the item and risk that is being hedged), the derivative that is being used and how hedge effectiveness is being assessed. A derivative has to be effective in accomplishing the objective of offsetting either changes in fair value or cash flows for the risk being hedged. The effectiveness of the hedging relationship is evaluated on a prospective and retrospective basis using qualitative and quantitative measures of correlation. Qualitative methods may include comparison of critical terms of the derivative to the hedged item. Quantitative methods include a comparison of the changes in the fair value or discounted cash flow of the hedging instrument to the hedged item. A hedging relationship is considered effective if the actual results of the hedge are within a ratio of 80 to 125%.
Cash flow hedges are hedges of the exposure to variability in cash flows that is attributable to a particular risk of a forecast transaction or a recognized asset or liability and could affect profit or loss. To the extent that the hedge is effective, the change in the fair value of the derivative is recognized in the related revaluation reserve in equity. Any ineffectiveness is recognized directly in the income statement. The amount recorded in equity is released to the income statement to coincide with the hedged transaction, except when the hedged transaction is an acquisition of a non-financial asset or liability. In this case, the amount in equity is included in the initial cost of the asset or liability.
Net investment hedges are hedges of currency exposures on a net investment in a foreign operation. To the extent that the hedge is effective, the change in the fair value of the derivative is recognized in equity. Any ineffectiveness is recognized in the income statement. The amount in equity is released to the income statement when the foreign operation is disposed of.
On disposal of an interest in an associate, the difference between the net proceeds and the carrying amount is recognized in the income statement and gains and losses previously recorded directly in equity are reversed and recorded through the income statement.
Reinsurance contracts are contracts entered into by the Group whereby it will receive compensation for losses on contracts written by the Group from another insurer. For contracts transferring sufficient insurance risk, a reinsurance asset is recognized for the expected future benefits, less expected future reinsurance premiums. Reinsurance contracts with insufficient insurance risk are accounted for as investment or service contracts, depending on the nature of the agreement.
b. Deferred transaction costs Deferred transaction costs relate to investment contracts without discretionary participation features under which AEGON will render investment management services. Incremental costs that are directly attributable to securing these investment management contracts are recognized as an asset if they can be identified separately and measured reliably and if it is probable that they will be recovered.
c. Deferred interest rebates An interest rebate is a form of profit sharing whereby the Group gives a discount on the premium payable based on the expected surplus interest that will be earned on the contract. The expected return on investments is based on a portfolio of existing government bonds. The rebate can be subject to additional conditions concerning actual returns or the continuation of the policy for a specified number of years.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF AEGON GROUP Amounts in EUR millions, unless otherwise stated 2.13 OTHER ASSETS AND RECEIVABLES
Cash comprises cash at banks and in-hand. Cash equivalents are short-term, highly liquid investments that are readily convertible to known cash amounts, are subject to insignificant risks of changes in value and are held for the purpose of meeting short-term cash commitments.
An asset is impaired if the carrying amount exceeds the amount that would be recovered through its use or sale. Tangible and intangible assets, financial assets and reinsurance assets, if not held at fair value through profit or loss, are tested for impairment when there are indications that the asset may be impaired. Irrespective of the indications, goodwill and other intangible assets that are not amortized are tested at least annually. For assets denominated in a foreign currency, a decline in the foreign exchange rates is considered an indication of impairment.
a. Impairment of non-financial assets Assets are tested individually for impairment when there are indications that the asset may be impaired. The impairment loss is calculated as the difference between the carrying and the recoverable amount of the asset, which is the higher of an asset’s value in use and its net selling price. The value in use represents the discounted future net cash flows from the continuing use and ultimate disposal of the asset and reflects all its inherent risks and uncertainties.
Assets that only generate cash flows in combination with other assets and liabilities are tested for impairment at the level of the cash-generating unit. When impairing a cash-generating unit, any goodwill allocated to the unit is first written-off and recognized in the income statement. The remaining impairment loss is allocated on a pro rata basis among the other assets, on condition that the resulting carrying amounts do not fall below the individual assets’ recoverable amounts. With the exception of goodwill, impairment losses on other non-financial assets can be reversed.
For debt instruments classified as available-for-sale, the asset is impaired to its fair value. Any unrealized gain or loss previously recognized in equity is reversed and recognized in the income statement. After impairment the interest accretion on debt instruments that are classified as available-for-sale is based on the rate of return that would be required by the market for similar rated instruments at the date of impairment.
Impairment losses recognized for debt instruments can be reversed if in subsequent periods the amount of the impairment loss decreases and that decrease can be related objectively to a credit related event occurring after the impairment was recognized. For debt instruments carried at amortized cost, the carrying amount after reversal cannot exceed its amortized cost at the reversal date.
c. Impairment of equity instruments For equity instruments, a significant or prolonged decline in fair value below initial cost is considered objective evidence of impairment and always results in a loss being recognized in the income statement. Equity investments are impaired to the asset’s fair value and any unrealized gain or loss previously recognized in equity is reversed and recognized in the income statement.
d. Impairment of reinsurance assets Reinsurance assets are impaired if there is objective evidence, as a result of an event that occurred after initial recognition of the reinsurance asset, that not all amounts due under the terms of the contract will be received and the impact of the event on the amount to be received from the reinsurer can be reliably measured. Impairment losses are recognized in the income statement.
Financial instruments that are issued by the Group are classified as equity if they evidence a residual interest in the assets of the Group after deducting all of its liabilities. In addition to common shares and preferred shares, the Group has issued perpetual securities that are classified as equity, rather than as debt, as these securities have no final maturity date, repayment is at the discretion of the issuer and AEGON has the option to defer coupon payments at its discretion. These securities are measured at par and are translated using historical exchange rates.
