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Aegon defines total financial leverage as borrowings issued to fund the capital employed in insurance activities. Total financial leverage includes hybrid leverage, subordinated and senior debt, and short term debt such as commercial paper. Aegon’s fixed charge coverage is a measure of the company’s ability to service its total financial leverage and is calculated as the ratio of underlying earnings before tax and prior to the payment of interest expenses on total financial leverage to interest payments on total financial leverage and preferred dividends. The numbers include the impact of hedging. 

At the end of 2013, Aegon’s total capitalization was EUR 25.5 billion (EUR 27.3 billion at end 2012). Its gross financial leverage was 30.1% (31.9% at end 2012) and its fixed charge coverage was 5.1x (4.5x at end 2012). Aegon targets a gross financial leverage ratio of 26-30% and a fixed charge coverage of 6.0-8.0x and expects a continued deleveraging in 2014 supporting Aegon’s commitment to these targets. 

## Debt funding and back-up facilities 

Most of Aegon’s debt is issued by Aegon N.V., the parent company. A limited number of other Aegon companies have also issued debt securities, but for the most part these securities are guaranteed by Aegon N.V. 

Aegon N.V. has regular access to international capital markets under a USD 6 billion debt issuance program. Access to the capital market in the United States is made possible by a separate shelf registration. 

Aegon also has access to domestic and international money markets through its USD 4.5 billion commercial paper programs. At December 31, 2013, