Aegon Ltd (AEG) 2004 Q4 法說會逐字稿

Good afternoon. Thank you for joining today's presentation on AEGON's Preliminary 2004 IFRS Information. Before we begin, I need to make you aware of our cautionary note regarding forward-looking statements, which is on the next slide. Please take a minute or 2 after the presentation to review this one.

During today's presentation Ruurd van den Berg, Executive Vice President, Group Finance and Information, will present the Preliminary 2004 Results on the basis of IFRS. And after the presentation there will be ample opportunity to ask questions.

Before we begin, I will introduce the other people in our team. Let me start with the lady, [Cornea Debier], working in Group Finance and Project Manager of the IFRS project; Darryl Button, CFO of AEGON USA; and finally, Michiel van Katwijk, Group Treasurer, is also available for questions. And in the room we also have Eric Martin, who's the Controller of AEGON USA, Eric. But now let me hand it over to Ruurd.

Thank you Michel(ph). Today is the beginning of the beginning of IFRS and almost the end of the end of Dutch accounting. Our team is proud that we can already present today our first 2004 IFRS numbers. It has been a lot of work, and we will do our best to provide you with a clear picture of the complicated IFRS story.

This is the agenda for the presentation today. Following a short introduction on the basis and status of our IFRS information and the purpose of this presentation, I will give you an overview of the most important 2004 IFRS figures and how they compare to our DAP reporting. Then I will discuss in some detail the effect on AEGON'S equity and the 2004 comparative earnings. Before we start the Q&A session, I will provide you with comments on the most important effects on our country units and line of business reporting.

This preliminary 2004 information on the International Financial Reporting Standards, referred to as IFRS, as presented today is unaudited and has been derived from accounting policies based on IFRS at the end of March 2004, referred to as the stable platform. These accounting policies, and consequently the information presented, may still change due to changes in IFRS up to the end of December this year.

In addition, further reviews and other procedures as well as analysis of issues, such as consolidation of investment vehicles, may cause the key impact as reported in the information today to change. Actually, until we have been through the whole reporting cycle including the Annual Report for 2005, which will be early next year, issues may arise.

The purpose of this presentation is to provide the financial community with comparative data and technical information relating to AEGON's transition to IFRS. The information provided in the document, as released today, should not be viewed as replacing the official financial statements that were prepared under Dutch Accounting Principles for 2004.

From January 1, 2005, more than 7,000 publicly listed companies in the European Union, including AEGON, moved from a patchwork of local accounting principles to 1 standard in conformity with IFRS. This brings an end to the application of various local sets of national accounting standards, by the listed companies in the different member states. IFRS has been developed by the International Accounting Standards Board, the IASB, in order to provide a single set of high quality, understandable and uniform accounting standards.

The IASB is also working closely with national standard setters to bring about convergence of national accounting standards, such as U.S. GAAP and IFRS. In view of the 2005 deadline, the IASB divided the development of a standard for insurance accounting into 2 phases. During phase 1, starting from 2005, insurers will continue to apply existing accounting principles for insurance contracts and investment contracts with discretionary participating features.

These contracts refer to contracts with the right to receive additional benefits, of which the amount and/or timing is at the discretion of AEGON. Phase 2 will bring a complete standard for insurance accounting, but is not expected to be ready for implementation in the near future. AEGON shares the objective of the IASB, supports the adoption of the standards, and will continue to contribute to the development of the standards, specifically for insurance accounting in Phase 2.

Our main interest is to ensure a level playing field, allowing fair comparison of all companies competing for capital. The first full set of financial statements under IFRS will be the annual financial statements for 2005. Comparative figures for '04 needs to be presented, not only in the annual financial statement for 2005, but also in the quarterly reporting presented during 2005.

The starting point for preparation of comparative figures is the opening balance sheet on January 1, 2004. The difference between assets and liabilities valued under Dutch Accounting Principles, DAP, and assets and liabilities valued on an IFRS basis, is reflected as an adjustment in shareholders' equity in the opening balance sheet.