Other products with account terms that are not fixed or guaranteed are generally measured at the policyholder’s account balance. Depending on local accounting principles, the liability may include amounts for future services on contracts where the policy administration charges are higher in the initial years than in subsequent years. In establishing the liability, guaranteed minimum benefits issued to the policyholder are measured as described in 2.18(c) or, if bifurcated from the host contract, as described in 2.9.
c. Embedded derivatives and participation features Life insurance contracts typically include derivative-like terms and conditions. With the exception of policyholder options to surrender the contract at a fixed amount, contractual features that are not closely related to the insurance contract and that do not themselves meet the definition of insurance contracts are accounted for as derivatives. If the embedded derivative cannot be reliably bifurcated, the entire insurance contract is carried at fair value through profit or loss.
In the United States the additional liability for guaranteed minimum benefits that are not bifurcated is determined each period by estimating the expected value of benefits in excess of the projected account balance and recognizing the excess over the accumulation period based on total expected assessments. The estimates are reviewed regularly and any resulting adjustment to the additional liability is recognized in the income statement. The benefits used in calculating the liabilities are based on the average benefits payable over a range of stochastic scenarios. Where applicable, the calculation of the liability incorporates a percentage of the potential annuitizations that may be elected by the contract holder.
All tests performed within the Group are based on current estimates of all contractual future cash flows, including related cash flows and policyholder options and guarantees. A number of valuation methods are applied, including discounted cash flow methods, option pricing models and stochastic modeling. Aggregation levels and the level of prudence applied in the test are consistent with local requirements. To the extent that the tests involve discounting of future cash flows, the interest rate applied may be prescribed by the local regulator or may be based on management’s expectation of the future return on investments. In the Netherlands, the discount rate is the lower of the tariff rate and management’s prudent assumption based on current market interest rates.
Any resulting deficiency is recognized in the income statement, initially by impairing the DPAC and VOBA and subsequently by establishing a technical reserve for the remaining loss. In subsequent periods, the liability for a block of business that has failed the adequacy test is based on the assumptions that are established at the time of loss recognition. The assumptions do not include a margin for adverse deviation, unless required under local accounting policies. Impairment losses resulting from liability adequacy testing can only be reversed if allowed by local accounting principles.
f. Non-life insurance contracts Non-life insurance contracts are insurance contracts where the insured event is not life-contingent. For non-life products the insurance liability generally includes reserves for unearned premiums, unexpired risk, inadequate premium levels and outstanding claims and benefits. No catastrophe or equalization reserves are included in the measurement of the liability.
Investment contract liabilities are recognized when the contract is entered into and are derecognized when the contracts expire, are discharged or are cancelled.
a. Investment contracts with discretionary participation features Some investment contracts have participation features whereby the policyholder has the right to receive potentially significant additional benefits which are based on the performance of a specified pool of investment contracts, specific investments held by the Group or on the issuer’s net income. If the Group has discretion over the amount or timing of the distribution of the returns to policyholders, the investment contract is measured based on the accounting principles that apply to insurance contracts with similar features.
b. Investment contracts without discretionary participation features At inception the Group designates investment contracts without discretionary features as at fair value through profit or loss if by doing so a potential accounting mismatch in the financial statements is eliminated or significantly reduced or if the contract is managed on a fair value basis. Some investment contracts with embedded derivatives that have not been bifurcated are also carried at fair value through profit or loss. All other contracts are carried at amortized cost.
a. Short-term employee benefits A liability is recognized for the undiscounted amount of short-term employee absences expected to be paid within one year after the end of the period in which the service was rendered. Accumulating short-term absences are recognized over the period in which service is provided. Benefits that are not service-related are recognized when the event that gives rise to the obligation occurs.
Defined benefit plans On transition to IFRS on January 1, 2004, assets or liabilities relating to defined benefit plans were recognized for the differences between the defined benefit obligations and the fair value of the plan assets.
The defined benefit obligation is based on the terms and conditions of the plan applicable on the balance sheet date. Plan improvements are charged directly to the income statement, unless they are conditional on the continuation of employment. In this case the related cost is deducted from the liability as past service cost and amortized over the vesting period. In measuring the defined benefit obligation the Group uses the projected unit credit method and actuarial assumptions that represent the Group’s best estimate of future variables. The benefits are discounted using an interest rate based on the market yields for high-quality corporate bonds on the balance sheet date.
The cost of the plans is determined at the beginning of the year, based on the prevalent actuarial assumptions, discount rate and expected return on plan assets. Changes in assumptions, discount rate and experience adjustments are not charged to the income statement directly, but are deferred and included in the liability on the balance sheet date as unrecognized actuarial gains and losses.
The unrecognized actuarial gains and losses are amortized in a straight line over the average remaining working life of the employees covered by the plan, to the extent that the gains or losses exceed the corridor limits. The corridor is defined as ten percent of the greater of the defined benefit obligation and the plan assets. The amortization charge is reassessed at the beginning of each year.
Gross premiums, including recurring and single premiums, from life and non-life insurance and investment contracts with discretionary participation features are recognized as revenues when they become receivable. Not reflected as premium income are deposits from certain products that are sold in the United States and Canada, such as deferred annuities. For these products the surrender charges and charges assessed have been included in gross premiums.
Fees and commissions from investment management services and mutual funds and from sales activities are recognized as revenue over the period in which the services are performed or the sales have been closed.
Gains and losses on investments includes realized gains and losses on general account financial assets, other than those classified as at fair value through profit or loss, and gains and losses on investments in real estate. It also includes fair value changes for derivatives that are used for economic hedge purposes, as part of the Group’s asset liability management, and for which no hedge accounting is applied. These derivatives are considered economic hedges of certain exposures related to an existing asset or liability. The fair value movements of these derivatives are not offset by fair value movements as the underlying asset or liability is not valued at fair value through profit or loss. Gains and losses on investments also include the ineffective portions of hedge transactions. The impact of gains and losses on the valuation of DPAC, VOBA and insurance liabilities are included in gains and losses on investments.
Impairment charges on investments in financial assets are disclosed in note 41. Other impairment charges are included in fair value and foreign exchange losses.
