Q3 2014 Results: Earnings impacted by assumption changes and model updates

Q3 2014 Results | AEX:AGN | NYSE:AEG

Outcome of annual assumptions review impacts underlying earnings

  • Underlying earnings amount to EUR 291 million, impacted mainly by actuarial assumption changes
  • Fair value items loss of EUR 296 million, due mostly to hedging programs and model updates
  • Net income amounts to EUR 52 million
  • Return on equity of 5.0%, or 8.5% excluding assumption changes and model updates

Double-digit sales growth demonstrates strength of franchise

  • Gross deposits up 38% to EUR 15.2 billion, driven by asset management and variable annuities; net deposits up 20% to EUR 3.5 billion
  • Life sales increase 34% to EUR 552 million, as a result of strong production across markets
  • Accident & health and general insurance sales 40% higher to EUR 257 million, driven by US
  • Profitability of sales remains strong despite lower market consistent value of new business at EUR 192 million; decline driven by lower interest rates and changes in product mix
  • Total revenue-generating investments increase to EUR 538 billion

One-time items impact capital position and cash flows

  • Holding excess capital of EUR 1.5 billion following payment of interim dividend
  • Solvency ratio declines to 202%, mainly due to change in valuation methodology for Dutch mortgages
  • Operational free cash flows excluding market impacts and one-time items of EUR 275 million

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Aegon Q3 2014 Performance Indicators

Click image to enlarge. For notes see Q3 2014 Results Tables.

Strategic Highlights

  • Sale of Canadian business for CAD 600 million
  • Tsinghua Tongfang new joint venture partner in China
  • Knab, Aegon's online bank in the Netherlands, is gaining popularity

Aegon's ambition
Aegon continues to pursue its strategic aim to be a leader in all of its chosen markets, supported by four strategic objectives embedded in all Aegon businesses: Optimize portfolio, Deliver operational excellence, Enhance customer loyalty, and Empower employees.

These provide the strategic framework for the company's ambition to become the most-recommended life insurance and pension provider by customers and business partners, as well as the most-preferred employer in the sector.

Optimize portfolio
Aegon is committed to continually assessing its businesses to ensure they contribute to the company meeting its strategic objectives.

After a comprehensive strategic review, Aegon has announced that it has reached an agreement to sell its Canadian life insurance, asset management and mutual fund operations to Wilton Re for CAD 600 million.

The transaction is expected to close during the first quarter of 2015 and proceeds from the sale will be used to reduce leverage. The sale and leverage reduction will improve the company's return on equity by 40 basis points.

In China, Tsinghua Tongfang, one of the country's premier information technology companies, will replace CNOOC as Aegon's joint venture partner.

The joint venture will combine Aegon's experience as an international insurer with Tsinghua Tongfang's technological expertise to help take the business to its next stage of growth and development.

Deliver operational excellence
Aegon's mortgage origination business in the Netherlands has long been an example of operational excellence. High standards of customer service and efficient processing have helped grow the business to a new business market share of around 13%.

In 2013, Aegon established a Dutch mortgage fund and this longer duration asset class is proving popular among investors, specifically other pension providers without own mortgage origination capabilities.

More than half of Aegon's third quarter 2014 mortgage production has been allocated to third party investors, with assets in the Dutch mortgage fund now exceeding EUR 2 billion.

Enhance customer loyalty
An essential element of Aegon's strategy is to get closer to its customers by increasing innovation at all levels of the organization. Technology is enabling Aegon to respond quicker to changing markets and customer behavior, to create a more customer-centric culture.

Knab, Aegon's unique online bank in the Netherlands, is quickly gaining popularity by focusing on simple to use tools to help customers manage their finances and prepare for their financial future.

Supported by the recent launch of an account dedicated to addressing the needs of small business owners, Knab's total number of customers has doubled while savings balances have increased to over EUR 800 million.

As part of the Building Public Trust Awards, Aegon was awarded the International Award in recognition of the company's transparency of both financial and non-financial information.

The award category consisted of around 100 international companies participating in the International Integrated Reporting Council's (IIRC) pilot program. The judging panel of the Building Public Trust Awards referred to Aegon as "one of the leaders showing the way forward."

Operational Highlights
Assumption changes and model updates

Aegon reviews its assumptions in the Americas and Asia annually in the third quarter, which resulted in an adjustment to its actuarial assumptions.