In the number that's presented today, and as will be presented in the future, you will see volatility in earnings and in equity, as a consequence of different valuations on each side of the balance sheet, with investments valued at fair value and insurance liabilities, under Phase 1, still at cost. Accounting should not drive business decisions, as to a large extent volatility reflects the change in timing of the emergence of earnings, rather than a change in underlying value of the business.

Our cash flows from the businesses are not affected, and our dividend paying ability and policy remain unaffected by the change to IFRS. To enable analysts and investors to assess the underlying business performance, we have identified operating earnings as a key item in the presentation of our results. Another key item in understanding our performance is embedded value, and it is our intention to report our embedded value for 2004 in conformity with European Embedded Value Principles on May 11, 2005.

So let's move to an overview of some key financial measures, reported on the basis of IFRS, and how they compare to their DAP equivalents. The table on this slide provides you with a quick snapshot of the most important figures and as you can see, we have introduced a new measure for financial performance, the operating earnings.

As explained earlier, we believe this measure gives a good indication of AEGON's underlying business performance. Our pre-tax operating earnings amounted to €1.8b. Our total net income of €2.2b is some 30% higher on an IFRS basis than under DAP. Our shareholders' equity of nearly €15b is 4% higher than under DAP, and I will explain the reasons for these differences later in the presentation.

This slide gives the breakdown of pre-tax operating earnings by country unit. The pie chart shows that AEGON's 3 main country units still account for 95% of its total operating earnings, very much in line with the breakdown of earnings before on a DAP basis. AEGON businesses in the America remained the largest contributor to Group pre-tax operating earnings.

The Americas accounted for 77% of operating earnings before tax, the Netherlands for 8%, the U.K. for 10%, and the remaining 5% is from other countries, which mainly reflects businesses in Hungary, Spain, Taiwan and China.

With the introduction of IFRS, we have also made certain changes in our structure for reporting line of business information. The new line of business structure is here on this slide and as you can see, we have added a separate line for our reinsurance business. In addition, the Americas has changed its reporting of payout annuities. The earnings production and balances related to these products will all be reported as part of fixed annuities.

[Debt and funding] agreements have been renamed to 'Institutional guaranteed products', without making any changes to the results in this line. The line item 'Other' is currently used to report corporation tax attributable to policyholder return in the U.K., which is presented on a gross basis under IFRS.

When comparing the results of the lines of business under IFRS to their DAP counterparts, a few things stand out. Firstly, the results from the line 'Traditional Life' are significantly lower under IFRS. This is primarily caused by the exclusion of deferred bond gains in the Netherlands. Secondly, the result from the line 'Institutional guaranteed products' is clearly much higher under IFRS than under DAP. This mainly reflects the valuation of financial assets at fair value with changes through income.

Finally, 'Interest charges and other' are lower under IFRS than under DAP. This reflects the fact that coupons and transaction costs on perpetual capital securities are recognized as a direct deduction from equity, instead of an expense in the income statement. Additionally, the gain on the sale of TFC in 2004, which was credited to shareholders' equity under DAP, is now reflected in the income statement under IFRS. Let's now move to the effect of IFRS on equity.

The starting point for AEGON's preparation of comparative figures is the opening balance sheet on January 1, 2004. This slide shows the reconciliation from DAP to IFRS for the opening shareholders' equity. As indicated in previous presentations, the opening shareholders' equity under IFRS is slightly lower than under DAP. And as shown on the previous slide, this is the net effect of some large moves in both directions.

Now let's move to discuss the main effects on our shareholders' equity when moving from DAP to IFRS. And this slide shows a snapshot of our year-end 2004 shareholders' equity, which is up €525m, or 4%, to €14b in end of 2004. This move is actually, as you can see from the waterfall chart, the net result of some very large moves up and some very large moves down.

At €5.6b, the main positive effect came from valuation differences of certain investments, which was largely offset by DPAC, VOBA and liability valuation changes; the adjustment for defined benefit plans and taxes. I will discuss these items in more detail.