Valuation of assets and liabilities arising from life insurance contracts The liability for life insurance contracts with guaranteed or fixed account terms is either based on current assumptions or on the assumptions established at inception of the contract, reflecting the best estimates at the time increased with a margin for adverse deviation. All contracts are subject to liability adequacy testing which reflects management’s current estimates of future cash flows. To the extent that the liability is based on current assumptions, a change in assumptions will have an immediate impact on the income statement. Also, if a change in assumption results in the failure of the liability adequacy test, the entire deficiency is recognized in the income statement.
Some insurance contracts without a guaranteed or fixed account term contain guaranteed minimum benefits. Depending on the nature of the guarantee, it may either be bifurcated and presented as a derivative or be reflected in the value of the insurance liability in accordance with local accounting principles. Given the dynamic and complex nature of these guarantees, stochastic techniques under a variety of market return scenarios are often used for measurement purposes. Such models require management to make numerous estimates based on historical experience and market expectations. Changes in these estimates will immediately affect the income statement.
In addition, certain acquisition costs related to the sale of new policies and the purchase of policies already in force are recorded as DPAC and VOBA assets respectively and are amortized to the income statement over time. If the assumptions relating to the future profitability of these policies are not realized, the amortization of these costs could be accelerated and may even require write offs due to unrecoverability.
Fair value of investments and derivatives determined using valuation techniques Financial instruments In the absence of an active market, the fair value of non-quoted investments in financial assets is estimated by using present value or other valuation techniques. For example, the fair value of non-quoted fixed interest debt instruments is estimated by discounting expected future cash flows using a current market rate applicable to financial instruments with similar yield, credit quality and maturity characteristics. For mortgage and other loans originated by the Group interest rates currently being offered for similar loans to borrowers with similar credit ratings are applied. The fair value of floating interest rate debt instruments and assets maturing within a year is assumed to be approximated by their carrying amount.
Financial derivatives Where quoted market prices are not available, other valuation techniques, such as option pricing or stochastic modeling, are applied. The valuation techniques incorporate all factors that market participants would consider and are based on observable market data when available. All models are validated before they are used and calibrated to ensure that outputs reflect actual experience and comparable market prices.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF AEGON GROUP Amounts in EUR millions, unless otherwise stated under a variety of market return scenarios are often used. A variety of factors are considered, including expected market rates of return, market volatility, correlations of market returns, discount rates and actuarial assumptions.
The expected returns are based on risk-free rates, such as the current London Inter-Bank Offered Rate (LIBOR) forward curve or the current rates on local government bonds. Market volatility assumptions for each underlying index are based on observed market implied volatility data or observed market performance. Correlations of market returns across underlying indices are based on actual observed market returns and relationships over a number of years preceding the valuation date. The current risk-free spot rate is used to determine the present value of expected future cash flows produced in the stochastic projection process.
Recognition of deferred tax assets Deferred tax assets are established for the tax benefit related to deductible temporary differences, carryforwards of unused tax losses and carryforwards of unused tax credits when in the judgment of management it is more likely than not that AEGON will receive the tax benefits. Since there is no absolute assurance that these assets will ultimately be realized, management reviews AEGON’s deferred tax positions periodically to determine if it is more likely than not that the assets will be realized. Periodic reviews include, among other things, the nature and amount of the tax income and expense items, the expected timing when certain assets will be used or liabilities will be required to be reported and the reliability of historical profitability of businesses expected to provide future earnings. Furthermore, management considers tax-planning strategies it can utilize to increase the likelihood that the tax assets will be realized. These strategies are also considered in the periodic reviews.
Valuation of share appreciation rights and share options Because of the inability to measure the fair value of employee services directly, fair value is measured by reference to the fair value of the rights and options granted. This value is estimated using the binomial option pricing model, taking into account the respective vesting and exercise periods of the share appreciation rights and share options.
As an insurance company, AEGON is in the risk business and as a result is exposed to a variety of risks. Some risks, such as currency translation risk, are related to the international nature of AEGON’s business. Other risks include insurance related risks, such as changes in mortality, morbidity and lapses. However, the Group’s largest exposures are to changes in financial markets (for example interest rate, credit and equity market risks) that affect the value of the investments, liabilities related to the products sold, VOBA and deferred expenses.
General account life products With general account life insurance products, AEGON typically bears the investment risk, earns a spread (the difference between investment performance and crediting rates to customers), realizes underwriting results (on mortality, morbidity, persistency and expenses) or targets a combination thereof.
The timing and extent of policyholder lapses is another risk of these products. Early policyholder lapsation before acquisition costs have been fully recovered and without sufficient commission claw back clauses can cause a loss. In some products, lapses significantly below expectations can result in more future claims than anticipated in the premium pricing and contribute to losses.
AEGON’s underwriting strategy is intended to ensure that the risks underwritten are well diversified in terms of type of risk and level of benefits. AEGON also uses third-party reinsurers to spread mortality risk. Furthermore, AEGON’s risk policy dictates a maximum insured benefit on a country basis it will retain on any one life, reinsuring the excess.
UNITED STATES In the United States traditional life products consist largely of permanent life, universal life and term life insurance.
Universal life Universal life insurance has either a flexible or single premium. The contract has a feature that allows the customer greater flexibility as to when to pay premiums and with regard to the amount of the premiums, subject to a minimum and a maximum. The interest rate at which the cash value accumulates is adjusted periodically.
Minimum interest rate guarantees exist in all generations of fixed universal life products, as they are required by non-forfeiture regulations. These are mostly at 4%, with newer products at 3%. No lapse guarantees were introduced in recent universal life products. The no lapse guarantee feature provides a policyholder the guarantee that the universal life policy will stay in force, even if the cash value becomes zero or less than zero, provided that a specified minimum premium payment is made when due or a shadow account remains positive. The guarantee period can vary from five years to the entire contract term.
