UNITED STATES AEGON USA offers accident, critical illness, cancer treatment, hospital indemnity and short-term disability policies. Some of these plans provide lump sum or specified income payments when hospitalized, disabled or diagnosed with a critical illness. Others pay scheduled benefits for specific hospital or surgical expenses and cancer treatments, hospice care and cover deductible, as well as co-payment amounts not covered by other health insurance.
Long-term care products offered by AEGON USA provide benefits to customers who, because of their advanced age or a serious illness, require continuous care. These products protect the insured’s income and retirement savings from the costs of long-term care. Sales of long-term care insurance by AEGON USA were discontinued in 2005.
CANADA In Canada, AEGON offers accidental death, critical illness and out-of-the-country medical expense coverage.
THE NETHERLANDS AEGON The Netherlands offers sick leave products that cover the sick leave payments to employees that are not covered by social security and where the employers bear the risk.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF AEGON GROUP Amounts in EUR millions, unless otherwise stated 4.1.9 GENERAL INSURANCE
General insurance is sold in the Netherlands and Hungary. AEGON sold its general insurance business in Spain with effect from January 1, 2005.
AEGON offers limited forms of general insurance, such as automobile insurance, liability insurance, household insurance and fire protection.
Banking products are only sold by AEGON The Netherlands and include savings accounts and investment contracts. Both products generate investment-spread income for AEGON. Savings accounts retain flexibility to withdraw cash with limited restrictions. AEGON discontinued selling security lease products in early 2003. Banking products also include investment products that offer index-linked returns and generate fee income on the performance of the investments.
To manage its risk exposure, AEGON employs risk management programs, including asset liability management processes and models, hedging programs (which are largely conducted via the use of derivatives) and insurance programs (which are largely conducted through the use of reinsurance). These risk management programs are in place in each country unit and are not only used to manage risk in each unit, but also for AEGON. Derivative and reinsurance usage by the company is governed by derivative and reinsurance usage policies. These policies establish the control, authorization, execution and monitoring requirements of the usage of such instruments. In addition, these policies stipulate necessary mitigation of credit risk created through these risk management tools of derivatives and reinsurance. For derivatives, credit risk is often mitigated by requirements to post collateral via credit support annex agreements. For reinsurance, credit risk is often mitigated through funds withheld treaties (when AEGON owns the assets) or through assets held in trust for the benefit of AEGON (in the event of reinsurer insolvency).
b. Interest rate risk 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 of the businesses 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.
fixed-income investments likely will have declined with the market interest rates. In addition, mortgages and redeemable bonds in the investment portfolio are more likely to be repaid as borrowers seek to borrow at lower interest rates and AEGON may be required to reinvest the proceeds in securities bearing lower interest rates. Also, in a period of low interest rates, AEGON may not be able to reduce crediting rates on policies and still preserve margins as a result of minimum guaranteed crediting rates provided on policies. Accordingly, during periods of sustained low interest rates, net income may decline as a result of a decrease in the spread between either the interest rates credited to policyholders or the rates assumed in reserves and returns on the investment portfolio.
The general account fixed-income portfolios of AEGON Americas and AEGON The Netherlands accounted for 95% of the total general account fixed-income portfolio of the Group on December 31, 2005. AEGON USA and AEGON The Netherlands manage their duration mismatch on the basis of their expectations for the future level of interest rates within limits. Presently, other AEGON country units target the duration of their assets to equal approximately the duration of their liabilities where possible. In addition to point in time duration measurement, deterministic and stochastic scenarios are used to measure and manage interest rate risk. In these models, policyholder behavior changes are anticipated. These models are used by all country units and aggregated at group level.
GENERAL ACCOUNT BONDS, MONEY MARKET INVESTMENTS, MORTGAGE LOANS AND PRIVATE LOANS – 2004
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF AEGON GROUP Amounts in EUR millions, unless otherwise stated 114 AEGON ANNUAL REPORT 2005 c. Credit risk 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), OTC 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 manages credit risk exposure by individual counterparty, sector and asset class. It may mitigate 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 mitigate 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 the Group’s credit risk profile, associated earnings and capital implications due to various credit loss scenarios.
CCC or lower 341 — — — 341 293 1Includes investments of Holding and other activities
The following table shows the credit quality of general account reinsurance assets specifically.
The table that follows shows the Group’s maximum credit exposure from investments in general account financial assets, as well as general account derivatives and reinsurance assets and off balance sheet exposures.
Refer to note 50 for further information on capital commitments and contingencies, which may expose the Group to credit risk.
AEGON group wide counterparty exposure limits in EUR million1: Credit Rating Limit
Asset backed securities (ABSs) — Aircraft 303 — — — 303 199 ABSs — Collateralized Bond Obligations (CBOs) 1,153 — — 44 1,197 1,037
has a risk related to the investment performance. In addition, some of this business has minimum return or accumulation guarantees, which are often life contingent or contingent upon policyholder persistency. AEGON is at risk if equity market returns do not exceed these guarantee levels and the company may need to set up additional reserves to fund these future guaranteed benefits. AEGON is also at risk if returns are not sufficient to allow amortization of DPAC and deferred transaction costs. It is possible under certain circumstances that AEGON would need to accelerate amortization of DPAC and deferred transaction costs and to establish additional reserves for minimum guaranteed benefits, which would reduce net income and shareholders’ equity. Volatile or poor market conditions may also significantly reduce the popularity of some of AEGON’s savings and investment products, which could lead to lower sales and lower net income.
e. Underwriting risk AEGON’s earnings depend significantly upon the extent to which actual claims experience is consistent with the assumptions used in setting the prices for products and establishing the technical liabilities and liabilities for claims. To the extent that actual claims experience is less favorable than the underlying assumptions used in establishing such liabilities, income would be reduced. Furthermore, if these higher claims were part of a trend, AEGON may be required to increase liabilities, which could reduce income. In addition, certain acquisition costs related to the sale of new policies and the purchase of policies already in force have been recorded as assets on the balance sheet and are being amortized into income over time. If the assumptions relating to the future profitability of these policies (such as future claims, investment income and expenses) are not realized, the amortization of these costs could be accelerated and may even require write offs due to unrecoverability. This could have a material adverse effect on AEGON’s business, results of operations and financial condition.
Estimated approximate Estimated approximate effects on net income effects on shareholders’ equity 10% increase in lapse rates (57) (57) 10% decrease in lapse rates 41 41 5% increase in mortality/morbidity rates (47) (47) 5% decrease in mortality/morbidity rates 45 45 1Basic 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.
Share in profit/(loss) of associates — 4 — 16 — — 20
Attributable to minority interest 2 — — — — — 2
1 Operating earnings before tax for 2005 consists of: Segment revenues
Holding and other activities — — — — 741 (620) 121
2Charges to policyholders in respect of income tax in AEGON UK to the amount of EUR 104 million are excluded from segment expenses and included in other non-operating income/(charges).
Life for account of policyholders 86 45 168 5 — — 304 Fixed annuities 284 — — — — — 284 Variable annuities 177 — — — — — 177 Institutional guaranteed products 367 — — — — — 367 Fee — off balance sheet products (1) 26 5 6 — — 36
Accident and health insurance 290 27 — 8 — — 325
Banking activities — 24 — — — — 24 Other — — — — — — — Interest charges and other — — — — (328) 1 (327)
Life for account of policyholders 1,168 2,720 6,476 130 — — 10,494 Fixed annuities 2,710 — — — — — 2,710
Banking activities — 284 — — — — 284 Holding and other activities — — — — 837 (518) 319
2Charges to policyholders in respect of income tax in AEGON UK to the amount of EUR 58 million are excluded from segment expenses and included in other non-operating income/(charges).
The United Other and other Americas Netherlands Kingdom countries activities Total
Revenue from transactions between reporting segments were not material during the financial period.
Fair value and foreign exchange gains 21 15 36 15 — 15
The United Other and other ElimiAmericas Netherlands Kingdom countries activities nations Total
Insurance contracts for account of policyholders 29,148 17,796 12,604 356 — — 59,904 Investment contracts general account 27,187 5,633 810 — — — 33,630 Investment contracts for account
Life for account of policyholders 6,084 23,634 64,204 1,136 — — 95,058 Fixed annuities 47,766 — — — — — 47,766
Institutional guaranteed products 31,620 — — — — — 31,620 Fee — off balance sheet products 516 172 170 56 — — 914
Accident and health insurance 6,331 621 — 68 — — 7,020
Life for account of policyholders 4,228 21,741 54,536 402 — — 80,907 Fixed annuities 45,379 — — — — — 45,379
Institutional guaranteed products 26,395 — — — — — 26,395 Fee — off balance sheet products 357 179 114 43 — — 693
Accident and health insurance 5,118 578 — 104 — — 5,800
Amortization / depreciation through income statement — 393 23 40 1 457 Shadow accounting adjustments — (6) — — — (6) Impairment losses — 95 — — — 95
Amortization / depreciation through income statement — 308 22 41 1 372 Shadow accounting adjustments — (187) — — — (187) Impairment losses — 1 — — — 1
Goodwill relates to the acquisition of Nationwide Poland in the last quarter of 2005, as well as the acquisition of an investment advisor company, Westcap Investors, LLC during 2005 and a smaller acquisition by AEGON UK in 2004. On both acquisitions in 2005, as well as on the acquisition of an insurance portfolio in 2005, VOBA has been recognized as an intangible asset relating to the value of established customer relationships. In the preparation of the Opening Balance Sheet under IFRS as at January 1, 2004, business combinations prior to that date have not been restated and goodwill previously written off through equity has not been reinstated.