Before discussing each of the items listed here to reconcile shareholders' equity as measured on DAP to shareholder's equity measured on IFRS, I would like to point your attention to the line item 'Group equity' at the bottom of the table. AEGON's equity under IFRS differs from that under DAP. First of all, perpetual capital securities are classified as equity under IFRS. In addition, certain entities that are consolidated under IFRS give rise to a minority shareholders' interest line.

Total Group equity consists of shareholders' equity, minority shareholders' interest and the perpetual capital securities. Group equity amounted to nearly €18b at the end of December 2004.

The condensed consolidated balance sheet also looks slightly different under IFRS. Besides the change in presentation of equity, as I just discussed, we have split our technical provision in those for insurance contracts and those for investment contracts. Also note that our balance sheet total of €269b at year-end, is higher than the €238b as shown under DAP.

This is mainly due to valuation differences and the fact that certain items, such as DPAC, VOBA and reinsurance under DAP deducted from liabilities, are under IFRS separated and presented on a gross basis as an asset.

So let's go back to equity and I will discuss the main effects of IFRS. Note that these concern the effects from the differences between assets and liabilities, valued under DAP and IFRS, as these differences are adjusted to shareholders' equity. First, investment in bonds; they are mostly classified as either available for sale or as financial assets at fair value to profit or loss under IFRS.

These bonds fair valued at cost under DAP, and consequently have been revalued to fair value. There is a strong relationship here with movements in interest rates, and in last year's relatively low interest rate environment, there was a substantial, positive difference between market value and cost basis.

The default reserve; under DAP, a default reserve was required for bonds. This default reserve is not allowed under IFRS and is therefore released to equity. Releases of deferred bond gains; under DAP, interest-related gains and losses on debt securities were deferred and released into earnings over the estimated average remaining term to maturity. Under IFRS, gains and losses are recognized in the income statement when realized.

The net deferred gains that existed in the DAP balance sheet have been released to shareholders' equity for IFRS. Derivatives under IFRS; all derivatives have been valued at fair value. Under DAP, accounting for derivatives followed the accounting for the related investment or DAP instrument.

DPAC, VOBA and liability valuation; while no change in cost deferral for products classified as insurance contracts or contracts with discretionary participating features, fewer transaction costs can be deferred for products classified as investment contracts without discretionary participating features. Under IFRS only certain costs, directly related to the rendering of the investment management services, can be deferred.

For certain products DPAC and VOBA balances are amortized, based on expected gross profits, under both DAP and IFRS. But due to the removal of the deferred interest-related gains and other changes to the underlying basis of the assets under IFRS, the emergence of expected gross profits under IFRS changed when compared to DAP. And consequently, the DPAC and VOBA balances were reduced.

Apart from the change in pattern of expected gross profits, DPAC and VOBA but also liability valuation, is affected by the application of shadow accounting. If all unrealized gains and losses from the revaluation of bonds, from cost to fair value, are deferred in equity, equity shall be misstated.

IFRS allows shadow accounting, whereby the positive effect of the reflection of the unrealized gains on bonds and shareholders' equity has been partially offset through application of shadow accounting, insurance liabilities and related assets. Such as deferred policy acquisition cost and value of business acquired, VOBA, are adjusted to the same extent that they would have been adjusted if those unrealized gains and losses had actually been realized.

Apart from shadow accounting, liability valuation is also affected by the valuation of embedded derivatives, and the recognition of losses from liability adequacy testing. Some of our products in AEGON USA contain embedded derivatives related to ceded reinsurance. These embedded derivatives have to be separated from the host contract, and valued on a standalone basis at fair value in the financial statements. The same applies for certain guarantees within the variable annuity business, the segregated funds, in AEGON Canada.