Term life insurance The terms and conditions of AEGON Canada’s term life insurance product are consistent with those described above for the operations of the United States.
Universal life Universal life insurance is another form of permanent life insurance and has features similar to those described for the United States.
Single premium immediate annuities This product is a life contingent payout annuity with guaranteed regular payments for the life of the annuitant. Some of these contracts have a minimum guaranteed payment period.
THE NETHERLANDS The traditional life products of AEGON The Netherlands consist largely of endowment insurance and pensions and annuity insurance.
Endowment insurance This category includes products that accumulate a cash value and term life insurance products. Premiums are paid at inception or over the term of the contract.
Interest rebates are given on both single and regular premium pension and annuity insurance and may be based on a portfolio of Dutch government bonds, although other calculation bases are also applied. There are also profit sharing schemes set by reference to external indices that are based on predefined portfolios of Dutch government bonds.
UNITED KINGDOM The AEGON UK traditional life business primarily comprises immediate annuity, individual protection and group protection business. The protection business provides insurance of major life events such as death, critical illness and total or permanent disability on individual or groups of lives. A menu approach offers flexibility on the level and combination of benefits that can be chosen. Premium levels for individual business are typically fixed over the term of the contract, while those for group arrangements are normally reviewed every two years.
In Slovakia the current minimum interest rate on universal life products is 3%. Universal life products in the Czech Republic have a guaranteed interest rate of 2.4%.
AEGON USA also reinsures variable annuity business on a modified coinsurance with funds withheld basis. Under modified coinsurance with funds withheld arrangements, Transamerica Reinsurance typically finances acquisition costs of a variable annuity block of the client company. In return, Transamerica Reinsurance gets a regular fee generated from the underlying variable annuity account. Lapse risk is a significant risk assumed by the reinsurer.
AEGON USA also assumes fixed annuity business on a coinsurance basis from client companies. With the coinsurance arrangement, the client company pays the reinsurer the reinsurance premiums equal to the reinsurer’s quota share of the gross contribution or premiums that the client company receives on the policies. The reinsurer will pay the client death or surrender benefits upon death or surrender of the policyholder and will reimburse the client specific allowances which cover its share of expenses. The reinsurer can choose whether to participate in the annuitization guarantee, but shares in all other significant risks inherent in the underlying contract, including lapse, expense and investment risks.
UNITED STATES Fixed annuities include both deferred annuities and immediate annuities. A fixed deferred annuity exposes AEGON to both interest rate risk and lapse risk. The interest rate risk can be mitigated through asset liability matching and hedging, though policyholder behavior can never be fully matched. Surrender charges in early policy years serve as a deterrent to early duration lapses. In addition, fixed annuities sold in the United States contain a significant longevity risk created by guaranteed annuity options and may also offer waiver of account value surrender charges upon the death of the insured. Immediate annuities contain interest rate risk and also longevity risk if annuity payments are life contingent.
An immediate annuity is purchased with a single lump sum premium payment and the benefit payments generally begin within a year after the purchase. The benefit payment period can be for a fixed period, for as long as the beneficiary is alive, or a combination of the two. Fixed deferred annuity contracts may be purchased on either a flexible or single premium basis. Deferred annuities are offered on a fixed or indexed basis with the option of liquidating the contract at any time after the purchase. Upon maturity of the annuity, the customer can select payout options, including a lump sum payment or income for life, as well as payment for a specified period of time. Should the customer die prior to receiving the benefits of the policy, the beneficiary receives either an accumulated cash value death benefit or an enhanced death benefit in the event there are benefit riders attached to the base contract. The customer can surrender the annuity prior to maturity and receive the cash value less surrender charges. Fixed deferred annuities have a specified crediting rate that can be reset periodically by AEGON. Fixed deferred annuity contracts in the United States also offer discretionary crediting rates, as well as guaranteed minimum surrender values and payout options.
A discontinued multi-strategy annuity allows a customer a choice of investment strategies to allocate funds and provides a cumulative minimum guaranteed interest rate. Early withdrawal by the customer of the cash value of the annuity is subject to surrender charges.
Minimum interest rate guarantees exist in all generations of deferred annuity products, as they are required by non-forfeiture regulations. On average, minimum interest guarantees are at around 3%, with new products at 1.5%. Equity indexed annuities offer returns that are indexed to S&P 500, with a minimum of 0% and a cap on the return. The cap is reset periodically and is currently at 6.5%.
CANADA Fixed annuity contracts in Canada have fixed rates for specified terms and contracts are sold as redeemable or non-redeemable. Some contracts are sold on the basis that a market value adjustment will apply for surrenders prior to maturity, while other contracts are sold on the basis that they are redeemable; however these contracts will provide a lower rate of interest than the non-redeemable contracts.
This line of business primarily includes the issuance of guaranteed investment contracts (GICs) and funding agreements (FAs). GICs and FAs are marketed to institutional investors, such as pension funds, retirement plans, college savings plans, money market funds, municipalities and United States and overseas investors. GICs are generally issued to tax qualified plans, while FAs are typically sold to non-tax qualified institutional investors. The products are marketed through an internal sales force in the United States and Ireland.
GICs and FAs are spread-based products that are generally issued on a fixed- or floating-rate basis and provide the customer a guarantee of principal and a specified rate of return. For some of the products, the customer receives a return based on a change in a published index, such as the S&P 500. The term of the contract can be fixed, primarily from six months up to ten years, or it can have an indefinite maturity. Contracts with an indefinite maturity provide the customer with a put option whereby the contract will be terminated with advance notice, ranging from three to thirteen months. Some contracts offer benefit-responsive withdrawal rights to the client, but these withdrawals cannot be for economic reasons.
In addition, AEGON utilizes consolidated special purpose entities linked to asset-backed commercial paper for the issuance of certain FAs. These are reflected in other FAs in the table that follows.
The account balances at December 31, 2005 consisted of fixed-rate, fixed-maturity contracts (48%); floating-rate, fixed-maturity contracts (30%); indeterminate-maturity contracts (21%); and market-indexed, fixed-maturity contracts (1%). Practically all of the fixedrate contracts are swapped to floating-rate via swap agreements. Credited interest on floating-rate contracts reset mostly on a monthly basis on various indices. Indeterminate-maturity contracts allow the customer to withdraw funds with advance notice periods, ranging from three to thirteen months, without a withdrawal penalty. Market-indexed contracts provide a return based on the market performance of a designated index, such as the S&P 500. Futures or swap contracts are used to hedge the market risk and effectively convert the contracts to a floating-rate. All contracts are swapped to US dollars to eliminate the currency risk.
TOTAL GICs AND FAs 26,348 21,571 1Book value out: the amount equal to the sum of deposits less withdrawals with interest accrued at the contractual interest rate. 2Market value out: the amount equal to the book value out plus a market value adjustment to adjust for changes in interest rates.
The municipal/governmental FAs generally include downgrade language pursuant to which, should various downgrade events be triggered, one of the following four options must be followed: • Transfer contract to a higher-rated party • Purchase a credit enhancement • Collateralize the underlying position or • Pay the contract out at book value.
These options are negotiated with the customer at contract issuance, but AEGON unilaterally retains the ultimate decision-making capability in the event of a downgrade. Available collateral is monitored to ensure AEGON would be able to utilize this option at its discretion.
For account of policyholders life products Products for the account of policyholders are those where the policyholder carries the investment risk. AEGON earns management, administration and guaranteed minimum benefit fees, as well as mortality results on products.
Life for account of policyholder products are sold in the United States, the Netherlands, the United Kingdom, Hungary, Slovakia, Czech Republic, Poland, Spain, Taiwan and China.
Life for account of policyholder products include several forms of life insurance and pension products whereby death benefits and cash values vary with the performance of a portfolio of investments. Premiums can be allocated among a variety of investments that offer different degrees of risk and reward, including shares, bonds, combinations of both, or investment products that guarantee interest and principal. The customer retains the investment risk and AEGON earns a return from investment management fees, mortality-based cost of insurance charges, other guarantee charges and expense charges. The contract account balance varies with the performance of the investments chosen by the policyholder.
These products include: • Variable universal life in the United States • Tontine plans in the Netherlands • Separate account group contracts in the Netherlands • Unit-linked contracts in the Netherlands, the United Kingdom, Hungary, Spain, Taiwan and Slovakia and • With-profit business in the United Kingdom.
Separate account group contracts of AEGON The Netherlands are large group contracts that have an individually determined asset investment underlying the pension contract. The guarantee given is that the profit sharing is the minimum of 0% or the realized return (on an amortized cost basis), both corrected for the technical interest of either 3% or 4%. If there is a negative profit sharing, the 0% minimum is effective, but the loss in any given year is carried forward to be offset against any future surpluses. In general, a guarantee is given for the life of the underlying employees so that their pension benefit is guaranteed.
For AEGON The Netherlands, within individual unit-linked policies, the sum insured at maturity or upon the death of the beneficiary has a minimum guaranteed return (of 3% or 4%) if the premium has been paid for a consecutive period of at least ten years and is invested in a mixed fund and/or fixed-income funds. No guarantees are given for equity investments only.
UNITED KINGDOM The main life for account of policyholder products currently sold in the United Kingdom are: • Unit-linked pensions, for individuals or groups of lives, through regular and/or single premium contributions and • Unit-linked single premium savings contracts (bonds) outside the pensions environment.
Included in for account of policyholder assets and liabilities are the invested assets and the insurance and investment contract liabilities of AEGON UK’s with profit funds. The assets and liabilities are equal as any excess of assets over liabilities in respect of guaranteed benefits and constructive obligations are classified as an insurance or investment contract liability. The Scottish Equitable with profit fund is a 100:0 fund, where all benefits are held for participating policyholders. The Guardian Assurance plc with profit fund is a 90:10 fund where there is a 10% profit participation by AEGON UK in surpluses distributed to policyholders. For the Guardian fund, profit for AEGON UK emerges based on bonuses declared.
Guarantees All AEGON UK contracts with investment guarantees have been written in ‘policyholder-owned’ funds (called with profit funds) that contain assets which, as yet, have not been distributed to individual policyholders. These ‘free assets’ help meet the cost of guarantees and provide a buffer to deal with adverse events; an exposure for AEGON UK only arises once these have been exhausted and, as also outlined later, AEGON believes this exposure to be low.
Under a number of contracts written mainly in the 1970s and 1980s, Scottish Equitable also offered minimum pension guarantees (including guaranteed annuity options). As longevity has improved and interest rates have fallen over time, these minimum guarantees are now often valuable.
• Guardian Assurance plc The AEGON UK interest in Guardian Assurance plc’s with profit fund is 10% of profits in the fund, with the remaining 90% going to with profits policyholders. In 1998, prior to acquisition by AEGON UK, the with profit fund was restructured and became closed to new business, except for a low level of increments.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF AEGON GROUP Amounts in EUR millions, unless otherwise stated guarantees and provide a buffer to deal with adverse events. An exposure for AEGON UK only arises once ‘free assets’ have been exhausted; this has been assessed by AEGON UK to be immaterial through extending the risk based capital approach now required for solvency reporting to the regulator in the United Kingdom.
As all of AEGON UK’s with profit funds are closed to new business with investment guarantees, the process has begun of gradually distributing free assets to with profits policyholders through the bonus system outlined earlier. Part of the management of this process involves trying to ensure that any surpluses in the with profit fund from other (historic) business lines can be distributed to existing with profit policyholders at a suitable rate. In particular, Guardian Assurance plc has reinsured blocks of immediate annuity business to AEGON UK on terms reflective of prevailing market rates; this helps avoid a tontine effect building up in the fund, as the number of with profit policyholders decline.