Traditional life 1,965 1,690 Life for account of policyholders 1,121 1,061 Fixed annuities 140 150 Variable annuities 115 100 Institutional guaranteed products 23 23
Total financial assets, excluding derivatives 143,652 126,332 Investments in real estate 7.5 2,068 1,856 Real estate held for own use 7.6 355 328
TOTAL INVESTMENTS FOR GENERAL ACCOUNT 146,075 128,516 1Refer to note 48 for a summary of all financial assets and financial liabilities at fair value through profit or loss.
Receivables out of share lease agreements — 772 — — 772 — 1,312 — — 1,312
Included in debt securities at fair value through profit or loss are convertible bonds and preferred shares of EUR 505 million (2004: EUR 412 million). At the end of 2005 approximately 97% of these convertible options are exercisable within the next year and the remaining 3% are exercisable within one to five years, all at various exchange ratios. In addition, AEGON also holds EUR 818 million (2004: EUR 852 million) of convertible bonds and preferred shares backing a fixed annuity product considered to contain an embedded derivative. This entire liability is also measured at fair value, with changes reported through the income statement.
Only insignificant amounts of unquoted equity instruments are measured at cost.
PROCEEDS, REALIZED GAINS AND REALIZED LOSSES FROM SALES OF AVAILABLE-FOR-SALE INSTRUMENTS 2005 2004
Carrying Carrying value of value of instruments instruments with Gross with Gross unrealized unrealized unrealized unrealized losses losses losses losses
UNREALIZED LOSSES — BONDS AND MONEY MARKET INVESTMENTS 2005 2005 2004 2004
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF AEGON GROUP Amounts in EUR millions, unless otherwise stated 7.2 LOANS
Receivables out of share lease agreements 772 4 — 776 776 —
Receivables out of share lease agreements 1,312 — — 1,312 1,312 —
UNREALIZED GAINS AND LOSSES — 2005 cost gains losses value gains losses
Listed shares 1,651 1,177 Unlisted shares 1,044 200 Listed bonds 5,859 7,388 Unlisted bonds 56 41 7.5 INVESTMENTS IN REAL ESTATE
Fair value gains/(losses) 221 104 Net exchange differences 49 (23) Other (2) —
Not later than one year 38 33 Later than one year and not later than five years 87 86 Later than five years 12 17
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF AEGON GROUP Amounts in EUR millions, unless otherwise stated 7.6 REAL ESTATE HELD FOR OWN USE
Capitalized subsequent expenditure 1 — Expenditure in the course of construction — 61 Revaluations — 1
Realized gains/(losses) through income statement 1 (1) Transfers to investments in real estate (108) (77) Net exchange differences 26 (11)
Depreciation through income statement 7 9 Disposals — (51) Net exchange differences 1 — Other (5) —
Included in the year end balance are EUR 1 18 million (2004: EUR 105 million) relating to property under construction. Borrowing costs to the amount of EUR 4.5 million (2004: EUR 3.5 million) have been capitalized during the period, applying a capitalization rate of 6%.
Real estate held for own use was last revalued in 2005, based on market value appraisals by qualified internal and external appraisers. Approximately 30% of the appraisals in 2005 were performed by independent external appraisers.
Investments for account of policyholders comprise financial assets at fair value through profit or loss, excluding derivatives, as well as investments in real estate and real estate held for own use. Refer to note 9 for detail on derivatives for account of policyholders.
TOTAL INVESTMENTS FOR ACCOUNT OF POLICYHOLDERS 127,547 106,838 1Refer to note 48 for a summary of all financial assets and financial liabilities at fair value through profit or loss.
— Derivatives not designated in a hedge 1,058 734 690 569 — Derivatives designated as fair value hedges 335 276 516 755 — Derivatives designated as cash flow hedges 326 140 227 95 — Net foreign investment hedges 136 383 91 84
• A swaption is an option to enter into an interest rate swap at a specific future date. • Caps/floors are contracts to settle the difference between a market interest rate and a certain strike rate for a certain period of time on a specified notional amount.
• Forward rate agreements/futures are commitments to purchase or sell a financial instrument at a future date for a specific price. Foreign exchange contracts are used to manage AEGON’s exposure on its net investment in subsidiaries denominated in foreign currencies and other investments. The main types of derivative financial instruments used are cross currency swaps and forward foreign exchange contracts: • Cross currency swap agreements are contracts to exchange two principal amounts of two currencies at the prevailing exchange rate at inception of the contract. During the life of the swap the counterparties exchange fixed- or floating-rate interest payments in the swapped currencies and at maturity the principal amounts are again swapped at a predetermined rate of exchange.
• Futures are contractual obligations to buy or sell financial instruments on a future date at a specified price. • Credit derivatives are contracts between two parties that allow for transfer of credit risk from one party to another. The party transferring the risk has to pay a fee to the party that assumes the risk. — A commonly used credit derivative instrument is a credit default swap. A credit default swap allows the transfer of third party credit risk from one party to another. In essence, the buyer of a credit default swap is insured against third party credit losses. If the third party defaults, the party providing insurance will have to purchase the defaulted asset from the insured party or settle net in cash. AEGON uses credit derivatives to hedge credit exposures.
• Derivatives not designated in a hedge AEGON utilizes derivative instruments as a part of its asset liability risk management practices, where the derivatives do not qualify for hedge accounting, or AEGON has elected to not apply hedge accounting. These derivatives include financial futures contracts, interest rate swaps, currency swaps, credit derivatives, financial options, and foreign currency forwards. These derivatives are considered economic hedges of certain exposures related to an existing asset or liability. In all cases, these are in accordance with internal risk guidelines and are closely monitored for continuing compliance.
AEGON USA reinsures some business on a modified coinsurance basis or coinsurance with funds withheld basis. These reinsurance arrangements contain embedded derivatives in that the credit risk of the underlying investment is not closely related to the host contracts. These embedded derivatives are bifurcated and carried at fair value. The change in fair value of the embedded derivative, as well as the gains or losses on trading investments supporting these arrangements, flows through the income statement. This embedded derivative is not eligible for hedge accounting treatment.
The following table provides information on the liabilities for guarantees for minimum benefits that are included in the bifurcated embedded derivatives: United The 2005 United The 2004 States1 Canada1 Netherlands2 Total States1 Canada1 Netherlands2 Total
Refer to note 4 for a discussion of these guarantees for minimum benefits. In addition, AEGON reinsures the elective guaranteed minimum withdrawal benefit rider issued with a ceding company’s variable annuity contracts. The rider is essentially a return of premium guarantee, which is payable over a period of at least fourteen years from the date that the policyholder elects to start withdrawals. At contract inception, the guaranteed remaining balance is equal to the premium payment. The periodic withdrawal is paid by the ceding company until the account value is insufficient to cover additional withdrawals. Once the account value is exhausted, AEGON pays the periodic withdrawals until the guaranteed remaining balance is exhausted. At December 31, 2005, the reinsured account value was EUR 9.9 billion (2004: EUR 8.6 billion) and the guaranteed remaining balance was EUR 7.3 billion (2004: EUR 6.7 billion).
The reinsurance contract is accounted for as a derivative and is carried in AEGON’s balance sheet at fair value. At December 31, 2005, the contract had a value of EUR 14 million (2004: EUR 19 million). AEGON entered into a derivative program to mitigate the overall exposure to equity market and interest rate risks associated with the reinsurance contract. This program involves selling S&P 500 futures contracts to mitigate the effect of equity market movement on the reinsurance contract and the purchase of over-the-counter interest rate swaps to mitigate the effect of movements in interest rates on the reinsurance contracts.
For the years ended December 31, 2005 and 2004, AEGON recognized gains and losses related to the ineffective portion of designated fair value hedges of EUR 32 million and EUR 37 million respectively. No portion of derivatives were excluded when assessing hedge effectiveness.
• Derivative instruments designated as net foreign investment hedges AEGON funds its investments in insurance subsidiaries with a mixture of debt and equity. AEGON aims to denominate debt funding in the same currency as the functional currency of the investment. When the debt funding of investments is not in the functional currency of the investment, AEGON uses derivatives to swap the currency exposure of the debt instrument to the functional currency of the investment. This policy will ensure that total capital will reflect currency movements without distorting debt ratios. AEGON utilizes various financial instruments as designated hedging instruments of its foreign investments. These instruments include subordinated borrowings, long-term and short-term borrowings, short-term debts to credit institutions, cross currency swap contracts, forward foreign exchange contracts and foreign swap contracts.