Defined benefit plans. Under IFRS, if the risk is with the employer, the fair value position of the defined benefit plan is included on the balance sheet. Based on recognition of past, current and future pension expenses, the liability will be shown in the opening balance sheet for defined benefit plans that are under-funded and in assets for defined benefit plans that are over-funded.

And IFRS allows the use of fresh start approach for the opening balance sheet, under which all cumulative actuarial gains and losses, both realized and unrealized, were effectively recognized in equity on the opening balance sheet, leaving no unrecognized actuarial gains and losses.

AEGON elected to make use of this approach and therefore, part of the asset related to AEGON USA that existed in the DAP balance sheet is charged to shareholders' equity in the opening balance sheet under IFRS. Going forward, we will defer and amortize these gains and losses again.

Goodwill. Under Dutch accounting, goodwill was not capitalized but charged directly to equity at the time of acquisition. Under IFRS, goodwill is capitalized as an asset. IFRS allows the prospective application of the standards applicable to business combination, to acquisitions after January 1. As a result -- January 1, 2004. As a result, goodwill written off to equity before this date will not be reinstated on transition to IFRS. The adjustment from DAP equity relates to goodwill from acquisitions during 2004 only.

Tax differences. They mainly relate to the tax effects of reconciling items, as well as tax differences due to discounting. Dutch accounting required that the deferred tax balances be presented on a discounted basis. Under IFRS, discounting is no longer allowed and as a result, the deferred tax liability is increased in the opening balance sheet, with a corresponding charge to shareholders' equity.

The minority shareholders' interest relates to entities that are consolidated under IFRS and in which AEGON owns less than 100%. This means that we bring 100% of the assets and liabilities on the balance sheet, but recognize in the minority share not owned as a minority interest in equity. Similar in the income statement, we include 100% income and expenses, and deduct the minority interest in a separate line.

The perpetual capital securities are classified as equity under IFRS, rather than as a 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 own discretion. So let's move to the effect of IFRS on earnings.

At slide -- As this slide shows, there are also some significant moves up and down in the earnings area. Together, the various reconciling items leads to a €596m increase to our 2004 net income, from nearly €1.7b under DAP, to €2.2b under IFRS. In the following slides, I will discuss these main effects on net income.

First, the investment income. Under Dutch accounting, interest-related gains and losses on debt securities were deferred and released into earnings, as investment income over the estimated average remaining term to maturity. Investment income under IFRS has decreased, due to the reversal of the amortization of deferred investment gains.

The fair value movement reconciling items relates to fair value movements on general account financial assets. Including embedded derivatives separated from host contracts that are classified as financial assets, assets at fair value through profit or loss. These movements, in particular, are subject to volatility from the market.

Again, the DPAC, VOBA and liability valuation, but this time the effects in earnings. The amount of transaction costs, as explained earlier, that can be deferred under IFRS is less than what can be deferred under DAP for investment contracts without discretionary participating features. This in itself results in a decrease of IFRS net earnings compared to DAP.

This decrease is somewhat offset by the fact that amortization charges are lower under IFRS, as deferred transaction cost balances are lower. However, for flexible premium products such as universal life and some fixed and variable annuity products, the amortization of DPAC is based on profit emergence.

This is not new when compared to DAP, but the inclusion of the net realized gains on debt security causes the total investment return on assets backing this business to be higher than the investment return on the DAP. This increase in total investment return was slightly offset by the reversal of the amortization of deferred investment gains. But the net increase in profit caused increases in DPAC and VOBA amortization.

For example, an adjustment to the VOBA of AEGON USA caused a decreased in earnings compared to DAP. This adjustment was primarily necessary due to changes in estimates regarding future gross profits on certain assumed reinsurance contracts. For DAP, no such adjustment was necessary because there were excess future margins, due to the amortization of deferred interest-related payments.

Furthermore, a specific product sold by AEGON USA, that provides customers with the 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 standalone 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 minimum contractual guarantees.

Interest charges and related fees. Perpetual capital securities are classified as equity under IFRS, rather than as a debt. As a result, coupon and transaction costs on these instruments are recognized as a direct deduction from equity, instead of as an expense in the income statement. And therefore, caused an increase in IFRS earnings.