Certain variable insurance contracts also provide guaranteed minimum death benefits and guaranteed minimum income benefits. Under a guaranteed minimum death benefit, the beneficiaries receive the greater of the account balance or the guaranteed amount upon the death of the insured. The guaranteed minimum income benefit feature provides for minimum payments if the contractholder elects to convert to an immediate payout annuity. The guaranteed amount is calculated using the total deposits made by the contractholder, less any withdrawals and sometimes includes a roll-up or step-up feature that increases the value of the guarantee with interest or with increases in the account value. These benefits subject the company to equity market risk, since poor market performance will cause the guaranteed benefits to exceed the policyholder account value and thus become in the money.
Bundled retirement plans are sold to mid-sized and large employers. A ‘manager of managers’ investment approach is generally used specifically for the retirement plans market, which allows clients access to institutional investment managers across the major asset classes. These funds are available in a ‘core-and-feeder’ structure, in which the core is similar to a mutual fund and the feeder provides an institutional customer with a choice of products that are directly linked to the performance of the mutual fund, such as a registered 110 AEGON ANNUAL REPORT 2005
When the premium is not guaranteed, AEGON reserves the right to raise premiums, if justified by adverse experience. A related risk is persistency, in that greater than expected persistency may increase the aggregate level of claims beyond what was anticipated in the pricing. An additional risk is investment related, in that recurring future premiums are subject to investment at future rates that may be less than those assumed when pricing the product.
The Group manages risk at the local level where business is transacted, based on principles and policies established at the group level. AEGON’s integrated approach to risk management involves common measurement of risk and scope of risk coverage to allow for aggregation of the Group’s risk position. In addition, this integrated framework facilitates the sharing of best practices and the latest research on methodologies. The risk management functions are applied locally with corporate oversight and are tied to the speed of business, while remaining independent of the business activity providing oversight and peer review.
In periods of rapidly increasing interest rates, policy loans, surrenders and withdrawals may and usually do increase. Premiums in flexible premium policies may decrease as policyholders seek investments with higher perceived returns. This activity may result in cash payments requiring the sale of invested assets at a time when the prices of those assets are adversely affected by the increase in market interest rates; this may result in realized investment losses. These cash payments to policyholders result in a decrease in total invested assets and a decrease in net income. Among other things, early withdrawals may also require accelerated amortization of DPAC, which in turn reduces net income.
During periods of sustained low interest rates, life insurance and annuity products may be relatively more attractive to consumers, resulting in increased premium payments on products with flexible premium features, and a higher percentage of insurance policies remaining in force from year to year. During such a period, investment earnings may be lower because the interest earnings on new 112 AEGON ANNUAL REPORT 2005
If interest rates rise, there may be unrealized losses on some of our assets that will be recorded as negative income under IFRS. This is inconsistent with the IFRS accounting on much of the company’s liabilities where corresponding unrealized gains when interest rates rise do not affect income in the shorter term. Over time, the short-term reduction in income due to rising interest rates would be offset by higher income in later years all else equal. Therefore, rising interest rates are not considered a long-term risk to the company.
The tables that follow show the effective interest rates and the earliest of contractual repricing or maturity dates for general account financial assets and borrowings.
FINANCIAL LIABILITIES RELATING TO TRUST PASS-THROUGH SECURITIES AND BORROWINGS — 2005
• Trust pass-through securities — — — — — — 437 7.67%
FINANCIAL LIABILITIES RELATING TO TRUST PASS-THROUGH SECURITIES AND BORROWINGS — 2004
Money market and other short-term investments 3,201 2,748 Mortgage loans 17,231 15,749 Private loans 609 836 Other loans 3,945 3,763 Other financial assets 2,823 1,984 Derivatives with positive values 1,855 1,533 Reinsurance assets 3,805 3,028
Country units apply specific guidelines for the acceptable levels of credit risk. AEGON monitors its aggregate exposure to credit counterparties at group level. For this purpose, AEGON aggregates exposures from its country units to assess overall credit risk. To manage its credit risk, AEGON has a single credit counterparty limit policy to be applied to all forms of credit risk. All forms of credit risk are required to be aggregated by counterparty and measured for compliance against country unit credit limits and group wide credit limits. The group wide limits are shown in the table that follows.
AAA 1,000 AA 1,000 A 750 BBB 500 BB 250 B 125 CCC or lower 50 1The fixed-income issuer rating is used when applying the credit counterparty limit exposure policy.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF AEGON GROUP Amounts in EUR millions, unless otherwise stated 116 AEGON ANNUAL REPORT 2005
Services non-cyclical — 165 — — 165 171 1Includes investments of Holding and other activities.
Equity market exposure is present in equity-linked products whereby policyholder funds are invested in equities at the discretion of the policyholder; here most of the risk remains with the policyholder. Examples of these products include variable annuities, variable universal life, unit-linked products and mutual funds. AEGON typically earns a fee on the asset balance in these products and therefore
AEGON’s shareholders’ equity is directly exposed to, among other things, movements in the equity and real estate markets and to movements in interest rates. With the implementation of IFRS, income and shareholders’ equity are expected to be more volatile and subject to increased sensitivity to movements in equity and real estate markets and to movements in interest rates. In addition, net income is sensitive to the fees earned on equity investments held for the account of policyholders as well as the amortization of DPAC and deferred transaction costs and provisioning for minimum product guarantees.
Sources of underwriting risk include policy lapses and policy claims such as mortality, morbidity and expenses. In general, AEGON is at risk if policy lapses increase as sometimes AEGON is unable to fully recover up front expenses in selling a product despite the presence of commission recoveries or surrender charges and fees. For mortality and morbidity risk, AEGON sells certain types of policies that are at risk if mortality or morbidity increases, such as term life insurance and accident insurance, and sells certain types of policies that are at risk if mortality decreases such as annuity products. AEGON is also at risk if expenses are higher than assumed by management.
AEGON monitors and manages its underwriting risk by underwriting risk type. Attribution analysis is performed on earnings and reserve movements in order to understand the source of any material variation in actual results from what was expected. AEGON’s units also perform experience studies for underwriting risk assumptions, comparing AEGON’s experience to industry experience as well as combining AEGON’s experience and industry experience based on the depth of the history of each source to AEGON’s underwriting assumptions. Where policy charges are flexible in products, AEGON uses these analyses as the basis for modifying these charges, with a view to maintain a balance between policyholder and shareholder interests. AEGON also has the ability to reduce expense levels over time, thus mitigating unfavorable expense variation.
2The mortality sensitivities assume that mortality/morbidity increases or decreases for all products regardless of whether one product produces a gain or loss on the directional change.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF AEGON GROUP Amounts in EUR millions, unless otherwise stated 5 SEGMENT INFORMATION
Life for account of policyholders 87 (53) 203 6 — — 243 Fixed annuities 425 — — — — — 425 Variable annuities 130 — — — — — 130 Institutional guaranteed products 280 — — — — — 280 Fee — off balance sheet products 54 15 (40) 4 — — 33
Accident and health insurance 277 45 — 2 — — 324
Interest charges and other — — — — (260) (20) (280)
Life for account of policyholders 1,077 3,181 6,412 257 — — 10,927 Fixed annuities 2,538 — — — — — 2,538
Institutional guaranteed products 1,133 — — — — — 1,133 Fee — off balance sheet products 459 269 142 20 — — 890
Accident and health insurance 2,299 218 — 72 — — 2,589
Income from reinsurance ceded 1,407 — 278 6 — — 1,691 Fair value and foreign exchange gains 270 303 13 2 117 (7) 698 Gains on investments for account of policyholders 3,061 1,751 6,477 62 — (11) 11,340
Fair value and foreign exchange losses (58) (202) — (12) (113) — (385) Losses on investments for account of policyholders — — — (2) — — (2) Interest charges and related fees (58) (50) (2) — (881) 618 (373)
Share in profit/(loss) of associates 3 13 — 9 — — 25
Attributable to minority interest (2) — — — — — (2)
1 Operating earnings before tax for 2004 consists of: Segment revenues
Institutional guaranteed products 802 — — — — — 802 Fee — off balance sheet products 417 257 113 15 — — 802
Fair value and foreign exchange gains 189 6 2 1 7 1 206 Gains on investments for account of policyholders 3,424 50 2,359 39 — 1 5,873
Fair value and foreign exchange losses (114) (79) — (2) (4) — (199) Losses on investments for account of policyholders — — — (13) — — (13) Interest charges and related fees (29) (60) (1) — (825) 517 (398)
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF AEGON GROUP Amounts in EUR millions, unless otherwise stated 120 AEGON ANNUAL REPORT 2005
Accident Accident and health General and health General insurance insurance Total insurance insurance Total
Fair value and foreign exchange losses (6) (8) (14) (2) (1) (3)
Investments for account of policyholders 47,448 19,782 59,379 974 — (36) 127,547
Insurance contracts for account of policyholders 36,331 19,536 13,456 957 — — 70,280 Investment contracts general account 32,983 5,157 702 — — — 38,842 Investment contracts for account
Investments for account of policyholders 37,502 18,901 50,094 367 — (26) 106,838
Banking activities — 6,373 — — — — 6,373 1Segment assets include all assets, except income tax receivables.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF AEGON GROUP Amounts in EUR millions, unless otherwise stated 124 AEGON ANNUAL REPORT 2005
Amortization and depreciation through the income statement is included in ‘Commissions and expenses’, except when it is related to the gains and losses on investments, in which case it is included in ‘Gains and losses on investments’.
Investments for general account comprise financial assets, excluding derivatives, as well as investments in real estate and real estate held for own use. Refer to note 8 for investments for which the investment risk is borne by the policyholders and to note 9 for details on general account derivatives.
Held-to-maturity (HTM) 7.3 1,202 584 Financial assets at fair value through profit or loss (FVTPL)1 7.4 10,739 10,351
Deposits with financial institutions — 1,342 — — 1,342 — 870 — — 870
Refer to the analysis of credit risk concentrations for bonds and money market investments on page 1 12, as part of note 4.2, for an overview of asset backed securities and collateralized mortgage backed securities. Asset backed securities expose the Group to prepayment risk. Changes in estimates of prepayments will impact the calculation of the effective yield and therefore the carrying value and interest income related to these securities. Collateralized mortgage backed securities are a combination of commercial and residential mortgage backed securities. Commercial mortgage backed securities are secured by a pool of mortgages on income producing properties and are subject to credit risk, but unlike other structured products, are generally not subject to prepayment risk due to protections within the underlying commercial mortgages, whereby borrowers are effectively restricted from prepaying their mortgages due to changes in interest rates. Residential mortgage backed securities are subject to credit risk and interest rate risk. The credit risk associated with residential mortgage backed securities is mitigated due to the fact that the portfolio consists of securities that were issued by, or have underlying collateral that is guaranteed by, US government agencies or US government sponsored entities.
AEGON owns EUR 126 million (2004: EUR 93 million) of shares in the Federal Home Loan Bank of Des Moines, Iowa, that are measured at par. The bank has implicit financial support from the United States government. The redemption value of the shares is fixed at par and can only be redeemed by the bank.