The following table represents aggregate notional amounts and fair values of derivatives, held for own account as well as for account of policyholders. The notional amounts listed for interest rate contracts will not be exchanged by parties and, thus, do not reflect an exposure of the company. The amounts listed for cross currency swaps will be exchanged at amounts calculated on the basis of the notional amounts and the terms of the derivatives, which are related to interest rates, exchange rates and/or certain indices.
OTC: — Forwards — — 2 — — — — —
The fair value of the derivatives reflects the estimated amounts that AEGON would receive or pay to terminate the contracts on reporting date. Market quotes are available for many derivatives; for those products without readily available market quotes generally accepted valuation models are used to estimate fair value.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF AEGON GROUP Amounts in EUR millions, unless otherwise stated 10 INVESTMENTS IN ASSOCIATES
MOVEMENTS DURING THE YEAR IN REINSURANCE ASSETS RELATING TO LIFE INSURANCE Life Life insurance insurance for Total general account of life account policyholders insurance
Acquisitions through business combinations 1 — 1 Portfolio transfers and acquisitions (8) (22) (30) Gross premium and deposits — existing and new business 1,083 125 1,208 Unwind of discount / interest credited 184 10 194 Technical reserves released (1,012) (78) (1,090) Changes to valuation of expected future benefits 4 14 18 Net exchange differences 340 1 341 138 AEGON ANNUAL REPORT 2005
DPAC for insurance contracts and investment contracts with discretionary participation features 10,789 8,499 Deferred transaction costs for investment management services 287 234 Unamortized interest rate rebates 272 325
Costs deferred/rebates granted during the year 1,717 19 23 Amortization through income statement (1,137) (12) (59) Shadow accounting adjustments 137 — — Net exchange differences (359) (10) —
At December 31, 2005, the reversion to the mean assumptions for variable products, primarily variable annuities, were as follows in the United States: gross long-term equity growth rate of 9% (2004: 9%); gross short-term growth rate of 6% (2004: 6.25%); gross shortand long-term fixed security growth rate of 6% (2004: 6%); and the gross short- and long-term growth rate for money market funds of 3.5% (2004: 3.5%). For Canada these assumptions, at December 31, 2005, were as follows: gross long-term equity growth rate of 9% (2004: 9%); and gross short-term growth rate of 9.75% (2004: 10.75%). For both countries the reversion period for the short-term rate is five years.
DPAC AND DEFERRED TRANSACTION COSTS PER LINE OF BUSINESS DPAC Deferred transaction costs
Traditional life 3,699 2,688 — — Life for account of policyholders 4,257 3,941 127 105
Accident and health insurance 734 600 — — General insurance 1 1 — —
Included in the net book amounts of equipment are equipment held for lease of EUR 66 million (2004: EUR 205 million). Equipment has not been pledged as security for liabilities, nor are there any restrictions on title. Depreciation expenses have been charged in ‘Commissions and expenses’ in the income statement. Equipment is generally depreciated over a period of three to five years.
The weighted effective interest rate on short-term deposits was 2.71% (2004: 2.50%) and these deposits have an average maturity of 3.39 days (2004: 6.86 days).
The majority of cash is not subject to any restrictions. However, the Dutch National Bank requires AEGON The Netherlands to hold 2% of their assets relating to banking activities in an account with the bank. This amount on deposit is reassessed on a monthly basis and carries interest at approximately 2%. The balance at the end of the year was EUR 103 million (2004: EUR 106 million).
TOTAL SHAREHOLDERS’ EQUITY 19,276 14,875 15.1 SHARE CAPITAL — PAR VALUE
Common shares 192 186 Preferred shares A 53 53 Preferred shares B 6 4 142 AEGON ANNUAL REPORT 2005
Authorized share capital 360 360 Par value in cents per share 12 12
Authorized share capital 250 250 Par value in cents per share 25 25
All issued common and preferred shares are fully paid. Repayment of capital can only be initiated by the Executive Board, needs approval of the Supervisory Board and must be resolved by the General Meeting of Shareholders. Moreover, repayment on preferred shares needs approval by the related shareholders.
There are restrictions on the amount of funds that companies within the Group may transfer in the form of cash dividends or otherwise to the parent company. These restrictions come from solvency and legal requirements. Refer to note 47 for a description of these requirements.
Refer to note 40.1 for a description of share appreciation rights and share options.
Transactions in 2005: Purchase: one transaction on May 17, price EUR 9.85 3,821 — Sale: 31 transactions, average price EUR 10.28 (10,403) — Transactions in 2004: Purchase: two transactions on May 18 and September 24, average price EUR 9.88 — 7,467 Sale: three transactions April 1, April 22 and July 19, average price EUR 10.29 — (9,663)
As part of their insurance and investment operations, subsidiaries within the Group also hold AEGON N.V. common shares, both for their own account and for account of policyholders. These shares have been treated as treasury shares and are recognized at the consideration paid or received.
15.4 REVALUATION RESERVES Available- Real estate Cash flow for-sale held for hedging investments own use reserve Total
Gains/(losses) transferred to income statement — — (23) (23) Foreign currency translation differences (76) (1) — (77)
Movement in foreign currency translation and net foreign investment hedging reserves (827) 72 — (755) Equity movements of associates — — 59 59
The equity movements of associates reflect AEGON’s share of changes recognized directly in the associate’s equity.
Coupon Coupon date: Year of rate quarterly, as of first call
TOTAL PERPETUAL CUMULATIVE SUBORDINATED BONDS 567 1,517 1 Issued at an interest rate of 8%, which was reset in June 2005.
These loans are subordinated to all other unsubordinated borrowings and liabilities. There were no defaults or breaches of conditions during the period. Effective interest rates vary from 6.51% to 8.18% (2004: 6.51% to 8.18%). The fair value of these loans amounts to EUR 309 million (2004: EUR 279 million).
Life insurance 88,107 76,221 Non-life insurance — Outstanding claims 4,502 3,936
Certain insurance contracts contain surrender options, so that AEGON has no unconditional right to defer settlement of these liabilities for at least twelve months after balance sheet date. This feature results in the classification of these insurance contract liabilities as current. Insurance contract liabilities at December 31, 2005 that are considered non-current amount to EUR 23,955 million.
The following table provides information on the liabilities for guarantees that are included in the valuation of the host contracts: GMDB1 GMIB2 GMAB3 Total GMDB1 GMIB2 GMAB3 Total
Average attained age of contractholders 64 63 — — 60 61 — —
1Guaranteed minimum death benefit in the United States. 2Guaranteed minimum income benefit in the United States. 3Guaranteed minimum accumulation benefit in the Netherlands. 4Note that the variable annuity contracts with guarantees may offer more than one type of guarantee in each contract; therefore, the amounts listed are not mutually exclusive.
Refer to note 4 for a discussion of these guarantees for minimum benefits.
Portfolio transfers and acquisitions 3 Gross premium and deposits — existing and new business 2,684 Unwind of discount/interest credited 164 Technical reserves released (1,680) Changes in valuation of expected future benefits (17) Change in unearned premiums (833) Change in unexpired risks (3) Incurred related to current year 682 Incurred related to prior years 64 Release for claims settled current year (253) Release for claims settled prior years (483) Change in IBNR 23 Disposals (309) Net exchange differences 470 Other 6
Fair value of investment contracts without discretionary participation features 37,658 150 AEGON ANNUAL REPORT 2005
Refer to note 4.1.4 for a description of institutional guaranteed products and an analysis of the contractual maturities for all institutional guaranteed products with defined maturities, based on nominal amounts. Below follows a maturity analysis of those contracts with defined maturities, based on carrying amounts. EUR 5,361 million (2004: EUR 4,514 million) of the total balance of institutional guaranteed products have no contractual maturities.
Savings accounts are part of the banking activities of the Group, as described in note 4.1.10. Due to the nature of these products, policyholders have flexibility to withdraw cash from these savings accounts, with limited restrictions.
The balance of investment contracts with discretionary participation features reflects the excess of the liability over the funded value of the units.
On consolidation of an investment fund, participations held by third parties are classified as liabilities, as opposed to minority interests in equity, if the Group is legally obliged to buy back these participations. A portion of the balance of investment contract liabilities relate to such participations held by third parties, amounting to EUR 858 million (2004: EUR 734 million).
