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For its with-profit business, Aegon UK’s general philosophy is to match guarantees with appropriate investments. However, the nature of with-profit businesses typically prevents perfect matching, and the role of the MIC is therefore to monitor the capital implications of any mismatching. On a regular basis, reports are produced covering the impact of a range of possible investment scenarios on the solvency of each of the funds. These reports allow the investment strategy for the with-profit funds to be discussed and are summarized for the With-Profits Forum, a sub-committee of the Board of Aegon UK. 

For non-profit business, interest rate risk arises substantially on Aegon UK’s large book of annuities in payment. Assets are purchased to provide a close expected match to liability outflows, with regular reporting to the MIC on the capital implications of any mismatching. 

For unit-linked business, the matching philosophy results in close matching of the unit liabilities with units in the relevant underlying funds. A proportion of the unit-linked assets are invested in funds managed by external investment managers. The MIC monitors the performance of the investment managers against fund benchmarks. 

## With-profit fund 

The invested assets, insurance and investment contract liabilities of Aegon UK’s with-profit fund are included in 'for account of policyholder assets and liabilities'. Assets and liabilities are always equal, as an excess of assets over liabilities regarding guaranteed benefits and constructive obligations is classified as an insurance or investment contract liability. The Scottish Equitable with-profit fund is a 100:0 fund, whereby benefits are held for participating policyholders. 

The operation of the Scottish Equitable with-profit fund is complex. Below is a summary of Aegon UK’s overall approach. 

## Guarantees 

With the exception of Aegon Secure Lifetime Income and 5 for Life, which are written by Aegon Ireland plc, and the product guarantees within Investment Control and Income for Life, which are reinsured to Aegon Ireland plc, all Aegon UK contracts with investment guarantees are written in policyholder-owned funds (otherwise called with-profit funds). These funds contain free assets which have not yet been fully distributed to individual policyholders. Free assets help meet the cost of guarantees and provide a buffer to protect the fund from the impact of adverse events. Aegon UK has an exposure only once these assets have been exhausted. As outlined below, Aegon UK believes this exposure to be low. 

In previous years, Scottish Equitable sold guaranteed annuity products in the United Kingdom. Certain policies also have a guaranteed minimum rate of return or guaranteed minimum 

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Annual Report 2013 

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pension or guaranteed death or other benefits. Guaranteed rates of return apply only if the policy is kept in force to the dates specified, or only on the events described in the policy conditions. The costs of all guarantees are borne by the with-profit funds and therefore impact the pay-outs to with-profit policyholders. 

As part of its demutualization process prior to acquisition by Aegon N.V., the business and assets of Scottish Equitable Life Assurance Society were transferred to Scottish Equitable plc on December 31, 1993. Aegon UK has no financial interest in Scottish Equitable plc.’s with-profit fund, except routine yearly fund management charges, and costs and expenses that the company agreed to accept at the time of demutualization. 

Guaranteed rates of return on with-profit policies are typically in the range of 0% to 5.5% a year; however, the highest rates have been closed to premiums since 1999, and all funds have been closed to new business with investment guarantees since October 2002, except for a small increase in regular payments. For a number of contracts written mainly in the 1970s and 1980s, Scottish Equitable also offered minimum pension guarantees, including guaranteed annuity options. As life expectancy rates have improved and interest rates have fallen over time, these minimum guarantees are now often valuable. 

## Management of the with-profit fund 

Aegon UK’s with-profit fund has an investment strategy that reflects the nature of the underlying guarantees. The fund can invest in a variety of different asset types. The main categories are United Kingdom and overseas equities, United Kingdom fixed interest securities, and cash. The with-profit fund has a target range for the percentage of its assets that are invested in equities, and this range may be varied. Within these target ranges, there is a policy of holding an appropriate mix of asset classes to reduce risk. 

The results of the with-profit fund’s investment performance are distributed to policyholders through a system of bonuses which depends on: 

■ The guarantees under the policy, including previous annual bonus additions. 

■ The investment returns on the underlying assets, with an allowance for ‘smoothing’ to reduce volatility. Although smoothing means that investment profits are spread from one year to the next, the aim is to pay out all of the investment profits earned by the fund over the long term. For early withdrawals, there are other measures to ensure that a fair share of total fund growth is received. A market value reduction may be applied to certain funds where, for cohorts of similar contracts, the face value of the benefits is greater than the value of the underlying assets. Policy conditions may state specific points for which a market value reduction will not apply. 

