Results Q3 2008
Alex Wynaendts, CEO: "Aegon’s underlying business remained resilient during the third quarter, despite ongoing turbulence in world financial markets."[node:field_featured_media:entity:field_media_image]
- Third quarter results in line with pre-announcement of October 28, 2008
- Underlying earnings before tax of EUR 500 million, mainly affected by lower equity markets and mortality experience
- Net loss for the quarter of EUR 329 million
- Shareholders’ equity (including revaluation reserve) of EUR 9.4 billion at the end of third quarter; decline in revaluation reserve of EUR 2.5 billion, driven by widening in credit spreads
Excess capital in operating units of EUR 300 million above AA rating requirements; IGD surplus of EUR 5 billion including revaluation reserve, equivalent to an EU solvency ratio of 160%
- As announced on October 28, 2008, Aegon will receive EUR 3 billion of additional core capital from Vereniging Aegon, funded by Dutch State - reinforces capital buffer to withstand global financial market and macro economic uncertainties
Statement Alex Wynaendts, CEO
“Aegon’s underlying business remained resilient during the third quarter, despite ongoing turbulence in world financial markets. Our recent agreement with the Dutch State through Aegon’s largest shareholder, Vereniging Aegon, will give us an additional buffer in what continues to be an extremely uncertain market environment. This additional core capital complements Aegon’s previously announced acceleration of risk reduction and capital release strategy, which freed up EUR 729 million of capital during the third quarter. In each of our key markets, we have maintained our strong positions and are taking the right steps to improve returns and achieve future growth. In the United States, we achieved the highest level of quarterly fixed annuity sales since 2003, with positive net inflows. Aegon is well-positioned to withstand the current financial crisis and benefit from an upturn in market conditions.”
Underlying earnings before tax declined 28% to EUR 500 million. Underlying earnings in the Americas were down on the impact of lower equity markets on variable annuities (EUR 48 million) and mortality experience (EUR 28 million) in life reinsurance. In the Netherlands underlying earnings were impacted by a charge to meet guaranteed returns on specific group pension contracts (EUR 35 million) and the costs of modifying unit-linked products (EUR 28 million). The decline in financial markets also negatively impacted underlying earnings in the United Kingdom. Aegon’s net loss in Q3 2008 is a result of impairment charges (EUR 407 million pre tax) and significant underperformance on fair value items (EUR 384 million pre tax), such as alternative investments and products containing financial guarantees. As a result of the strengthening of the US dollar, the revenue generating investments increased 2% compared to the second quarter to EUR 351 billion.
View the table key performance indicators Q3 2008.
In June this year Aegon set out three strategic priorities:
1. To reallocate capital toward businesses with higher growth and return prospects;
2. To improve growth and returns from existing businesses;
3. Manage Aegon as an international company.
Despite the significant deterioration in world financial markets over recent months, Aegon has made definite progress toward the company’s strategic objectives:
- In July, Aegon completed a securitization in the United Kingdom, freeing up EUR 315 million in additional capital. Aegon is now looking actively at other, similar opportunities in the United States, the Netherlands and the United Kingdom, aimed at strengthening the company’s capital position and enhancing its overall financial flexibility.
- In July, Aegon’s joint venture with Religare in India started operations.
- In July, Aegon finalized the acquisition of the Turkish life insurance and pension provider Ankara Emeklilik.
- In August, Aegon agreed a new joint venture with the Catalan-based savings bank Caixa Terrassa. The partnership gives Aegon access for the first time to Catalonia, one of Spain’s wealthiest regions with a population of more than seven million people.
- In September, Aegon announced important changes to the company’s operations in Canada, aimed at ensuring profitable future growth by reducing capital use and focusing resources on areas with strong return prospects.
- In October, Aegon signed an agreement to acquire a 50% stake in Brazilian life insurer Mongeral SA Seguros e Prevedência, further strengthening the company’s position in the fast-growing Latin American market.
- Aegon is using its hedging expertise in the United States in variable annuities and life reinsurance expertise to expand into new markets in Europe and Asia.