USD 250 million Eurobonds1 7.375% 2000/05 July 25 — 172 USD 250 million Senior Notes floating 2003/05 Quarterly — 184 EUR 350 million Eurobonds1 4.75% 2001/05 February 28 — 350 JPY 10,000 million Medium-Term Notes floating 2003/05 Semi-annual — 72 USD 200 million Domestic Debentures1 6.75% 1996/06 May/November 15 170 146 USD 50 million Zero Coupon Bonds1 1982/07 34 26 USD 100 million Domestic Debentures1 9.375% 1996/08 March/September 1 87 77 EUR 1,000 million Medium-Term Notes 4.625% 2003/08 April 16 1,000 1,000 USD 147 million Domestic Debentures1 6.4% 1998/08 March/September 15 102 83 USD 133 million Zero Coupon Bonds1 1982/10 65 50 USD 200 million Zero Coupon Bonds1 1982/12 70 54 USD 750 million Senior Notes 4.75% 2003/13 Semi-annual 636 550 EUR 500 million Medium-Term Notes 4.125% 2 2004/14 December 8 512 499 EUR 75 million Medium-Term Notes 4.625% 2 2004/19 December 9 79 75 USD 500 million Medium-Term Notes1 5.75% 2 2005/20 December 15 434 —
Floating-rate Expiring within one year 254 2,775 Expiring beyond one year 2,607 447
Retirement benefit plans 1,369 1,398 Other post-employment benefit plans 237 237
Present value of wholly unfunded obligations 1,6291 254 1,883 1,5431 246 1,789
1Assets held by AEGON The Netherlands for retirement benefits do not meet the definition of plan assets and as such were not deducted in calculating this amount. Instead, these assets are recognized as general account assets. Consequently, the return on these assets also do not form part of the calculation of defined benefit expenses.
Fair value of AEGON’s own financial instruments included in plan assets 574 471 Fair value of other assets used by AEGON included in plan assets 1 1
Best estimate of contributions expected for the next annual period 30
TARGET ALLOCATION OF PLAN ASSETS FOR RETIREMENT BENEFIT PLANS FOR THE NEXT ANNUAL PERIOD IS
Pension plan contributions were not required for AEGON USA in 2005.
AEGON The Netherlands also has a post-retirement medical plan that contributes to the health care coverage of employees and beneficiaries after retirement. The liability related to this plan amounted to EUR 75 million at December 31, 2005.
The principal actuarial assumptions that apply for the year ended December 31, 2005 are as follows: Discount rate 4% 4.75%
Health care cost trend rate assumed for next year 5% 5% Rate that the cost trend rate gradually declines to 2.5% 2.5% Year that the rate reaches the rate it is assumed to remain at 2014 2014
AEGON UK operates a defined benefit pension scheme providing benefits for staff based on final pensionable salary. The assets of the scheme are held under trust separately from those of the Group. The assets of the scheme are held in policies effected with Scottish Equitable plc. The scheme is closed to new entrants. The defined benefit plan was underfunded by EUR 256 million at December 31, 2005.
Salary increase rate 4.1% 4.6% Pension increase rate 2.6% 2.6% Price inflation 2.6% 2.6%
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF AEGON GROUP Amounts in EUR millions, unless otherwise stated 26 DEFERRED REVENUE LIABILITIES
Real Financial Insurance intangible benefit estate assets contracts assets plans Losses Other Total
Acquisition through business combinations — — — — — — 14 14
Financial assets 3 3 Insurance and investment contracts 56 35 Deferred expenses, VOBA and other intangible assets (120) (65) Defined benefit plans 2 1
Real estate 555 479 Financial assets 1,939 1,404 Insurance and investment contracts (2,943) (1,189) Deferred expenses, VOBA and other intangible assets 3,654 2,827 Defined benefit plans 13 (43)
Deferred income tax liabilities have not been recognized for withholding taxes and other taxes that would be payable on the unremitted earnings of certain subsidiaries, branches, associates and joint ventures, since such amounts are permanently reinvested. Unremitted earnings totaled EUR 1,741 million (2004: EUR 1,300 million).
The carrying amounts disclosed reasonably approximate the fair values as at the year end.
Investment income related to general account 7,031 6,547 Investment income for account of policyholders 2,906 2,790
Included in interest income is EUR 37 million (2004: EUR 39 million) in respect of interest income accrued on impaired financial assets.
Fair value and foreign exchange gains 698 206 Fair value and foreign exchange losses 385 199
Gains on investments for account of policyholders 11,340 5,873 Losses on investments for account of policyholders 2 13
Investments for account of policyholders comprise of financial assets, investments in real estate and real estate for own use. Refer to note 8 for further information. Financial assets for account of policyholders are classified as at fair value through profit or loss.
Positive fair value changes of for account of policyholder financial assets at fair value through profit or loss 11,240 5,820 Positive fair value changes of investments in real estate for account of policyholders 100 53
Gross losses on investments — 86 Fair value losses on economic hedges for which no hedge accounting is applied 112 1
Other income in 2005 relates to the sale of Seguros Generales, the general insurance company in Spain. The corresponding amount in 2004 relates to the gain on the sale of businesses of Transamerica Finance Corporation.
Claims and benefits paid to policyholders 16,025 11,266 Change in valuation of liabilities for insurance and investment contracts 17,782 15,718 39 PROFIT SHARING AND REBATES
Included in administration expenses above is depreciation amounting to EUR 125 million in 2005 (EUR 264 million in 2004) that relates to equipment, software and real estate held for own use.
Senior executives of AEGON companies, as well as other AEGON employees, have been offered both share appreciation rights and share options. These share appreciation rights and share options have been granted at an exercise price equal to the market price of the shares at the date of the grant. The rights and options granted in 2005 and 2004 vest after three years and can only be exercised during the four years after the vesting date. The rights and options granted in 2003 and 2002 vest after two years and can only be exercised during the five years after the vesting date. The plans for 2000 and 2001 can be exercised three years after being granted and then during a period of two years. Vesting and exercisability depend on continuing employment of the individual employee to which the rights and options have been granted.
The following tables present the movements in balances over the last two years, as well as the breakdown of share appreciation rights (SARs) and options outstanding.
SARs/options number granted1 20051 20051 in EUR1 Exercise period 1Adjusted for the share split in 2000. 2Weighted average exercise price of the outstanding share options in USD calculated at the closing rate. 3Number of share options granted in 2005 amounted to 5,965,560 (2004: 364,400; 2003: 438,200; 2002: 263,100).
The total intrinsic value of options exercised and share appreciation rights paid during 2005 amounts to EUR 17 million (2004: nil). At December 31, 2005, the total compensation cost related to non-vested awards not yet recognized is estimated at EUR 28 million. The weighted average period over which it is expected to be recognized is 1.5 years. The intrinsic value at the balance sheet date for the vested share options and share appreciation rights amounts to EUR 38 million.
The exposure from the issued share appreciation rights and share options is economically hedged by a position in treasury shares. At December 31, 2005 AEGON held 18,650,865 of its own common shares with a face value of EUR 0.12 each by virtue of acquisitions for this purpose.
Impairment charges from: — Bonds and money market instruments 91 229
Impairment reversals from: — Bonds and money market instruments 139 80
TOTAL IMPAIRMENT REVERSALS 160 79 42 INTEREST CHARGES AND RELATED FEES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF AEGON GROUP Amounts in EUR millions, unless otherwise stated 44 INCOME TAX
Current tax — Current year 751 437 — Adjustments to prior year (5) (17)
Deferred tax (refer to note 27) — Origination / (reversal) of temporary differences 245 164 — Changes in tax rates/bases (48) (49) — Recognition of previously unrecognized tax loss/tax credit (66) 1 — Write off / (reversal of write off) of deferred tax assets 8 1
Income before tax 3,615 2,795 Income tax calculated using weighted average applicable statutory rates 1,217 956
Difference due to the effects of: — Non-taxable income (229) (373) — Non-tax deductible expenses 8 79 — Changes in tax rate/base (48) (49) — Different tax rates on overseas earnings (15) (19) — Tax credits (143) (71) — Other taxes 164 28 — Adjustments to prior years (5) (17) — Changes in deferred tax assets as a result of recognition/write off of previously not recognized/recognized tax losses, tax credits and deductible temporary differences (66) 1 — Non-recognition of deferred tax assets 2 3 — Tax effect of profit/losses from associates 1 —
BASIC EARNINGS PER SHARE: Basic earnings per share is calculated by dividing the net income attributable to equity holders, after deduction of preferred dividends declared and accrued coupons on perpetuals, by the weighted average number of ordinary shares, excluding ordinary shares purchased by the company and held as treasury shares (refer to note 15).
Weighted average number of ordinary shares (thousands) 1,548,346 1,503,127 Adjustments for: — Share options (thousands) 201 —
The table that follows reconciles total shareholders’ equity to the total capital base: Total shareholders’ equity 19,276 14,875 Junior perpetual capital securities 2,809 1,352 Perpetual cumulative subordinated bonds 567 1,517 Share options not yet exercised 3 Minority interest 15 15 Trust pass-through securities 437 378 Subordinated borrowings 284 254
Borrowings not related to capital funding of insurance activities1 (3,473) (3,392)
Both insurance and banking companies are required to maintain a minimum solvency margin based on local directives. AEGON’s insurance subsidiaries in the United States are subject to risk-based standards established by the National Association of Insurance Commissioners. At December 31, 2005, the combined risk-based capital ratio of AEGON’s life insurance subsidiaries in the United States was 383%. Under the Insurance Industry Supervision Act 1993 in the Netherlands, life insurance companies are required to maintain equity of among others 4% of general account technical reserves and, in case of no interest guarantee, 1% of technical reserves with investments for account of policyholders plus 0.3% of the amount at risk under the insurance policies for life insurers. The Financial Services Authority regulates insurance companies in the United Kingdom under the Financial Services and Markets Act 2000 and sets minimum standards for capital adequacy and solvency.