Over the past year, as part of an ongoing commitment to deliver operational excellence, the company also intensified efforts to review and enhance its models where necessary.

These actuarial assumption changes and model updates on balance accounted for charges of EUR 299 million in the third quarter of 2014. The adjustments impacted underlying earnings by EUR 221 million, fair value items by EUR 46 million and earnings from the run-off businesses by EUR 32 million.

In addition, underlying earnings before tax are reduced by approximately EUR 20 million per quarter on a recurring basis.

Underlying earnings before tax

Aegon's underlying earnings before tax in the third quarter of 2014 of EUR 291 million were impacted by charges for actuarial assumption changes and model updates in the Americas and Asia (EUR 221 million).

In addition, unfavorable mortality and morbidity experience in the Americas also contributed to lower earnings (EUR 45 million).

These items more than offset a one-time gain on reinsurance recaptures in the Americas (EUR 40 million), higher investment income and margins in the Netherlands (EUR 10 million) and improved persistency in the United Kingdom (EUR 6 million).

Underlying earnings from the Americas amounted to EUR 134 million. Higher earnings from growth in variable annuity, mutual fund and pension balances, driven by both markets and net inflows, were more than offset by charges for assumption changes and model updates of EUR 195 million.

These were primarily the result of introducing updated mortality and reinsurance assumptions. Assumption changes on client behavior in variable annuities had a smaller positive impact. A detailed description of the assumption changes and model updates can be found in the Americas section on page 8 of this press release.

In the Netherlands, underlying earnings increased 11% to EUR 127 million. This was mainly driven by higher investment income, primarily generated by mortgages and improved margins on savings.

Underlying earnings from Aegon's operations in the United Kingdom were up 21% to EUR 28 million in the third quarter of 2014, the result of improved persistency and favorable currency movements.

Underlying earnings from New Markets declined to EUR 40 million. The negative impact of model updates in Asia of EUR 26 million more than offset growth at Aegon Asset Management, which resulted from an increase in third party balances, higher performance fees and dividend income from the Chinese joint venture AIFMC.

Total holding costs increased to EUR 37 million. This was primarily the result of higher net interest costs following a debt issuance in the second quarter of 2014 to replace a more expensive perpetual capital security for which the coupons were not part of underlying earnings.

Net income
Net income declined to EUR 52 million due to lower underlying earnings and lower realized gains on investments, which more than offset the improvement in fair value items and impairments.

Fair value items
The results from fair value items amounted to a loss of EUR 296 million. Assumption changes and model updates amounted to EUR 46 million before tax, and were primarily the result of adjusting the modeled hedging costs for the GMWB variable annuity book.

Next to these charges, the loss was mainly driven by the macro equity hedge in the United States (EUR 40 million), credit spread tightening in the Netherlands (EUR 63 million) and underperformance of fair value investments in the Americas (EUR 48 million).

Realized gains on investments
Realized gains on investments declined to EUR 85 million, and were primarily related to rebalancing of the fixed income portfolio in the Netherlands.

Impairment charges
Net impairments improved to a positive EUR 5 million. This was the result of the favorable credit environment in the United States, where impairments remained low and were more than offset by recoveries, and lower impairments on Dutch mortgages. This more than compensated for higher impairments on Hungarian mortgages driven by new legislation.

Other charges
Other charges amounted to EUR 29 million and were primarily caused by a provision taken for the closed block of European direct marketing activities.

Run-off businesses
The results of run-off businesses amounted to a loss EUR 31 million as earnings in the third quarter were impacted by model updates of EUR 32 million, affecting the legacy life reinsurance book.

Income tax
Income tax amounted to a positive EUR 29 million in the third quarter, which was mainly the result of losses being tax relieved at high marginal tax. The effective tax rate on underlying earnings was 19%, driven by tax exempt income in the United States and in the Netherlands.

Return on equity
Return on equity declined to 5.0% for the third quarter of 2014, driven by the charges for actuarial assumption changes and model updates in the United States. Return on equity excluding these charges amounted to 8.5% over the same period.

Operating expenses
Operating expenses increased 1% to EUR 826 million, as lower restructuring costs were offset by higher expenses to support the growth of the business in the United States and the Netherlands.