Given the current troubled market environment, Aegon has been taking a number of actions to accelerate capital preservation and risk mitigation to enhance its capital buffer. These actions include lowering investment risk on both the existing portfolio and new money; transferring risk through reinsurance and additional securitizations like the one completed in the UK during the third quarter. During the third quarter, similar actions freed up EUR 729 million of capital in total. Aegon expects that the continued execution of these actions will release capital in the range of EUR 600 to 800 million during the fourth quarter. All these measures aim to ensure Aegon maintains a level of capital above its AA rating requirements.
Value of new business
Value of new business decreased by 12% to EUR 206 million in the third quarter (4% at constant currency). Aegon’s internal rate of return remained stable at 17.7% as the company continued its focus on writing profitable new business.
Return on equity
Aegon’s return on equity was 10.9% for the first nine months of 2008, down due to lower underlying earnings.
Aegon’s underlying earnings before tax declined 2% in constant currency in the first nine months of 2008 primarily as a result of continued turmoil in world financial markets.
Aegon and the global financial crisis
Like many other insurance companies, Aegon had to contend with unprecedented turmoil in world financial markets during the third quarter. Despite the extremely difficult conditions, Aegon is well positioned to withstand the current global financial crisis. The company has ample liquidity, and a strong capital position going into next year.
Over the past few months, the global financial crisis has worsened to a degree few would have expected. The crisis has led to considerable difficulties at a number of well-known financial institutions. Since then corporate bond and equity values have fallen sharply.
Over the past few years, the company has taken a number of steps to strengthen its capital position and to prepare itself for a potential downturn in market conditions. These included:
- Reducing direct exposure to equity markets and upgrading the quality of the company’s bond portfolio;
- Lowering interest rate risks and the guarantees offered on certain products;
- Hedging more of the company’s financial market risks;
- And more effective matching of assets and liabilities.
By reducing risk, Aegon has been able to free up more capital. These measures continued in the third quarter and are continuing now.
Recently, Aegon has also taken additional measures to strengthen its capital position, going into 2009. These included:
- Foregoing the final dividend payment to shareholders for 2008;
- And, securing an extra EUR 3 billion in core capital from the Vereniging Aegon funded by the Dutch State.
Taken together, all these measures strengthen Aegon’s overall financial position by ensuring a capital buffer substantially in excess of AA rating requirements. At the end of the third quarter, Aegon had approximately EUR 5 billion in capital over and above minimum EU regulatory requirements. This would rise to approximately EUR 8 billion pro forma for the additional capital buffer.
Clearly, Aegon’s balance sheet has also been affected by recent market turmoil. In the third quarter, the value of Aegon’s corporate bond investments declined significantly. This decline was due primarily to an unprecedented widening in credit spreads. Lower bond values, however, have no impact on Aegon’s earnings. They are reflected instead in the company’s so-called ‘revaluation reserve’, which given current market conditions decreased by EUR 2.5 billion in the third quarter.
The lower valuation of these bonds will only affect earnings if Aegon:
- Either impairs its investments because, for one reason or another, the company does not expect to get its money back (as happened, for example, with Lehman Brothers);
- Or is forced to sell those investments at a loss to generate cash.
In any economic downturn, there is an increase in impairments. But history shows the correlation between widening investment grade bond spreads and an increase in impairments is not as strong as many might suppose. Even if there is an increase in impairments because of deterioration in the general economic climate, Aegon believes these impairments will remain at manageable levels. This is primarily because of measures the company has already taken to limit risk and improve the quality of its portfolio.
Moreover, Aegon’s long-term business model ensures that the company is unlikely to be in a position to have to sell its investments at a loss, simply to generate cash.
As an insurance company, Aegon sells products that last ten, twenty, even thirty years, and it matches these liabilities to similar, long-term investments. Before the onset of this financial crisis, Aegon was proactive in positioning its bond portfolio more defensively. Aegon’s ample liquidity and strong asset and liability management mean that it is unlikely that Aegon will be forced to sell assets at distressed prices, as reflected in the revaluation reserve. Therefore, Aegon’s negative revaluation reserve is not a good indication of future losses.
Like other financial sector companies, Aegon is operating in an extremely uncertain economic and market environment. Nevertheless, the steps already taken to reduce risk and strengthen the company’s capital position mean Aegon is now well-placed to withstand the current crisis and take advantage of an eventual upturn in market conditions.