48 SUMMARY OF TOTAL FINANCIAL ASSETS AND FINANCIAL LIABILITIES AT FAIR VALUE THROUGH PROFIT OR LOSS
Investment contracts — 223 — 217 Investment contracts for account of policyholders — 22,258 — 17,283 Derivatives with negative values not designated as hedges 1,368 — 1,041 —
In the normal course of business, the Group has committed itself through purchase and sale transactions of investments, mostly to be executed in the course of next year. The amounts represent the future outflow and inflow, respectively, of cash related to these investment transactions that are not reflected in the consolidated balance sheet.
Other commitments include private placement commitments, mortgage loan commitments, and limited partnership commitments. Certain insurance and investment products have minimum guarantees for which liabilities have been recognized and are therefore not included in the table. These guarantees are discussed in note 4.
AEGON N.V. has entered into a Net Worth Maintenance Agreement with its indirect subsidiary AEGON Financial Assurance Ireland Limited (AFA), pursuant to which AEGON N.V. will cause AFA to have a tangible net worth of at least 3% of its total liabilities under financial guaranty policies which it issues up to a maximum of EUR 3 billion.
Not later 1-5 Later than Not later 1-5 Later than than 1 year years 5 years than 1 year years 5 years
The following table summarizes the carrying amounts on the balance sheet of financial assets pledged as collateral. Collateral paid as part of share borrowing or reverse repurchase transactions are included in this information.
When AEGON pays cash collateral as part of security borrowing or reverse repurchase transactions, an asset is recorded to receive back the cash pledged. The balance of these receivables, as also reflected in note 13, are as follows: Cash collateral pledged on reverse repurchase agreements 23 2
Details of collateral accepted that the Group is permitted to sell or repledge in the absence of default by the owner of the collateral are as follows: Fair value of financial assets accepted as collateral 4,616 4,910
AEGON does not account for the delivery of the securities as the Group still has economic ownership. When collateral received takes the form of non-cash, AEGON does not account for the collateral received, nor for the delivery of securities as there is no change in economic ownership.
AEGON acquired 100% of the shares of Nationwide Towarzystwo Ubezpieczen na Zycie S.A. (Nationwide Poland) in early October 2005 and consolidated the business as of October 1, 2005. AEGON also acquired an investment advisor company, Westcap Investors, LLC during 2005. These business combinations did not have a material impact on the consolidated financial statements of the Group.
The Netherlands AEGON Bank N.V., Utrecht AEGON Financiële Diensten B.V., The Hague AEGON International N.V., The Hague AEGON Levensverzekering N.V., The Hague AEGON NabestaandenZorg N.V., Groningen AEGON Nederland N.V., The Hague AEGON Schadeverzekering N.V., The Hague AEGON Spaarkas N.V., The Hague AEGON Vastgoed Holding B.V., The Hague Meeùs Groep B.V., Amersfoort Spaarbeleg Kas N.V., Utrecht TKP Pensioen B.V., Groningen AEGON Investment Management B.V., The Hague
Other countries AEGON-CNOOC Life Insurance Company Ltd, Beijing (China) (50%) Caja Badajoz Vida y Pensiones, Sociedad Anónima de Seguros, Badajoz (Spain) (50%)
SUMMARIZED FINANCIAL INFORMATION OF JOINT VENTURES FOR 2005 ACCOUNTED FOR USING PROPORTIONATE CONSOLIDATION
There were no operations yet in Caja Badajoz Vida y Pensiones by the end of 2005.
The Netherlands Nieuw Rotterdam Holding B.V., Utrecht (45%) N.V. Levensverzekering-Maatschappij ‘De Hoop’, The Hague (35%)
As described in note 4.1.5, 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 profits policyholders at a suitable rate. In particular, Guardian Assurance plc has reinsured blocks of immediate annuity business to the shareholder on terms reflective of prevailing market rates; this helps avoid a tontine effect building up in the fund, whilst the number of with profit policyholders reduces.
In addition to these transactions, the remuneration and share-based compensation of members of the Executive Board and the Supervisory Board are disclosed in the sections that follow.
2Mr. Shepard earns a salary of USD 1 million. 3 In line with the regulations of the Short-Term Incentive (STI) plan 2004, it was established that the 2004 value of new business of the Group and of the relevant country units was positive. Subsequently, operating earnings were calculated and established per area of responsibility. After adoption of the 2004 annual accounts by the shareholders, the disclosed STI cash bonuses for the 2004 plan were paid in 2005. Under the 2003 STI Plan, paid in 2004, Mr. Shepard was entitled to receive USD 50,000 per percentage point increase in the preceding year’s earnings per share. The other members of the Executive Board were entitled to receive EUR 32,432 per percentage point increase in the preceding year’s earnings per share in excess of the rate of European inflation as indicated by the European Central Bank. The relevant percentage was 8.9%. All 2003 bonuses were maximized at 150% of the year’s salary. Under the STI Plan 2003, Executive Board members could opt for payment in cash or in shares.
5 In addition to the STI Plan, Mr. Shepard is entitled to a short-term incentive bonus equal to 0.1% of the net income of AEGON N.V. according to the adopted accounts. The amounts included in the 2005/2004 figures presented in the table are based on the 2004/2003 net income as reported in accordance with Dutch accounting principles.
In accordance with the 2005 LTI Plan, non-vested (conditional) AEGON common shares and options were granted to each of the Executive Board members. Vesting of these rights is conditional upon AEGON’s TSR performance relative to that of the peer group over a three-year period. The date of grant for the 2005 LTI Plan was April 22, 2005 and the closing price of that day was EUR 9.91. The value of the performance option was set at 50% of the value of the performance share.
The numbers of shares and options conditionally granted were based on the closing price on the day of the grant. This was also the exercise price of the options. For the conditionally granted options, the exercise prices are: EUR
Options of reference period 2004-2006 11.74 Options of reference period 2005-2007 9.91
1Share appreciation rights. For a description refer to pages 163 - 165. 2The share appreciation rights were granted before becoming a member of the Executive Board.
The above rights have been granted under the LTI Plan in force until December 31, 2003. For each of the members of the Executive Board, the shares held in AEGON as shown in the above table do not exceed 1% of total outstanding share capital at the balance sheet date.
At the balance sheet date, the following members of the Executive Board had loans with AEGON or any AEGON related company: Mr. Streppel had a 5% mortgage loan of EUR 608,934 after voluntary repayment of EUR 71,766 in 2005; Mr. Van der Werf had a mortgage loan of EUR 1,240,000 at a 2,5% floating-rate at year end; and Mr. Wynaendts had two mortgage loans totalling EUR 635,292, with interest rates of 3.9% and 4.1% respectively. In accordance with the terms of the contracts, no principal repayments were received on the loans in 2005 from Messrs Van der Werf and Wynaendts. The terms of the board members’ loans have not been amended.
Termination of the employment contracts requires a three months’ notice period for the current members of the Executive Board. In the event of contract termination by AEGON, the company must adhere to a notice period of six months and, unless terminated for urgent cause, the member of the Executive Board would be entitled to a severance arrangement.
Under his Employment Agreement, Mr. Shepard shall be entitled to a specified amount of severance upon termination of his employment for reasons specified in the Employment Agreement. Under his Employment Agreement, Mr. Shepard shall be entitled to severance in the amount of three year’s base salary and the aggregate short-term incentive compensation he received during the three years prior to the termination in the event that Mr. Shepard’s employment is terminated (a) by AEGON other than for urgent cause, death, disability, voluntary resignation or retirement, (b) by AEGON in connection with a merger, take-over or fundamental changes of policy and related organizational amendments, or (c) by Mr. Shepard in the event that his responsibilities or position are diminished by such circumstances. Any such severance payments received by Mr. Shepard shall be taken into account in determining the amounts payable to him under his AEGON USA Supplemental Executive Retirement Plan (SERP). In addition, three additional years of service will be credited for the purpose of calculating his benefits under the SERP.
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 take-over.
I.W. Bailey, II (as of April 22, 2004) 48,750 23,562 R. Dahan (as of April 22, 2004) 59,500 23,562 S. Levy (as of April 21, 2005) 46,808 —
P.R. Voser (as of April 22, 2004) 54,000 34,906 L.M. van Wijk 48,750 34,034
M. Tabaksblat (up to April 21, 2005) 22,769 56,722 H. de Ruiter (up to April 22, 2004) — 14,137 F.J. de Wit (up to April 22, 2004) — 10,603
SHARE OPTIONS AND SHARE APPRECIATION RIGHTS OF ACTIVE MEMBERS OF THE SUPERVISORY BOARD
I.W. Bailey, II 29,759 29,759 55 EVENTS AFTER THE BALANCE SHEET DATE
On January 10, 2006, AEGON announced that AEGON-CNOOC Life Insurance Company Ltd., the 50/50 joint venture of AEGON N.V. and the Chinese National Offshore Oil Corporation (CNOOC), received a license from the regulatory authorities to begin life insurance activities in China’s Shandong province.
On January 30, 2006, Fitch Ratings assigned AEGON N.V. AA- (double A minus) ratings to AEGON N.V.’s senior debt and A+ ratings to subordinated debt and perpetual securities, with a stable outlook. In addition, Fitch affirmed the AA+ (double A plus) insurance financial strength ratings of AEGON USA.
Investments Revaluation from amortized cost to fair value and changes in impairments 4,062 3,738 Release of bond default reserve 170 192 Release of deferred bond gains 1,456 1,386
REVALUATION FROM AMORTIZED COST TO FAIR VALUE AND CHANGES IN IMPAIRMENTS
Investments in bonds are mostly classified as either available-for-sale financial assets or as financial assets at fair value through profit or loss under IFRS. These bonds were valued at cost under DAP and consequently have been revalued to fair value under IFRS.
Where applicable, impaired financial assets have been adjusted to fair value at the date of impairment, rather than amounts expected to be recovered. This difference in valuation of impaired financial assets also results in differences in impairment reversals.
Under DAP, a default reserve was required for bonds. This default reserve is not recognized under IFRS and is therefore released to equity.
Shadow accounting is applied when there is a direct relationship between the measurement of the invested assets and the measurement of the insurance liabilities or related DPAC and VOBA. When unrealized gains or losses arise on available-for-sale financial assets, insurance liabilities and related assets are adjusted to the same extent that they would be adjusted if those unrealized gains or losses had been realized.
Some of the products in AEGON USA contain embedded derivatives related to ceded reinsurance under IFRS. These embedded derivatives have to be separated from the host contracts and valued on a stand alone basis at fair value in the financial statements. The same applies for certain guarantees within the variable annuity business (segregated funds) in AEGON Canada.
IFRS allows the use of the ‘fresh-start’ approach for the Opening Balance Sheet, under which all cumulative actuarial gains and losses, both realized and unrealized, are effectively recognized in retained earnings on the Opening Balance Sheet, leaving no unrecognized actuarial gains and losses. AEGON elected to make use of this approach and, as a result, additional liabilities for AEGON The Netherlands and AEGON UK were set up and assets relating to AEGON Americas that existed in the DAP balance sheet were charged to shareholders’ equity in the Opening Balance Sheet.
Investment income (422) Fair value movements on financial assets at fair value through profit or loss 52 DPAC, VOBA and liability valuation (322) Interest charges and related fees 122 Net gains on investments and impairment charges 845 Non-recurring income 138 Other 155 Tax 25
This adjustment relates to fair value movements on general account financial assets, including embedded derivatives that are separated from host contracts and that are classified as financial assets at fair value through profit or loss.
Furthermore, a specific product sold by AEGON USA that provides customers with a pass-through of total investment returns, subject to a cumulative minimum guarantee, caused some changes in liability valuation. The product contains an embedded derivative that cannot be separated from the host contract and valued on a stand alone basis at fair value and, as a result, the entire contract is valued at fair value. The investments backing this product have also been classified as financial assets at fair value through profit or loss. The changes in the fair value of the liabilities and the assets backing the product should generally offset each other. However, changes in the asset values are not always offset with changes in the liabilities during a rising interest rate environment, due to the contractual minimum guarantees.
Under IFRS, all realized gains and losses on investments are recognized as incurred. Under DAP, only realized gains and losses on shares and real estate were recognized as incurred, while interest related gains and losses were deferred. The recognition of realized gains and losses in 2004 result in an increase of net income under IFRS.
Impaired assets are written down to fair value for IFRS, while for DAP write offs were only to the recoverable amount. As a result, impairment charges and reversals of impairments for IFRS are higher compared to DAP.
FINANCIAL ASSETS CLASSIFIED AS AVAILABLE-FOR-SALE AT JANUARY 1, 2004 Carrying value Fair value under January 1, DAP 2004
D.G. Eustace D.J. Shepard O.J. Olcay J.B.M. Streppel I.W. Bailey, II J.G. van der Werf R. Dahan A.R. Wynaendts S. Levy T. Rembe W.F.C. Stevens K.J. Storm P.R. Voser L.M. van Wijk
Alexander F.J. van Overmeire Chris J. Westerman 182 AEGON ANNUAL REPORT 2005
Amounts owed to credit institutions 1,444 1,400 Loans from group companies 441 1,152 Payables to group companies 3,448 1,764 Deferred tax liabilities — 44
INCOME STATEMENT OF AEGON N.V. FOR THE YEAR ENDED DECEMBER 31, 2005 Amounts in EUR millions
The financial statements have been prepared in accordance with accounting principles in the Netherlands as embodied in Part 9 of Book 2 of the Netherlands Civil Code. Based on article 2:362.8 of the Netherlands Civil Code, the valuation principles applied are based on International Financial Reporting Standards (IFRS), as used for the preparation of the consolidated financial statements of the Group.
Exchange differences on monetary items are recognized in the income statement when they arise, except when they are deferred in equity as a result of a qualifying cash flow or net investment hedge.
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. Derivatives with positive fair values are reported as other assets and derivatives with negative values are reported as other liabilities.
Financial instruments that are issued by the company are classified as equity if they evidence a residual interest in the assets of the company after deducting all of its liabilities. In addition to common shares and preferred shares, the company 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.
Subordinated loans and other borrowings are initially recognized at their fair value and are subsequently carried at amortized cost using the effective interest rate method. The liability is derecognized when the company’s obligation under the contract expires or is discharged or cancelled.
Capital contribution and acquisitions 46 — Divestitures — (203) Dividend paid (250) — Net income for the financial year 2,681 2,346
Common shares 360 360 Preferred shares A 125 125 Preferred shares B 125 125
Common shares 12 12 Preferred shares A 25 25 Preferred shares B 25 25
In both 2001 and 2002, AEGON N.V. entered into total return swaps with Vereniging AEGON in order to hedge the share option plan for each respective year. On April 15, 2005, these total return swaps were terminated, resulting in a positive impact on shareholders’ equity of EUR 1 15 million. The amount has been added to retained earnings.
For detailed information on share appreciation rights and share options granted to senior executives and other AEGON employees, refer to note 40.1 on page 163 of the consolidated financial statements of the Group.
Share in- Retained Net luation Other capital surplus earnings income account reserves Total
CHANGES IN EQUITY FROM RELATION WITH SHAREHOLDERS 5 232 (676) — — — (439)
Changes in foreign currency translation reserve — — — — — 1,515 1,515 Changes in revaluation subsidiaries — — 4 — 152 — 156 Transfer to legal reserve — — (60) — 60 — —
CHANGES IN EQUITY FROM RELATION WITH SHAREHOLDERS 8 214 (188) — — — 34
Instruments issued 1,457 — — 1,457 Instruments redeemed — (950) — (950) Share options granted — — 3 3
USD 250 million floating Libor rate March 15 2010 212 — EUR 950 million floating CMT rate January 15 2014 950 950 USD 500 million floating CMS rate January 15 2014 402 402
TOTAL PERPETUAL CUMULATIVE SUBORDINATED BONDS 567 1,517 1Issued at an interest rate of 8%, which was reset in June 2005.
The market value of the long-term liabilities amounts to EUR 2,712 million (2004: EUR 2,970 million).
• Due and punctual payment of payables by the consolidated group companies AEGON Funding Corp., Commonwealth General Corporation, Transamerica Corporation and Transamerica Finance Corp. with respect to bonds, capital trust pass-through securities and notes issued under commercial paper programs (EUR 1,659 million).
• Due and punctual payment of any amounts owed to third parties by the consolidated group company AEGON Derivatives N.V. in connection with derivative transactions. AEGON Derivatives N.V. only enters into derivative transactions with counterparties with which ISDA master netting agreements including Collateral Support Annex agreements have been agreed; net (credit) exposure on derivative transactions with these counterparties was therefore minimal as at December 31, 2005.
Supervisory Board Executive Board D.G. Eustace D.J. Shepard O.J. Olcay J.B.M. Streppel I.W. Bailey, II J.G. van de Werf R. Dahan A.R. Wynaendts S. Levy T. Rembe W.F.C. Stevens K.J. Storm P.R. Voser L.M. van Wijk
6. The Executive Board may, subject to the approval of the Supervisory Board, decide that a distribution on common shares shall not take place as a cash payment but as a payment in common shares, or decide that holders of common shares shall have the option to receive a distribution as a cash payment and/or as a payment in common shares, in all cases out of the profit and/or at the expense of reserves. Subject to the approval of the Supervisory Board, the Executive Board shall also determine the conditions applicable to the aforementioned choices.