In the third quarter of 2014, Aegon's total sales were up 38% to EUR 2.3 billion, which is the result of Aegon's focus on growing profitable sales in variable annuities, universal life and Dutch group pensions, in addition to growing its third party asset management business.

Gross deposits increased 38%, as higher deposits in Aegon Asset Management and variable annuities more than offset lower retirement deposits in the United States. Net deposits, excluding run-off businesses, were up 11% to EUR 3.8 billion.

New premium production for accident and health insurance increased 44% to EUR 241 million, mainly due to several portfolio acquisitions in the United States, which were the result of new distribution agreements.

New life sales increased 34%, driven by higher sales of universal life products in the United States and a strong improvement of pension production in the Netherlands as Aegon closed the largest pension buyout contract achieved to date.

Market consistent value of new business
The market consistent value of new business remained strong but declined to EUR 192 million. Strong sales growth in the United States and the Netherlands were more than offset by the effect of lower interest rates and less Dutch mortgage production for Aegon's general account.

Revenue-generating investments

Revenue-generating investments increased 7% during the third quarter of 2014 to EUR 538 billion, driven by net inflows and favorable currency movements.

Capital management
Shareholders' equity increased EUR 1.6 billion compared to the end of the second quarter of 2014 to EUR 21.9 billion at September 30, 2014. This was mainly driven by the effect of lower interest rates, resulting in higher revaluation reserves, and favorable currency movements.

The revaluation reserves increased by EUR 1.1 billion to EUR 6.5 billion. Aegon's shareholders' equity, excluding revaluation reserves and defined benefit plan remeasurements, amounted to EUR 16.7 billion - or EUR 7.90 per common share at the end of the third quarter.

The gross leverage ratio further improved to 30.9% in the third quarter, driven by higher shareholders' equity, and is on track to end up within the target range of 26 to 30% by the end of 2014.

Excess capital in the holding declined to EUR 1.5 billion, as the cash allocated to the interim dividend, in addition to interest payments and operating expenses were only partly offset by proceeds from the divestment of the stake in the joint venture with Caja de Badajoz.

At September 30, 2014, Aegon's Insurance Group Directive (IGD)a solvency ratio was 202%. Earnings generated in the quarter, were offset by the payment of the interim dividend over the first half of 2014 and the impact of a change in the valuation methodology for mortgages in the Netherlands.

This adjustment reflects the use of additional market observable data points, including market transactions.

This resulted in a reduction of available capital of EUR 0.5 billion, which is expected to be recovered over the lifetime of the mortgage portfolio. The IGD ratio in the Netherlands, excluding Aegon Bank, declined to ~220%, driven primarily by this valuation adjustment (25 percentage points) and a high new business strain resulting from a large pension contract gain.

The capital in excess of the S&P AA threshold in the United States increased to USD 1.1 billion, resulting from earnings generated in the third quarter of 2014.

The Pillar I ratio in the United Kingdom, including the with-profit fund, was stable at ~145%, as the negative impact of de-risking and business transformation costs offset earnings generated during the quarter.

On October 16, Aegon announced that it will sell its Canadian operations to Wilton Re for
EUR 423 million. This transaction will result in a book loss of EUR 0.8 billion at closing, while the proceeds will be used to redeem the USD 500 million 4.625% senior bond due December 2015.

The combination of the divestment and the non-refinancing of the bond will keep Aegon's leverage ratio unchanged on a pro forma basis, while its fixed charge cover ratio will improve by 0.6 times.

Recognizing the improvements Aegon has made to both its leverage and fixed charge coverage ratios, Fitch has revised the outlook for its ratings on Aegon companies from negative to stable. Fitch rates Aegon N.V. (A), Aegon Americas (AA-), Aegon UK (AA-) and Aegon Bank (A-). Additionally, Moody's has affirmed its ratings on Aegon companies with a stable outlook. Moody's rates Aegon N.V. (A3) and Aegon Americas (A1).

Cash flows
Operational free cash flows were EUR (124) million in the third quarter of 2014.

Excluding one-time items of EUR (300) million and market impacts of EUR (99) million, operational free cash flows amounted to EUR 275 million.

This was below the average level achieved in previous quarters as the new business strain reflected a large pension contract gain in the Netherlands. Market impacts during the third quarter were mainly the result of lower interest rates. One-time items were primarily related to the valuation framework change for mortgages in the Netherlands.