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, and in some cases unrealized gains and losses on real estate, were recognized as impaired. While interest-related gains and losses are deferred. The recognition of all the realized gains in 2004 result in an increase of net earnings under IFRS.

Also included in net gains on investment, are fair value changes for derivatives that are used for economic hedges purposes, as part of our asset and liability management. But for this, no hedge accounting is applied. These derivatives are considered economic hedges of certain exposures related to existing assets or liabilities.

The fair value movement of these derivatives are not offset by fair value movements, as the underlying asset or liability is not valued at fair value through profit or loss. In addition, this line also includes the ineffective portions of transactions for which hedge accounting is applied. And also, this line is subject to volatility from market movements.

Non-recurring income. As explained earlier, the gain on the sale of TFC businesses in 2004, which was credited to shareholders' equity under DAP, is reflected in the income statement in 2004 under IFRS and caused an increase in earnings.

So let's move to the country unit line of business information. Before moving over to the Q&A, let me highlight some of the items that are most striking, when looking at the country unit IFRS results on a quarterly basis.

In the Americas, a few things stand out. First, the 'Fixed Annuity' line. This line is quite volatile from quarter-to-quarter, and the second quarter result shows a strong decline. The quarterly earnings volatility in the fixed annuity line of business was primarily due to a product that provides customers with a pass through of total investment returns, subject to a cumulative minimum guarantee, as discussed just a while ago.

This product contains an embedded derivative that cannot be separated from the host contract, and valued on a standalone basis at fair value. And as a result, the entire contract is valued at fair value. And the investments backing this product have also been classified at fair value through profit or loss. And the changes in the fair value of the liabilities and assets should generally offset each other.

But in the second quarter, when interest rates were increasing, declines in asset value could not be offset with changes in the liability, due to minimum contractual guarantees.

Another item that stands out is the negative result from variable annuities in the third quarter. The variable annuity business, with segregated funds of AEGON Canada, contains guaranteed, minimum accumulation benefits that are regarded as embedded derivatives.

The change in fair value of the embedded derivatives is subject to volatility from equity market performance, and the changes in the risk-free interest rates. The net loss in the third quarter is related to a reduction in the risk-free interest rate, combined with negative equity market returns. The loss on reinsurance in the fourth quarter comes from a review of the margins supporting the VOBA asset.

We changed our estimate for future gross profits, and the asset was written down. Under DAP this write-off was not necessarily due to the availability of deferred interest gains.

This slide shows how we get from operating earnings before tax to net income for the Americas. A few items stand out here. First of all, there are net losses on investments of US$87m in the second quarter. The line 'Net gains and losses on investments' for AEGON America primarily includes net realized gains and losses on available for sale financial assets.

It also includes fair value changes for derivatives that are used for economic hedge purposes, as part of our asset and liability management, but for which no hedge accounting is applied. Lastly, this line also includes the ineffective portion of transactions for which hedge accounting is applied. During 2004, the low interest rate environment has caused net gains from these items. This is noticeable in all quarters except for the second quarter, when interest rates rose temporarily.

Another item that stands out is the low entry for impairment changes in the first quarter. Impairment charges, sorry. Impairment charges primarily relate to the impairment of available for sale financial assets, net of the impact of impairment reversals. In the first quarter, impairments were nearly offset with reversals. Impairments were relatively higher during the third quarter, primarily related to impairments of securities in the aircraft sector.

The effective tax rate was lower in the fourth quarter than the previous quarters, due to the reduction of deferred tax related to the liability for accrued policyholder surplus taxes. That can be released as a result of a change in tax legislation.

Let's move over to the Netherlands. The main item that stands out is the lower result from Traditional Life. This primarily reflects the exclusion of deferred bond schemes. In moving from operating earnings before tax to net income for the Netherlands, the high level of net gains on investments in the third and fourth quarter is noticeable.