In accordance with article 32, paragraph 3 of the Articles of Incorporation, a cash dividend equal to 3.75% of the amount paid on the preferred shares will be distributed.
In accordance with the 1983 Merger Agreement, Vereniging AEGON had certain option rights on preferred shares to prevent dilution of voting power as a result of share issuances by AEGON N.V. This enabled Vereniging AEGON to maintain voting control at the General Meeting of Shareholders of AEGON N.V. In September 2002, AEGON N.V. effected a non-dilutive capital restructuring whereby Vereniging AEGON sold 350,000,000 of its common shares, of which 143,600,000 common shares were sold directly by Vereniging AEGON in a secondary offering outside the United States and 206,400,000 common shares were purchased by AEGON N.V. from Vereniging AEGON. AEGON N.V. subsequently sold these common shares in a global offering. The purchase price for the 206,400,000 common shares sold by Vereniging AEGON to AEGON N.V. was EUR 2,064,000,000, which amount Vereniging AEGON contributed as additional paid-in capital on the existing AEGON N.V. preferred shares, all held by Vereniging AEGON. As a result of these transactions, Vereniging AEGON’s beneficial ownership interest in AEGON N.V.’s common shares decreased from approximately 37% to approximately 12% and its beneficial ownership interest in AEGON N.V.’s voting shares (excluding issued common shares held in treasury by AEGON N.V.) decreased from approximately 52% to approximately 33%.
At December 31, 2005, the General Meeting of Members of Vereniging AEGON consisted of eighteen members. The majority of the voting rights is with the sixteen members not being employees or former employees of AEGON N.V. or one of the AEGON Group companies, nor current or former members of the Supervisory Board or the Executive Board of AEGON N.V. The two other members are both elected by the General Meeting of Members of Vereniging AEGON from among the members of the Executive Board of AEGON N.V.
Vereniging AEGON has an Executive Committee consisting of seven members, five of whom, including the chairman and the vicechairman, are not nor have ever been, related to AEGON. The other two members are also members of the Executive Board of AEGON N.V. Resolutions of the Executive Committee, other than with regard to amendment of the Articles of Association, are made with an absolute majority of the votes. When a vote in the Executive Committee results in a tie, the General Meeting of Members has the deciding vote. With regards to the amendment of the Articles of Association of Vereniging AEGON, a special procedure is in place to provide for the need of a unanimous proposal from the Executive Committee, thereby including the consent of the representatives of AEGON N.V. at the Executive Committee. Following the amendment of the Articles of Association as effected on September 13, 2005, this requirement does not apply in the event of a hostile change of control at the General Meeting of Shareholders of AEGON N.V., in which event Vereniging AEGON may amend its Articles of Incorporation without the cooperation of AEGON N.V.
The consolidated financial statements of the AEGON Group have been prepared in accordance with International Financial Reporting Standards, as adopted by the European Union (IFRS), which differ in certain respects from those principles generally accepted in the United States (US GAAP). The following information is a summary of the effect on AEGON’s shareholders’ equity and net income of the application of US GAAP, which is included in further detail in the Form 20-F report filed with the Securities and Exchange Commission. The Form 20-F report is available on request, free of charge, and can also be retrieved from the EDGAR database of the SEC at www.sec.gov and via www.aegon.com.
RECONCILIATION OF SHAREHOLDERS’ EQUITY AND NET INCOME BASED ON IFRS TO US GAAP Shareholders’ equity
Other comprehensive income, net of tax: Foreign currency translation adjustments 1,987 (971) Unrealized gains and (losses) on available-for-sale financial assets 840 911 Reclassification adjustment for (gains) and losses included in net income (538) (526) Net unrealized gains on cash flow hedges 97 66 Minimum pension liability adjustment 30 (47)
COMPREHENSIVE INCOME IN ACCORDANCE WITH US GAAP 4,500 863 196 AEGON ANNUAL REPORT 2005
a) Goodwill IFRS 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.
US GAAP Under US GAAP goodwill is capitalized and reviewed and tested for impairment under a fair value approach. Goodwill must be tested for impairment at least annually or more frequently as a result of an event or change in circumstances that would indicate impairment may be necessary. Impairment testing requires the determination of the fair value for each of the identified reporting units. The reporting units identified for AEGON based upon the Statement of Financial Accounting Standards 142 Goodwill and other Intangible Assets include: AEGON Americas, AEGON The Netherlands, AEGON UK insurance companies, AEGON UK distribution companies and Other countries. The fair value of the insurance operations is determined using valuation techniques consistent with market appraisals for insurance companies, a discounted cash flow model requiring assumptions as to a discount rate, the value of existing business and expectations with respect to future growth rates and term. The valuation utilized the best available information, including assumptions and projections considered reasonable and supportable by management. The assumptions used in the determination of fair value involve significant judgment and estimates. The discount rates used are believed to represent market discount rates, which would be used to value businesses of similar size and nature.
Acquisition costs are deferred to the extent that they are recoverable and are subsequently amortized based on either the expected future premiums or the expected gross profit margins. For products sold in the United States and Canada with amortization based on expected gross profit margins, the amortization period and pattern are reviewed at each reporting date and any change in estimates is recognized in the income statement. Estimates include, but are not limited to: an economic perspective in terms of future bond and equity returns, mortality, disability and lapse assumptions, maintenance expenses and expected inflation rates. For all products, DPAC is assessed for recoverability at least annually on a country-by-country basis and is considered in the liability adequacy test for each reporting period. If appropriate, the assumptions included in the determination of estimated gross profits are adjusted. The portion of DPAC that is determined not to be recoverable is charged to the income statement.
When unrealized gains or losses arise on available-for-sale assets, DPAC is adjusted to equal the effect that the realization of the gains or losses would have had on its measurement. The adjustment is recognized directly in the related revaluation reserve in equity.
DPAC is derecognized when the related contracts are settled or disposed of. 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.
When a portfolio of insurance contracts is acquired, whether directly from another insurance company or as part of a business combination, the difference between the fair value and the carrying amount of the insurance liabilities is recognized as VOBA. The Group also recognizes VOBA when it acquires a portfolio of investment contracts with discretionary participation features.
VOBA is amortized over the useful life of the acquired contracts, based on either the expected future premiums or the expected gross profit margins. For products sold in the United States and Canada with amortization based on expected gross profit margins, the amortization period and pattern are reviewed at each reporting date. Any change in estimates is recorded in the income statement. For all products, VOBA is assessed for recoverability at least annually on a country-by-country basis and the portion determined not to be recoverable is charged to the income statement. VOBA is considered in the liability adequacy test for each reporting period.
VOBA is derecognized when the related contracts are settled or disposed of.
US GAAP Under US GAAP the accounting for fixed premium products is the same as under IFRS in all countries. For flexible premium products sold in the Americas, US GAAP is the same as IFRS. For flexible premium products sold in the Netherlands, the United Kingdom and Other countries an unlocking adjustment is made for US GAAP, using a revised DPAC amortization schedule based on actual gross profits earned to date and revised estimates of future gross profits.
Acquisition costs related to non-insurance investment type products related to 401(k) plans in the United States and investment products in the United Kingdom are deferred and amortized in terms of Statement of Financial Accounting Standard 97 Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments (SFAS 97). US GAAP allows for the deferral of costs that vary directly with production, while IFRS is more restrictive limiting deferral to costs that are incremental and directly attributable to the issuance of the contract. In addition, some service contracts are sold in the United States for which advertising costs are deferred and amortized under Statement of Position 93-7 Reporting on Advertising Costs (SOP 93-7). IFRS does not allow the deferral and future amortization of these costs.
c) Real estate IFRS 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.
Valuations of both investments in real estate and real estate held for own use are conducted with sufficient regularity to ensure the value correctly reflects the fair value at the balance sheet date. Valuations are mostly based on active market prices, adjusted for any difference in the nature, location or condition of the specific property. If such information is not available, other valuation methods are applied, considering the current cost of reproducing or replacing the property, the value that the property’s net earning power will support and the value indicated by recent sales of comparable properties.
US GAAP Under US GAAP real estate is carried at historical cost less accumulated depreciation and is adjusted for any impairment in value. Depreciation is provided over the estimated economic life of the real estate. Realized gains or losses and all other operating income and expense are reported in the income statement.
The adjustment shown in the net income column of the reconciliation represents: • The reversal of the unrealized gains (losses) under IFRS on investments in real estate, the difference in realized gains (losses) on disposed real estate reflecting different carrying values for both investment real estate and real estate held for own use under IFRS; and
• The annual depreciation charge on investment property under US GAAP and the difference in depreciation charge on property held for own use.
d) Financial assets A number of differences still exist between IFRS and US GAAP. These differences can be summarized as follows: • Write offs on impaired debt instruments can be partially or fully reversed under IFRS if the value of the impaired assets increase. Such reversals are not allowed under US GAAP. Under IFRS certain mortgage loan securitizations of AEGON The Netherlands have been derecognized and realized gains have been reported, while for US GAAP these mortgage loans are recognized on the balance sheet.
