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VARIABLE ANNUITIES
Q: In 2002, AEGON wrote down a substantial amount of the deferred policy acquistion costs (DPAC) related to variable annuities sold in the United States. Your unlocking appears large. Can you explain why?
A: We entered the variable business in the early 1990s with the acquisition of Western Reserve, but our variable annuity business has grown significantly in recent years as a result of our decision to increase our presence in this market. Well over half of our variable annuity balances result from business added since 1999. So we have a relatively young book of business which was written when markets where high. During 2002, we had record sales with EUR 10.0 billion of variable annuity deposits while at year-end 2002 variable annuity balances totaled EUR 27.4 billion. Also, a part of the unlocking of DPAC in 2002 is the result of a change in our return assumptions. We lowered our equity return assumptions at the end of 2002 to 12% for the first five years and 9% thereafter. This amounted to a DPAC unlocking of EUR 81 million in the USA.
Q: Are your capitalization practices in the US aggressive or are your commission rates high?
A: We only capitalize ‘pricing’ acquisition costs. If our actual acquisition costs exceed what has been priced in the product, the excess is directly expensed. If actual acquisition expenses are less than pricing assumptions, only actual expenses are capitalized. Acquisition costs include policy issue and internal marketing expenses. Commission rates are around 6% and we believe that we are in the middle of the compensation range.
Q: Have the additional charges changed the company's appetite for future new business?
A: Fundamentally, we believe the business is profitable. Business written prior to a market drop will not deliver expected returns unless the market recovers substantially. But business written prior to significant market appreciation will deliver superior returns. Continuing to sell business in up and down markets is important in order to avoid a concentration of business originated in a bad market. However, the risks arising from the guarantee features of these products are continuously critically evaluated and if appropriate product design altered to reduce or mitigate risk. At the beginning of 2003 we discontinued the guaranteed minimum income benefit feature on our variable annuity products.
FIXED ANNUITIES
Q: With the corporate default levels much higher than expected, are you continuing to get your priced spreads on fixed annuities? What are your priced spread assumptions?
A: We believe long-term pricing spreads will be achieved over the life of the business. However, it is clear that with the current low level of interest rates and the high level of corporate bond defaults we are not achieving our return targets for fixed annuities at the moment. Pricing of general account products anticipates some level of defaults. For many years, defaults were less than the pricing allowance. In addition, excess product spreads were achieved on in-force annuities for several years as new money rates on competing products fell. Over the lifetime of the business we price for a 225–250 basis point spread.
Q: What are the new money rates on your fixed annuities and how do they compare with minimum interest credited guarantees?
A. New money crediting rates have declined throughout the year in line with the decline of investment yields and were as low as 2.7% during the fourth quarter. In response, we refiled products with the US state regulators effectively allowing us to lower the crediting rate on fixed annuities to 2%. Many US states have approved this change, allowing us to lower crediting rates on new sales to levels, which are more consistent with our profitability objectives. At the same time, we are leading an industry effort in the US to tie the level of guarantees to actual interest rates. This effort is still in progress.
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