The high level of gains reflects the fair value movement in a decreasing interest rate environment of derivatives, used as part of asset and liability management. For these derivatives, no hedge accounting is applied and therefore, all fair value movements are directly recognized in income. These derivatives will potentially cause volatility in our future results.

Let's move to the U.K. In the United Kingdom, 'Life for account policyholders' includes profit emerging from the Guardian 90/10 fund. Under Dutch accounting, profit emerged on a smooth basis, while under IFRS profit emerged based on cash receipts. This difference between DAP and IFRS is a timing difference only.

The line 'Other' is used to report corporation tax attributable to policyholder return, which is presented on a gross basis under IFRS and are presented net under Dutch accounting. And as you can see on this slide, when moving from operating earnings to net income, there is a line 'Corporation tax' attributable to policyholder return offsetting the line 'Other', that we just discussed in the previous slide.

Let's move to Other countries. Actually, in other countries the movement in IFRS results from quarter-to-quarter is not very different from that under DAP. And the same comes if we move -- if we look at the move from operating earnings before tax to net income from other countries. There are no real surprises.

That brings us to some conclusions. First of all, we will see volatility throughout the quarters, and there is no change in behavior for accounting principles. We will not manage our business differently than we did under DAP. Also, operating earnings and embedded values are important additional performance measures, and cash flows and dividend payment ability are not affected by IFRS.

And finally, last week I met in Brussels a colleague of yours. He told me that he could actually only afford a minute of time to look at income statements and to look at balance sheets before he wrote his article, or just the performance. Prior to this, I tried to wake him up, because it really gets more and more complicated, with more and more information to digest, before the picture of performance will be entirely clear.

And with you we will work very hard to make that happen, probably not all today, but at least certainly over the quarters to come. Thank you very much for your attention.

Thank you. Anyone?

Hello. It's Tim Attenborough from BNP. Could you quantify on the equity, the impact of an increase of 100 basis points of the yield on your U.K., U.S. and Dutch business? Thank you.

Actually, I don't think we are prepared to give that sensitivity today. We certainly don't have figures for the U.S., I know that.

It's David Risinger from Merrill Lynch. I think at the end of 2003, you showed the embedded value was €3b higher than the shareholders' fund. Would the uplift of the €3b be the same under the IFRS shareholder funds figure?

This is Darryl Button from the U.S. Generally, with the impact of IFRS on our embedded value, maybe I can make a start by answering that. For the most part, embedded value analysis is a local regulatory, distributable earnings analysis. So except for the jurisdiction of the Netherlands operations, where their local statutory regulatory environment also adopted the IFRS environment, most of the life insurance calculations under embedded value will not change.

They won't change in the U.S. or, I think, in any of the other countries except the Netherlands. We haven't quantified the impact in the Netherlands yet. I expect when we get through that it'll be fairly small. It'll be basically a timing of distributable earnings change, as we split between accounting bases. That's for the life insurance side.

On the -- as you know, AEGON discloses our embedded value. We disclose it in 2 basic pieces. There's the embedded value of life insurance operations, and then there's other activities. Other activities are non-life entities, and we carry those at DAP book value, or we had -- and we will at 2004.

Certainly in 2005, those other activities will have to be carried at IFRS net carrying value. And actually, in the U.S. we will have 1 material adjustment which will be the U.S. pension plan. And there'll be a similar adjustment, as you've seen here, under IFRS, as we've gone to the fresh start principle under IFRS. And the old FAS 87 carrying value of the U.S. pension plan will be replaced by a new IFRS carrying value, which is roughly the level of over-funding of the plan as it existed at the opening balance sheet, 11.04.

Hi. It's Duncan Russell from Fox-Pitt Kelton. The first question's on disclosure. Are you going to provide any embedded value disclosure on a quarterly basis, going forward? Or any new disclosure on the cash flow statement?

Second question, and what's your impairment policy? There's quite a large number every quarter.

