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42 Business overview Overview AmericasAsset liability managementThe Aegon USA insurance companies are primarily subject to regulation under thelaws of the states in which they are domiciled. Each state’s laws prescribe thenature, quality, and percentage of various types of investments that may be madeby the companies. Such laws generally permit investments in government bonds,corporate debt, preferred and common stock, real estate, and mortgage loans.Limits are generally placed on other classes of investments.The key investment strategy for traditional insurance-linked portfolios is assetliability management, whereby predominately high-quality investment assets arematched in an optimal way to the corresponding insurance liability. This strategytakes into account currency, yield and maturity characteristics. Asset diversificationand quality considerations are also taken into account, along with considerations ofthe policyholders’ guaranteed or reasonably expected excess interest sharing.Investment-grade fixed income securities are the main vehicle for asset liabilitymanagement, and Aegon USA’s investment personnel are highly skilled andexperienced in these investments.The Aegon USA companies manage their asset liability matching through the workof several committees. These committees review strategies, define risk measures,define and review asset liability management studies, examine risk-hedgingtechniques, including the use of derivatives, and analyze the potential use of newasset classes. Cash flow testing analysis is performed using computer simulations,which model assets and liabilities under projected interest rate scenarios andcommonly used stress-test interest rate scenarios. Based on the results of thesesimulations an investment portfolio is constructed to best match the cash flow andinterest sensitivity of the underlying liabilities while trying to maximize the spreadbetween the yield on the portfolio assets and the rate credited on the policyliabilities. Interest rate scenario testing is a continual process and the analysis of theexpected values and variability for four critical risk measures (capital charges, cashflows, present value of profits, and interest rate spreads) forms the foundation formodifying investment strategies, adjusting asset duration and mix, and exploringhedging opportunities. On the liability side, Aegon USA has some offsetting risks,some liabilities perform better in rising interest rate environments while others tendto perform well in falling interest rate environments. The amount of offset can varydepending on the absolute level of interest rates and themagnitude and timing of interest rate changes, but it generally provides some levelof diversification. O n the asset side, hedging instruments are continuously studiedto determine whether their cost is commensurate to the risk reduction they offer.Reinsurance cededCeding reinsurance does not remove Aegon’s liability as the primary insurer. Aegoncould incur losses should reinsurance companies not be able to meet theirobligations. To minimize its exposure to the risk of such defaults, thecreditworthiness of its reinsurers is monitored regularly.Aegon USAAegon USA reinsures part of its life insurance exposure with third-party reinsurersunder traditional indemnity, quota share reinsurance treaties, as well as excess-oflosscontracts. Aegon USA’s reinsurance strategy is in line with typical industrypractice.These reinsurance contracts are designed to diversify Aegon USA’s overall risk andlimit the maximum loss on risks that exceed policy retention levels. The maximumretention limits vary by product and class of risk, but generally fluctuate betweenUSD 3,000 and USD 10 million per life insured.Aegon USA remains contingently liable with respect to the amounts ceded shouldthe reinsurance company not be able to meet its obligations. To minimize itsexposure to such defaults, Aegon USA regularly monitors the creditworthiness of itsreinsurers, and where appropriate, arranges additional protection through letters ofcredit or trust agreements. For certain agreements, funds are withheld forinvestment by the ceding company. Aegon USA has experienced no materialreinsurance recoverability problems in recent years.The Aegon USA insurance companies also enter into contracts with companyaffiliatedreinsurers, both within the United States and overseas. These contractshave been excluded from the company’s consolidated financial statements.Aegon CanadaIn the normal course of business, Transamerica Life Canada reinsures part of itsmortality and morbidity risk with third-party reinsurers that are registered withCanada’s Office of the Superintendent of Financial Institutions. The maximum lifeinsurance exposure retained is CAD 1.25 million per life insured.