Aegon’s exposure to equity markets
Over the past several years, Aegon has taken steps to reduce its exposure to world equity markets. As a result, the company’s direct equity exposure is limited.
However, Aegon also has indirect exposure to equity markets, most notably as a result of guarantees on variable annuities in the Americas and unit-linked products and group pension contracts in the Netherlands. Aegon receives fees on equity related products. In addition, Aegon defers policy acquisition costs (DAC) on part of its equity linked products.
Aegon has hedged the equity risk of variable annuity guarantees on the vast majority of the products sold since 2004. On older blocks of business, sold before 2004, Aegon has not hedged equity related risks. The rise in equity markets between 2003 and 2007 resulted in a reduction of equity market sensitivity of capital and earnings. Recent steep declines of equity markets and increased equity markets volatility reversed this development and materially increased the equity market sensitivity.
In the Netherlands, equity market related risks from guarantees in unit-linked products and guarantees on group pension contract are considered to be manageable and are not hedged.
The amortization of the DAC, in particular variable annuity DAC, depends on assumed equity market returns. Given current equity market volatility, assumptions on expected equity market returns can change and affect the original DAC schedule. The difference between the original DAC amortization schedule and the revised schedule is recognized in the income statement as an expense or a benefit in that period. Recent declines in equity markets can lead to charges in income from accelerated DAC amortization.
Aegon estimates that for the total Group, from market levels per September 30, a 20% decline in equity markets will negatively impact earnings with EUR 700 million, due to lower fees, higher reserve requirements and accelerated amortization of the deferred acquisition cost. Additionally, the negative impact from a 20% decline of equity markets would impact the capital position in the country units by EUR 900 million, which largely can be absorbed by capital preservation actions.
Aegon’s investment portfolio
Aegon’s credit risks are concentrated primarily in the United States. Most of the unrealized losses on Aegon’s investments may be attributed to its US bond portfolio.
View the table shifts in the US investment portfolio.
Over the past several years, Aegon has structured its US investment portfolio defensively in order to withstand a stressed credit environment, and also reduced its exposure to the US financial sector. During the third quarter, Aegon reported significant impairments linked to both financial institutions.
Over the past year, the yield on US investment grade corporate bonds has risen by more than 200 basis points. Seventy-five percent of this rise took place in the third quarter alone. Widening credit spreads accounted for the EUR 2.5 billion decrease in Aegon’s revaluation reserve during the quarter.
Lower corporate bond values may lead to higher future defaults and impairments. However, Aegon believes these will remain at manageable levels.
Recent steps taken by Aegon have resulted in a more conservative ratings profile for the company’s investment portfolio than during the last economic recession. In addition, the recapitalization of the financial sector in recent months has lowered an important source of risk.
Aegon USA’s corporate credit portfolio is highly diversified, well spread over sectors of the economy and individual companies.
The third quarter also saw a steep decline in the value of mortgage-backed assets, particularly near prime residential (RMBS) and commercial mortgage-backed securities (CMBS).
Clearly, risks in Aegon’s mortgage-backed asset portfolio have increased. In particular, Aegon has regularly referred to a part of the subprime mortgage backed portfolio where most impairments are expected to come from: securities backed by subprime mortgage with adjustable rate, so called hybrid ARM’s, assets which were originally rated AA. At the end of September, Aegon’s exposure in this area amounted to EUR 0.5 billion, less than 19% of the company’s overall subprime mortgage portfolio of EUR 2.7 billion.
Aegon also has investments in other mortgage-related assets, including securities backed by near-prime mortgages referred to as Alt-A and negative amortization/Option ARM floaters. Most of this portfolio is super senior and structured to withstand high collateral loss rates. Even with stressed loss levels on the underlying collateral, principal losses should remain modest.
Over 86% of Aegon’s commercial mortgage-backed securities are rated senior or super senior AAA, and can withstand very stressed loss levels without principal loss. Non-AAA bonds have been conservatively underwritten.
United Kingdom and the Netherlands
Aegon also has credit investments as part of its general account in both the Netherlands and the United Kingdom. In the Netherlands, during the third quarter, the impact of wider credit spreads was offset by a decline in yields on government bonds. In the United Kingdom, credit investments were adversely affected by the widening in spreads.
View the table financial overview.