• Some assets are reported as available-for-sale financial assets under IFRS, while US GAAP requires the equity method of accounting. • Additional impairments have been recorded for US GAAP. If a particular asset does not fit AEGON’s long-term investment strategy and is in an unrealized loss position due solely to interest rate changes, the security has been impaired to the fair value under US GAAP while such impairment would not be required under IFRS. For securities not impaired under US GAAP, AEGON has the intent and ability to hold these securities until recovery or maturity.
The adjustment shown in the shareholders’ equity column of the reconciliation represents transactions that are accounted for as derivatives under IFRS and not under US GAAP.
Under US GAAP the technical reserves for traditional life insurance contracts are computed using the net level premium method with investment yields, mortality, lapses and expenses based on historical assumptions and include a provision for adverse deviation. For universal life contracts and investment type contracts (annuities) the technical reserves are equal to the policyholder account balances at the balance sheet date. The technical reserve in the United Kingdom is reduced to equal the contractholder balance. The technical reserve for fixed annuities, guaranteed investment contracts and funding agreements is the same as under IFRS.
For AEGON UK, investment contracts without discretionary participation features are recognized using a funded value for IFRS and a nominal value for US GAAP. Furthermore, profits on reinsurance contracts are recognized directly in net income under IFRS and deferred and amortized under US GAAP.
In various countries products are sold that contain minimum guarantees. For these products the regular technical reserve is recognized under technical reserves with investments for account of policyholders. The liabilities for life insurance includes liabilities for guaranteed minimum benefits related to contracts where the policyholder otherwise bears the investment risk. The valuation of these guarantees under IFRS is the same as under SOP 03-1 for US GAAP, with the exception of the guarantees on the group pension contracts in the Netherlands. The minimum interest guarantees on group pension contracts in the Netherlands are given for nominal benefits, based on the 3% or 4% actuarial interest rate, after retirement of the employees. Due to the nature of the product, these guarantees have a long-term horizon of about 30 to 60 years. Under IFRS the liability is measured by applying the accrual method based on pricing assumptions less actual deductions. Under US GAAP an additional annuitization benefit liability is set up in accordance with SOP 03-1.
g) Pensions and other post-retirement benefits IFRS For defined benefit plans, a liability is recognized for the excess of the defined benefit obligation over the fair value of the plan assets, together with adjustments for unrecognized actuarial gains and losses and past service costs. However, actuarial gains and losses that occurred before the transition to IFRS on January 1, 2004 are not reflected in the measurement of the liability as they were recognized on transition to IFRS.
Some countries issued group life insurance policies covering own employee benefit obligations. These policies are generally at market-consistent terms and subject to policyholder protection legislation. However, the policies are not recognized in the consolidated financial statements as they do not meet the definition of a liability. The employee benefit obligation is therefore considered unfunded. The assets held by the country to cover the benefits payable under the eliminated contract do not qualify as plan assets, but are classified as investments.
US GAAP US GAAP Statement of Financial Accounting Standard 87 Employees Accounting for Pensions (SFAS 87), is applied to the pension plans of the Group. SFAS 87 calculations require several assumptions, including future performance of financial markets, future composition of the work force and best estimates of long-term actuarial assumptions. The expected return on plan assets is calculated using a moving average for the plan assets. In a period of market decline, such as recently experienced, this moving average is higher than the fair value of the assets. The difference between the expected return reflected in the income statement and the actual return on the assets in a certain year is deferred. Deferred gains or losses are amortized to the income statement applying a corridor approach. The corridor is defined as 10% of the greater of the moving average value of the plan assets or the projected benefit obligation. To the extent that the prepaid pension costs at the beginning of the year exceed the moving average asset value less the pension benefit obligation by more than the 10% corridor, the excess is amortized over the employees’ average future years of service (approximately seven years). The assumptions are reviewed on an annual basis and changes are made for the following year, if required.
The adjustment in the shareholders’ equity column of the reconciliation represents the cumulative unrecognized actuarial gains and losses at January 1, 2004 that were, as part of the conversion to IFRS, directly recognized in equity. For US GAAP, the unrecognized actuarial gains and losses at January 1, 2004 are capitalized.
h) Other equity instruments IFRS Other equity instruments comprise junior perpetual capital securities and perpetual cumulative subordinated bonds.
Under IFRS the junior perpetual capital securities, as well as perpetual cumulative subordinated bonds, are classified as equity instruments and are valued at face value. In the consolidated balance sheet these instruments are shown as a separate component of group equity and are not part of shareholders' equity. Accrued coupons are charged to retained earnings within shareholders’ equity.
The adjustment in the net income column of the reconciliation represents the interest charges for the respective years.
j) Taxation Reflects taxation on reconciling items between IFRS and US GAAP and include some differences in tax-treatment between IFRS and US GAAP.
At At At At At At At At Mar. 31 Jun. 30 Sept. 30 Dec. 31 Mar. 31 Jun. 30 Sept. 30 Dec. 31 1Net income refers to net income attributable to equity holders of AEGON N.V. 2After deduction of preferred dividend and coupons on perpetuals. 3Shareholders’ equity per share is calculated after deduction of the preferred share capital and considering the number of outstanding treasury shares.
AEGON N.V. AEGONplein 50 P.O. Box 202 2501 CE The Hague The Netherlands www.aegon.com
AEGON N.V. P.O. Box 202 2501 CE The Hague The Netherlands E-mail: gca-ir@aegon.com
March 8 AEGON will report on full year 2006 results April 25 Annual General Meeting of Shareholders May 9 AEGON will report on first three months 2007 results August 9 AEGON will report on first six months 2007 results November 8 AEGON will report on first nine months 2007 results
Acquisition date is the date on which the acquirer effectively obtains control of the acquiree. In most cases this includes at least the transfer of risks and rewards related to the acquired business or assets/liabilities.
Financial asset is any asset that is: • Cash; • An equity instrument of another entity; • A contractual right to receive cash or another financial asset from another entity or to exchange financial instruments with another party under conditions that are potentially favorable; or
• A contract that will or may be settled in the entity’s own equity instruments and is: — A non-derivative for which the entity is or may be obliged to deliver a variable number of the entity’s own equity instruments; or
Past service cost is the increase in the present value of the defined benefit obligation for employee service in prior periods, resulting in the current period from the introduction of, or changes to, postemployment benefits.
• Are not available to the reporting entity’s own creditors. Real estate investments foreclosed are real estate investments purchased through foreclosure on the mortgage. Such purchases are not accounted for as mortgages, but as real estate investments until they can be sold at a better price than at the foreclosure. Meanwhile they yield a rental income.
The statements contained in this Annual Report that are not historical facts are forward-looking statements as defined in the US Private Securities Litigation Reform Act of 1995. The following are words that identify such forward-looking statements: believe, estimate, intend, may, expect, anticipate, predict, project, counting on, plan, continue, want, forecast, should, would, is confident, will, and similar expressions as they relate to our company. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. We undertake no obligation to publicly update or revise any forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which merely reflect company expectations at the time of writing. Actual results may differ materially from expectations conveyed in forwardlooking statements due to changes caused by various risks and uncertainties. Such risks and uncertainties include but are not limited to the following: • Changes in general economic conditions, particularly in the United States, the Netherlands and the United Kingdom; • Changes in the performance of financial markets, including emerging markets, such as with regard to: — The frequency and severity of defaults by issuers in our fixed income investment portfolios; and — The effects of corporate bankruptcies and/or accounting restatements on the financial markets and the resulting decline in the value of equity and debt securities we hold; • The frequency and severity of insured loss events; • Changes affecting mortality, morbidity and other factors that may impact the profitability of our insurance products; • Changes affecting interest rate levels and continuing low or rapidly changing interest rate levels; • Changes affecting currency exchange rates, in particular the EUR/USD and EUR/GBP exchange rates; • Increasing levels of competition in the United States, the Netherlands, the United Kingdom and emerging markets; • Changes in laws and regulations, particularly those affecting our operations, the products we sell, and the attractiveness of certain products to our consumers; • Regulatory changes relating to the insurance industry in the jurisdictions in which we operate; • Acts of God, acts of terrorism, acts of war and pandemics; • Changes in the policies of central banks and/or governments; • Litigation or regulatory action that could require us to pay significant damages or change the way we do business; • Customer responsiveness to both new products and distribution channels; • Competitive, legal, regulatory, or tax changes that affect the distribution cost of or demand for our products; • Our failure to achieve anticipated levels of earnings or operational efficiencies as well as other cost saving initiatives; and
• The impact our adoption of the International Financial Reporting Standards may have on our reported financial results and financial condition.
AEGON is one of the world’s largest life insurance and pension companies, and a strong provider of investment products. We empower our local business units to identify and provide products and services that meet the evolving needs of our customers, using distribution channels best suited to their local markets. We take pride in balancing a local approach with the power of an expanding global operation.