The third question is can you split out the DAP and shadow accounting effect and the movement in the shareholders' equity?

And then the fourth question is could you just go over again the fixed annuity loss included in the second quarter? I don't really understand that. Thanks.

Okay. I'll take the first part. Your first question. I don't think it is likely that we will speed up our disclosure of embedded value. I think next year we're looking at a similar publication date of embedded value as this year. What we are compensating is to move to a system where we will provide value of new business figures on a quarterly basis, along with our regular reporting.

But that certainly will not happen in '05 but we're contemplating that for '06. And cash flow information, there's actually quite a bit of cash flow information that you can derive from the embedded value reporting. And if you have any questions after that reporting, I'll be happy to take -- to give you more information.

Could you repeat your second question, please?

It was on the movement in the balance sheet. You give 1 number for the DAP and the shadow accounting effect. If you could split that out?

The €2.7b you mean?

Yes.

Well, about half of it is related to the shadow accounting.

I'll take the fixed annuity question, and I think there was maybe 1 more question and I didn't get it -- jot it down, so I'll have to come back to you.

Fixed annuities, I think you were just looking for a little more color on what's going on in the -- on the quarterly earnings volatility. Most of that, the lion's share of that, is driven by a total return [class 2] product that we have. It is about $2.6b of account value and declining, it's in a run-off mode. We've shut off new business to that product last year. Lapses are running about 15% a year, so it is a product that's going to go away.

The -- it's not your typical fixed deferred annuity. It is a total -- it's called a total return [tax] annuity, although we report in the fixed annuity line. Typically what it is, is a -- there's a portfolio of -- a mixture of corporate bonds and convertible bonds, about a 50/50 split.

And what typically happens is the policy is -- or the crediting rate is determined based on the total return of that portfolio. So it's -- even though it's a general account product, it is more of a direct pass through product. However, there is a 3% minimum cumulative guarantee on that product as well. And currently the guarantee value is about 2% higher, that's about 102% of the actual account value. So the guarantee is a little bit underwater by about $50m.

Now, because of the total return nature of that product, it's been -- under IFRS it's been deemed to be an embedded derivative in the product. So what that means is we've had to -- well, we could either bifurcate out the derivative and fair value it, or fair value the entire contract. We've done the latter just because we didn't know mechanically how to take out just the derivative component.

So we've fair valued the entire liability. At the same time, we've also fair valued that pool of assets underneath it, because the guarantee is so close to being, as the money is very volatile from a quarter-to-quarter perspective on a fair value basis. If you go back into the second quarter, there was a very sharp rise in interest rates in the U.S., caused a very steep market value decline in the assets.

Because of the existence of the guarantee, that wasn't fully offset in the fair value liability. And then, of course, as the year wore on, interest rates trended back down, the market values came back. And a lot of the volatility wore off by the time you've got to the end of the year. But there will be continued quarter-to-quarter volatility on that product.

Also, in the second quarter we did change some parameters in our fair value model. We continue to refine that model and we changed some parameters, which increased the fair value of the cost of that guarantee. That was about $50m of charge in the second quarter. That did not wear away by the end of the year.

So at the end of the year we were left with a - I'll call it a parameter change to our fair value model, that hit the earnings. The rest of the volatility pretty much wore away by the end of the year. Sorry, that was a long-winded answer.

You had 1 question left, I think, related to the impairment policy?

Yes, could you just --?

That does not change compared to what we did under DAP.

And what was it under DAP?

You can read that in our Annual Report, but basically it takes into account a period how long an asset is -- the value of an asset is below cost, and on an individual basis.

It's Rob Haines, JP Morgan. You've introduced a new measure, operating earnings, that's going to be important going forward. To be honest, I don't even know what makes it up. So, I don't know a track record. What -- how do we judge it year performing? Have you got targets on that operating earnings? Is the operating earnings going to be the basis of the dividend going forward, like some other companies are talking about? What's the significant of this?