Unprecedented turmoil in world financial markets clearly impacted Aegon’s businesses across the globe during the third quarter. As a result, underlying earnings before tax declined 28% to EUR 500 million (22% at constant currency). Aegon reported a net loss for the third quarter mainly as a result of increased impairment charges and the impact of lower financial markets on so-called fair value items, which include certain investment classes in the Netherlands and the Americas, as well as a number of products containing financial guarantees. Earnings figures are in line with preliminary third quarter data published by Aegon on October 28, 2008.
New life sales in the third quarter decreased by 18% on a constant currency basis as a result of the current economic and financial environment. Total gross deposits were in line with last year on a constant currency basis, with strong gains in fixed annuities offsetting the drop in institutional business. Aegon realized net deposits in the quarter of EUR 1.7 billion.
During the third quarter, credit spreads widened significantly. This had an adverse effect on the market value of fixed income assets held in Aegon’s general account. As a result, the third quarter saw a further decline of EUR 2.5 billion in Aegon’s revaluation account.
Given current market levels and the ongoing uncertainty regarding the financial and economic environment, Aegon felt it prudent to further reinforce the capital buffer to a level substantially in excess of the AA rating requirements. On October 28, Aegon announced that it has secured EUR 3 billion of additional core capital from the Dutch State via its largest shareholder, Vereniging Aegon. Aegon’s move follows an announcement on October 9 by the Dutch government that it would make EUR 20 billion of capital available to companies in the financial sector that are fundamentally sound and viable.
Underlying earnings before tax
On a constant currency basis, underlying earnings declined by 22% compared to last year. Underlying earnings in the Americas were down 17% to USD 578 million reflecting the impact of lower equity markets on minimum guarantee reserves in Aegon‘s US variable annuities business.
Underlying earnings in the Americas were also affected by unfavorable mortality in life reinsurance.
In the Netherlands, underlying earnings were down 31% to EUR 74 million as a charge to meet guaranteed returns on certain group pension contracts and the cost of modifying unit-linked insurance products offset higher investment income during the quarter. Underlying earnings in the United Kingdom, meanwhile, declined 39% to GBP 28 million, due primarily to the impact of lower equity and bond markets on fee charges in Aegon UK’s pension business. The decline in earnings from Other countries was the result of lower contributions from associates.
Aegon reported a net loss for the third quarter of EUR 329 million. This net loss can be attributed to two main factors: a significant underperformance in fair value items (EUR 384 million pre tax) and impairment charges (EUR 407 million pre tax).
The underperformance in fair value items comprised a number of different elements:
- A significant underperformance in alternative assets, including hedge funds in the Americas and private equity in The Netherlands.
- The impact of lower interest rates, increased equity market volatility and wider credit spreads on the fair value of guarantees for certain variable annuities (Guaranteed Minimum Withdrawal Benefit), total return annuities and Canadian segregated funds.
- Aegon’s holding company senior debt is held at fair value. Movements in the value of this debt may, therefore, affect Aegon’s earnings. As a result, the widening in credit spreads resulted in a gain during the third quarter, offsetting the impact of mark-to-market losses on credit derivatives and adjustments to other credit-related instruments in the Americas.
The vast majority of the impairments during the third quarter were related to corporate bonds held in either Lehman Brothers or Washington Mutual (EUR 336 million). A further EUR 46 million in impairments were recognized on housing related asset backed securities. Of the total impairments, EUR 325 million were attributable to the Americas, EUR 49 million to the Netherlands, EUR 15 million to the United Kingdom and EUR 18 million to Other countries. Losses on investments (EUR 47 million) were the result mainly of ineffectiveness of hedges of guarantees in the Netherlands.
Net income for the quarter included an income tax benefit of EUR 14 million. Tax benefits related to impairment charges and mark-to-market losses on fair value items were offset by significant additional taxes on intercompany reinsurance treaties. Taxes in the Netherlands included a credit of EUR 34 million related to Aegon’s real estate investments.
Commissions and expenses
Commissions and expenses declined 10% in the third quarter to EUR 1.3 billion. Operating expenses were up 2% (or 8% at constant currency), a reflection primarily of new investments designed to expand Aegon’s existing businesses.
