AEGON Group
Report of the Executive board
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“Thanks to better-than-expected performances from our businesses in the Americas, Europa and Asia, AEGON also reported a fourth straight year of value of new business growth in 2007, putting the Group firmly on track to meet its target for 2010.” Overview AEGON’s businesses delivered a solid performance in 2007, as demonstrated by increased sales, deposits and a further growth in underlying earnings. In addition, AEGON continues to maintain its strong financial position. Despite turbulence in world financial markets, AEGON experienced no material impairments to its investment portfolio during the year. AEGON’s subprime portfolio, valued at EUR 2.9 billion, continues to be very high quality, with more than 99% rated either AAA or AA. AEGON’s net operating earnings and net underlying earnings declined as a result of a weaker US dollar and the impact of significant one-time tax benefits which had lifted earnings for 2006. Underlying earnings before tax increased 9% in 2007, a reflection of solid growth across AEGON’s business and country units. Net income was down 20%, mainly due to the impact of exceptional gains in the Netherlands in 2006. During the year, revenue generating investments grew by 2% (or 11% at constant currency exchange rates), reflecting a continued overall expansion of the Group’s businesses.
The completion of a EUR 1 billion share repurchase plan in November 2007 and a proposed 13% increase in the Group’s full year dividend are further evidence of AEGON’s continued strong cash flows and solid capital position. AEGON continues to have sufficient capital to support the organic growth of its businesses while at the same time pursuing acquisition opportunities consistent with the Group’s disciplined approach to pricing. During the year, AEGON took steps to further strengthen its distribution network, agreeing new partnerships with Barclays Bank in the United Kingdom, Taishin in Taiwan, Industrial Securities in China and the regional savings bank Caja Cantabria in Spain. In addition, AEGON’s new partnership with Merrill Lynch in the United States will further enhance the Group’s position as a leading provider of life insurance and variable annuity products to US brokers. Investment portfolio AEGON USA AEGON has a culture of strong and effective risk management. There are robust processes and controls in place throughout the Group’s asset management organization. Credit risks are mainly concentrated in AEGON USA’s general account portfolio. Over the last few years, AEGON has repositioned investments for its general account insurance portfolio, structuring them defensively in order to weather a stressed credit environment. The relative low level of impairments in the fourth quarter of 2007 demonstrates the high quality of AEGON’s investment portfolio and the limited impact the current stressed credit environment is having on expected cash flows from AEGON’s fixed income assets. Net impairments on investments for the Americas amounted to EUR 48 million. The current dislocation of credit markets, however, is characterized by price and/or spread volatility, low liquidity and, for certain segments of the market, may result in changes to credit ratings. Most assets contained in AEGON’s general account portfolio are accounted for as ‘Available for Sale’ under IFRS, and thus are held at fair value on the balance sheet. Any changes to the fair value of these assets are recorded on an after tax-basis in shareholders’ equity. AEGON USA’s subprime mortgage-backed securities (subprime ABS) portfolio of EUR 2.9 billion experienced no impairments. The portfolio is currently valued at approximately 88%, or a fair value of EUR 2.5 billion. Total negative pre-tax revaluations on this portfolio amounted to EUR 348 million in 2007. The pricing of certain parts of this portfolio, such as AA-rated floating rate 2006 and 2007 securities, reflects developments in the subprime ABS indices (ABX). AEGON’s subprime ABS portfolio consists of 70% AAA-rated securities and 29% AA-rated securities. AEGON does not originate subprime mortgages. AEGON USA’s residential mortgage-backed securities (RMBS) portfolio includes securities of near prime residential mortgage loans, such as so-called Alt-A and negative amortization floaters. AEGON’s EUR 862 million in Alt-A holdings are backed by fixed-rate loans. Ninety-nine percent of these securities are rated AAA. At the end of 2007 the Group’s Alt-A portfolio had total negative pre-tax revaluations of EUR 18 million, bringing the fair value of this portfolio to EUR 844 million, or approximately 98%. The negative amortization, or Option ARM floaters, are collateralized by affordability-type loan structures that allow for flexible monthly repayments. This EUR 1.6 billion portfolio is entirely AAA-rated and consists of super-senior AAA exposure. This means that subordination levels in the securitizations are four to five times what is typically required by rating agencies for a AAA rating. Total negative pre-tax revaluation of this portfolio amounted to EUR 73 million bringing the fair value on the portfolio to EUR 1.5 billion, or approximately 95%. AEGON’s collateralized debt obligations (CDO) portfolio totals EUR 1.0 billion. Total negative pre-tax revaluations on AEGON’s CDO portfolio amounted to EUR 48 million at the end of 2007, with a fair value of approximately 95%. The majority of these investments is backed by leveraged bank loans, of which 92% was rated AAA or AA at the end of 2007. The portfolio includes an investment of EUR 21 million in CDOs backed by subprime mortgages assets purchased before 2002. At the end of 2007, total negative pre-tax revaluations on subprime ABS, Alt-A RMBS, negative amortization floaters and CDOs totaled EUR 487 million, bringing the fair value of the portfolio to approximately 92%. For a fee, AEGON USA takes on credit exposure on a credit index, i.e. super-senior tranches of the CDX index, via a synthetic collateralized debt obligation program (synthetic CDO). This index is composed of a reference portfolio of 125 investment grade corporate credits. Eighty-four percent of the exposure is to the most senior of the super-senior tranches, i.e. the 30%-100% tranche. This means that losses to AEGON occur only if cumulative net losses on the CDX index exceed 30%, where cumulative net loss is defined as bond defaults net of recoveries. The average duration of the outstanding transactions is 4.7 years. AEGON considers the probability of losses at these levels to be extremely remote and hence does not expect any cash losses to occur from these synthetic CDO positions. As these derivatives are marked to market through earnings, they may however cause substantial operating earnings volatility prior to maturity due to movements in credit spreads, but will not affect underlying earnings. Assuming there are no cash losses from these positions, any mark to market effect on operating earnings will be reversed by maturity. At December 31, 2007, the notional amount of this program was EUR 4.5 billion with a negative market value of EUR 30 million.
