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and shareholders’ equity. Volatile or poor market conditions may also significantly reduce the popularity of some of AEGON’s savings and investment products, which could lead to lower sales and net income. 

AEGON’s general account equity holdings are shown in table 8 on the previous page. 

The general account equity and real estate portfolios of AEGON USA and AEGON The Netherlands accounted for 97% of the general account equity and real estate portfolio of the AEGON Group of EUR 8,784 million at December 31, 2003. Of AEGON’s country units, AEGON The Netherlands holds the largest amount of investments classified as equities, both in absolute terms and expressed as a percentage of total general account investments. The largest part of the equity portfolio of AEGON The Netherlands consists of a diversified portfolio of global equities and 5% equity holdings in Dutch companies, which include non-redeemable preferred shares. 

The table below sets forth the year-end closing levels of certain major equity market indices. 

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AEGON’s shareholders’ equity is directly exposed to movements in the equity markets. Beginning in 2004, AEGON will discontinue the indirect income method and instead recognize in income realized gains and losses on equities and real estate, which may lead to increased sensitivity of net income to movements in equity markets. In addition, net income is sensitive to the fees earned on equity investments held for account of policyholders as well as the amortization of deferred policy acquisition costs and provisioning for minimum product guarantees. 

Sensitivity analysis of net income and shareholders’ equity to equity and real estate markets is presented in table 10. 

The sensitivity of shareholders’ equity and net income to changes in equity and real estate markets reflects changes in the market value of AEGON’s portfolio, changes in DPAC amortization, contributions to pension plans for AEGON employees, no effect from realized gains or losses and the strengthening of the guaranteed minimum benefits, when applicable. The main reason for the non-linearity of results is that more severe scenarios can cause accelerated DPAC amortization and guaranteed minimum benefits provisioning, while moderate scenarios may not. 

## DERIVATIVES RISK 

AEGON is exposed to currency fluctuations, changes in the fair value of its investments, the impact of interest rate and credit spread changes and changes in mortality and longevity. AEGON uses common financial derivative instruments such as interest rate swaps, options, futures and forward contracts to hedge some of the exposures related to both investments backing insurance products and company borrowings. AEGON may not be able to manage the risks associated with this activity successfully through the use of derivatives. In addition, a counterparty may fail to honor the terms of its derivatives contracts. Both scenarios could have a material adverse effect on AEGON’s business, results of operations and financial condition. The notional amount of AEGON’s derivative use can be found on page 104 and following. 

Generally, derivatives are used for hedging purposes, however, credit default swaps are used for purposes of selectively increasing credit exposures. Credit default swaps are used in combination with high quality low risk assets to synthetically replicate corporate credit exposures in constructing investment portfolios. Credit default swaps are also sold on a limited basis to generate fee income. 

Derivative use is managed by requiring a written hedge or derivative program policy. All traded derivatives must be under one of these policies. The financial implications of derivatives are modeled along with all other financial instruments – whether interest rate, credit or equity risk modeling. 

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