New life sales in the third quarter held up well, despite the economic environment. On a constant currency basis new life sales decreased by 18%. In the Americas, sales of BOLI/COLI and life reinsurance were both significantly down. Retail life sales declined as well, due to economic uncertainty. Group pension business in the Netherlands was sluggish in the third quarter, while retail sales continued to grow. Sales in the United Kingdom were in line with last year. Equity market volatility impacted unit-linked sales in Central & Eastern Europe, while life sales in Taiwan declined, largely because of a shift from life products to variable annuity deposits.
View the table sales and revenue generating investments.
On a constant currency basis, total gross deposits were flat compared with the third quarter of 2007. Gross deposits declined 8% to EUR 11.1 billion, mainly due to the continued weak US dollar. In the Americas, fixed annuities sales enjoyed their best quarter since 2003, benefiting from a steepening in the yield curve, a new distribution partnership in the United States and growing demand among customers for guaranteed, stable return products. Variable annuity deposits were slightly down compared with last year, but sales through the bank and broker dealer/fee planner channels continued to perform well. Sales of retirement plans in the Americas continued to increase as well.
Net deposits were positive in the third quarter of 2008, primarily the result of positive net inflows in the pension business in the Americas, the large sales increase and a lower decrement rate of fixed annuities and net inflows in the institutional fee-based business. Retail mutual funds in the Americas continued to experience positive net inflows despite negative market sentiment as well, a result of the successful development of a dedicated wholesaling organization.
Asia showed a strong increase in total gross and net deposits in the third quarter – primarily the result of continued variable annuity sales growth in Taiwan and the inclusion of Aegon’s new asset management joint venture in China. Gross deposits also increased in Central & Eastern Europe as a result of continued growth in Aegon’s pension business in the region.
Revenue generating investments
Revenue generating investments totaled EUR 351 billion at the end of September 2008, up 2% from June 2008, as a result of the strengthening of the US dollar.
On October 28, Aegon announced that it has secured EUR 3 billion of additional core capital from the Dutch State via its largest shareholder, Vereniging Aegon. Given current market levels and the ongoing uncertainty regarding the financial and economic environment, Aegon felt it is prudent to reinforce the capital buffer to a level substantially in excess of its AA rating requirements. Aegon’s move follows an announcement on October 9 by the Dutch government that it would make EUR 20 billion of capital available to companies in the financial sector that are fundamentally sound and viable.
Aegon will issue 750 million non-voting securities at EUR 4 per security to Vereniging Aegon. In turn, Vereniging Aegon will be funded on back-to-back terms and conditions by the Dutch State. Aegon expects the transaction to close before the end of the year. (For details refer to the press release of October 28, 2008). Aegon’s overall ownership structure is not changing.
The additional core capital complements Aegon’s acceleration of its risk reduction and capital release strategy. These actions include lowering investment risk on both the existing portfolio and new money; transferring risk through reinsurance and additional securitizations like the one completed in the UK during the third quarter. During the third quarter, similar actions in total freed up EUR 729 million of capital. Aegon expects that the continued execution of these actions will release capital in the range of EUR 600 to 800 million during the fourth quarter. These actions, combined with the decision to forego the final dividend for 2008 will enable Aegon to enter 2009 with a significantly enhanced buffer.
After the transaction with Vereniging Aegon and the Dutch State, Aegon will continue its dividend policy based on its capital position and cash flows.
At the end of September, shareholders’ equity totaled EUR 9.4 billion, a decrease of EUR 2.2 billion compared with the end of June 2008. Foreign currency translation effects had a positive impact of EUR 1.1 billion. Aegon’s revaluation reserve declined by EUR 2.5 billion to minus EUR 5.5 billion. Also, the net loss of EUR 329 million this quarter added to the decline in shareholders’ equity. Finally, Aegon paid dividend on common shares totaling EUR 258 million and coupons on perpetuals net of tax of EUR 49 million.
At the end of September 2008, shareholders’ equity excluding the revaluation reserve represented 71% of Aegon’s total capital base, above Aegon’s 70% target7,8.
Aegon’s capital position remained above requirements for an AA rating. At September 30, Aegon had EUR 0.8 billion of financial flexibility, including EUR 0.3 billion over and above the required capital necessary to maintain an AA rating.
The capital position as per September 30, 2008 does not include the EUR 3 billion additional capital buffer provided by the Dutch State.