As part of the AEGON Levensverzekering N.V. funding program the company regularly enters into securitization contracts for its mortgage loans. At December 31, 2005 a total of five publicly placed and two privately placed securitization contracts were outstanding with a total value of EUR 6.1 billion. In 2005, AEGON Levensverzekering N.V. completed one publicly placed securitization transaction whereby the economic ownership of EUR 1.2 billion of aggregate mortgage receivables was conveyed to a special purpose company. The special purpose company funded this purchase with the issuance of mortgage-backed securities. The transfer of ownership title will take place upon notification of the borrowers by either AEGON or the special purpose company. The special purpose company has the right to notify the borrowers upon the occurrence of certain pre-defined ‘notification events’. A first ‘undisclosed’ right of pledge on the mortgage receivables was given to the special purpose company. At the same time AEGON entered into a fixed-to-floating swap agreement with the contract parties under which AEGON agreed to pay the floating rate (EURIBOR based) and receive the fixed rate (scheduled yield from the mortgage receivables). After a period of seven years, the interest of the notes issued by the special purpose company in respect of this transaction will step-up, together with a similar step-up in the fixed-to-floating swap agreement. At that same time, the special purpose company has the right to call the notes. A deferred purchase arrangement forming part of the contract to sell the mortgage loans to the special purpose company entitles AEGON Levensverzekering N.V. to any residual positive value of the special purpose entity at maturity. The value of this arrangement is included in the valuation of the interest rate swap as it is viewed as a correction on the assumptions underlying the cashflow forecasts. In 2004, AEGON Levensverzekering N.V. completed one mortgagerelated publicly placed securitization contract for EUR 1.1 billion that was structured similarly to the 2005 securitization described above. A portion of securitized mortgage loans amounting to EUR 28 million (2004: EUR 32 million) continues to be recognized as a financial asset on balance, representing the interest rate risk retained by AEGON in respect of the fourth publicly placed securitization contract.
Refer to note 51 for a discussion of collateral received and paid. No financial assets were reclassified during the financial year.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF AEGON GROUP Amounts in EUR millions, unless otherwise stated 7.1 AVAILABLE-FOR-SALE
Listed shares 4,223 3,772 Unlisted shares 978 1,325 Listed bonds 89,342 77,798 Unlisted bonds 11,524 8,972
Gross realized gains and losses are determined as the difference between proceeds and cost prices, before taking tax effects into account.
Subsequent expenditure capitalized 5 — Transfers from real estate held for own use and mortgage loans 134 89
Properties were last valued in 2005. More than 95% of these valuations were performed by independent external appraisers. AEGON has entered into operating leases on its portfolio of investments in real estate which consists primarily of residential properties, but also includes office, retail and industrial buildings. The leases on residential properties are for an indefinite period, whereas the leases on commercial property have remaining lease terms of between one month and twelve years. Although most leases have a clause enabling upward revision of the rental charge on an annual basis on the basis of either a fixed schedule or prevailing market conditions, a large proportion of the residential property is subject to limitations on rental increases. Under Dutch law, the rent on residential property rented for less than EUR 606 per month may be increased by a maximum of the inflation rate plus a margin varying between 1.5% and 3% over the next four years.
FUTURE MINIMUM LEASE PAYMENTS TO BE RECEIVED UNDER NON-CANCELLABLE OPERATING LEASES
Rental income of EUR 92 million (2004: EUR 106 million) is reported as part of investment income in the income statement. Of this amount EUR 3 million (2004: EUR 1 million) is attributable to rent on foreclosed real estate. Direct operating expenses (including repairs and maintenance) arising from investment property that generated rental income during the period amounted to EUR 33 million (2004: EUR 25 million). EUR 2 million (2004: EUR nil million) of direct operating expenses related to investment property did not generate rental income during the period.
There are no restrictions on the realizability of investment property or the remittance of income and proceeds of disposal. Refer to note 50 for a summary of contractual obligations to purchase investment property or for repairs, maintenance or enhancements.
General account real estate held for own use are mainly held by AEGON USA and AEGON The Netherlands, with relatively smaller holdings in Hungary and Spain and are carried at revalued amounts. The carrying value under a historical cost model would be approximately EUR 152 million (2004: EUR 159 million).
Real estate held for own use has not been pledged as security for liabilities, nor are there any restrictions on title. Depreciation expenses are charged in ‘Commissions and expenses’ in the income statement. The useful lives of buildings range between 40 and 50 years. Refer to note 50 for a summary of contractual commitments for the acquisition of real estate held for own use.
Total financial assets at fair value through profit or loss, excluding derivatives1 126,141 106,210
Investments in real estate 1,266 530 Real estate held for own use 140 98
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF AEGON GROUP Amounts in EUR millions, unless otherwise stated 9 DERIVATIVES
— Derivatives not designated in a hedge 440 183 678 472 1Refer to note 48 for a summary of all financial assets and financial liabilities at fair value through profit or loss.
Other derivative transactions are used to manage equity and credit related exposures. The main types of derivative financial instruments used are equity swaps, options, futures and credit derivatives: • An equity swap is a swap agreement in which one party makes payments based on either a floating index or a fixed-rate, while the other party makes payments based on the return of an equity index, basket, or single shares.
• Synthetic GICs sold by AEGON are fee-based products that are further described in note 4 under Fee — off balance sheet products. • Liquidity agreements issued by AEGON are fee-based products that could require AEGON to provide liquidity in certain predetermined events.
Furthermore synthetic GICs and liquidity agreements are sold by AEGON to earn a fee. In addition to these instruments, embedded derivatives that are not closely related to the host contracts have been bifurcated and recorded at fair value in the balance sheet, together with derivatives not designated in a hedge. These embedded derivatives that are bifurcated are embedded in various institutional products, modified coinsurance and insurance contracts in the form of guarantees for minimum benefits.
Paid guarantee benefits — — — — — — — —
• Derivative instruments designated as fair value hedges AEGON has entered into interest rate swap agreements that effectively convert certain fixed-rate assets and liabilities to a floating-rate basis (generally to six months or less LIBOR), in order to more closely match the performance of the assets and liabilities within AEGON’s portfolio. These agreements involve the payment or receipt of fixed-rate interest amounts in exchange for floating-rate interest amounts over the life of the agreement without the exchange of the underlying principal amounts.
AEGON has entered into cross-currency interest rate swap agreements that effectively convert certain foreign currency fixed- and floating-rate assets and liabilities to US dollar floating-rate assets and liabilities. These agreements involve the exchange of the underlying principal amounts.