Well, I will be happy to take that question. Operating earnings indeed is the definition. Under DAP we did not have a definition of operating earnings. In the report that we issued today, there's quite a bit of explanation what is and what is not included in operating earnings. The main differences were discussed here in the presentation. Gains and losses including defaults, for instance, are out of there.

Also, for instance, hedging effectiveness on derivatives is not in there. It's more fully described in the document. As of now it's very hard to say, well, our target is to grow operating earnings by this and that. Because we only have 1 year of history in operating earnings, as you know. Not just operating earnings but net income and shareholders' equity will become more volatile under IFRS. So if anything, it's going to be harder to have short-dated targets.

I think that what still stands is our underlying target of growing our business by 10% a year and -- on average, and that's based on growth of the business that we're in. But it's very hard to translate that to an annual target of operating earnings growth of 10%. So I wouldn't want to go there.

But 10%, you can't say operating earnings is the target for that 10% going forward?

Well, certainly operating earnings is supposed to be a better measure for that 10% than net income, because there you will see all the volatility from realization of gains. So operating earnings - we basically created that measure to have a better measure for growth of the business than just net income.

And is the dividend going to be based on that?

I forgot that part of your question, I'm sorry. No. Certainly, back in '02 we basically disconnected dividend from earnings. Earnings -- dividends are based on cash flows, and with cash flows we mean cash flows -- free cash flow to the holding companies, and based on our capital position. That's going to be determining our dividend policy.

But we are aware of the fact that we really would like to offer a stable and growing dividend, but with these 2 provisos, cash flow is in a capital position.

Nick Holmes at Lehmans. Just want to ask 2 questions. One is, just going back to the total pass through policies in the States, could you give an indication, could Darryl, perhaps, give an indication of the expected duration for the run-off of this book?

And the second question is, I don't think you explained the €133m of 'Other items' in the earnings? Thank you.

Okay, Nick. I'll take the first one. As I mentioned before, I don't think I have much better statistics than the current lapse rates are running around 15% a year. So, it's a $2.6b account value, currently running off at 15% a year. I expect lapses will be a little dynamic in nature, moving with major moves in interest rates. But as long as interest rates stay in a fairly modest zone, I don't have a better statistic than the current run rate.

As far as the line 'Other' is concerned, that mostly relates to pension expense. As you'll remember, we have set up 11.04. We had yet a fresh start for pensions, and consequently there is a difference between IFRS and DAP for pension expenses. We actually recognized the whole pension plan on January 1.

It's Bob Yates at Fox-Pitt Kelton. Could you, perhaps, amplify a little bit your comments about shadow accounting? Essentially I think you said that it's to try to restate the liability as it would be, if you had realized the gains on the assets as opposed to simply deferred and unrealized gains. Is that basically a reflection of the policy terms? What judgments are you making in doing that shadow accounting?

That must be a fairly good subjectivity, I assume, in what you assume you would distribute and what you wouldn't?

I'll take that Bob. Basically shadow accounting applies to, in the U.S. anyway, a FAS 97 type product that -- where you're unlocking your DACs based on future gross profit. So all shadow accounting does, is basically tell you to assume that those unrealized gains that you sell through equity were in fact realized.

And what that would do by realizing those gains and up-fronting -- taking the income now, you'd be lowering your future yield in the future, and lowering your future gross profit. And so you'd have to take an offsetting negative, DAC unlocking. So it applies to any product that has either a liability or valuation, or more commonly a FAS 97 DAC unlocking effect, that would be impacted by the future gross profits. Which would in turn be impacted by realizing those gains.

No further questions?

Sometimes I miss things in presentations. Was there a slide in here or something, which told us how to get from the IFRS earnings to these adjusted earnings that you give, or not?

Sure. You mean from DAP earnings to IFRS earnings?

No, IFRS earnings to your operational earnings, which you seem to --

You will find it in the publication, yes.

If there are no further questions, then I guess it's an early drink. Then I'll thank you very much for joining us here today and invite you happily for a drink. Thank you.