Results AEGON’s operating earnings before tax amounted to EUR 2,692 million in 2007, virtually unchanged from pro forma operating earnings before tax of EUR 2,693 million for the previous year (constant currency figures show a 6% increase). Lower operating earnings from the Americas and the Netherlands in 2007 offset increases in the United Kingdom and from ‘Other countries’. AEGON Americas saw its operating earnings before tax fall 3% to EUR 2,102 million (or increase of 5% at constant currency rates). Operating earnings can be significantly affected by movements in the value of financial assets carried at fair value, as well as total return annuity products and segregated fund guarantees. Earnings from these items in AEGON Americas exceeded expected returns by EUR 110 million in 2007, less than half the EUR 243 million seen in 2006. The decrease in operating earnings from AEGON The Netherlands was primarily due to movements in fair value items. AEGON UK’s operating earnings before tax rose as a result of a growth in profits from annuity products and increases in fund-related fees on pension business. The rise in operating earnings from ‘Other countries’ mainly reflected continued growth in AEGON’s businesses in both Central and Eastern Europe and Asia. AEGON’s net operating earnings declined to EUR 2,047 million in 2007, down from a pro forma figure of EUR 2,139 million the previous year, due mainly to an increase in the Group’s effective tax rate. In addition, net operating earnings in 2006 included significant one-off gains relating to tax payments in the Netherlands. In 2007, AEGON’s effective tax rate on operating earnings rose to 24%, up from 21% in 2006. The Group’s effective tax rate was higher in the Netherlands and Other countries (primarily as a result of an increase in Taiwan), while it decreased in both the Americas and the United Kingdom. Gains/(losses) on investments and impairment charges, totaled EUR 345 million in 2007, down from EUR 544 million the previous year. This decline was primarily the result of a decrease in the fair value of derivatives used to hedge guarantee provisions in the Netherlands, partly offset by a rise in net gains from the sale of bonds and shares in the Americas and the Netherlands. Other non-operating income/(charges) amounted to EUR 40 million in 2007, compared with EUR 86 million in 2006. In 2007, this figure included a one-time gain related to the acquisition of the Dutch life insurer OPTAS as well as the negative effect of a decision to refine the method for calculating unit-linked guarantees. As part of its acquisition of OPTAS, completed during the second quarter of 2007, AEGON gained net assets amounting to EUR 1.7 billion. This was higher than the original acquisition price of EUR 1.5 billion, resulting in a one-off gain for the Group of EUR 212 million. At the beginning of the second quarter of 2007, AEGON refined the method it uses to calculate the fair value of guarantees included in its unit-linked products to align them with existing group pension contracts and traditional products. The impact of this change on net income before tax (recognized in the second quarter of 2007) was a negative EUR 181 million. AEGON’s net income decreased by 20% in 2007 to EUR 2,551 million as a result primarily of lower gains from investments and hedging operations. The Group’s effective tax rate declined to 17% in 2007, down from 20% the previous year. Net income per share is EUR 1.47, down from EUR 1.87. Commissions and expenses, fell 2% to EUR 5,939 million (an increase of 3% at constant currency exchange rates), reflecting a change in AEGON’s overall business mix and lower DPAC amortization, offset partly by the underlying growth in the Group’s businesses. At the end of December 2007, total revenue generating investments stood at EUR 371 billion, up from EUR 363 billion twelve months previously. On a constant currency basis, the increase was 11%, reflecting net growth in AEGON’s in-force portfolio (both deposits and premium business), improved market performance and the inclusion for the first time of OPTAS and two former Merrill Lynch life insurance companies in the United States, acquired in 2007. Sales AEGON’s overall new life sales increased 7% in 2007 to EUR 3,274 million (an increase of 11% at constant currency rates). In the Americas, new life sales rose 2% to USD 1,276 million. Figures for 2006 had been lifted by USD 56 million from sales of investor-owned life insurance and a further USD 50 million from an assumed block of retail credit life insurance. In the course of 2006, sales of investor-owned life insurance were discontinued. In the Netherlands, total new life sales increased by 5% in 2007, driven by a growth in pension sales, particularly via corporate and other financial institutions. New life sales in the United Kingdom, rose 12% to GBP 1,183 million, following exceptionally strong sales in 2006 as a result of ‘Pension A-Day’. New life sales in ‘Other countries’ totaled EUR 353 million in 2007, an increase of 37% due mainly to continued strong growth in Central and Eastern Europe and higher sales of unit-linked products in Taiwan. Deposits rose 14% in 2007. In the Americas, deposits from the Group’s pension business were 28% higher than in 2006, while deposits from both fixed and variable annuities and mutual funds increased 8%. An overall increase in sales of institutional guaranteed products was driven by USD 6.6 billion in sales of synthetic CDOs, a new product in 2007. In Central and Eastern Europe, deposits of pensions and asset management products, as well as retail mutual funds, showed continued strong growth. In the United Kingdom, sales of both retail and institutional asset management products increased, as did savings deposits in the Netherlands.
The Group uses net operating earnings in its segment reporting as an important indicator of its financial performance. The reconciliation of this measure to the income before tax is shown below. AEGON believes that net operating earnings, together with the other information included in this report, provides a meaningful measure for the investing public to evaluate AEGON’s business relative to the businesses of its peers.
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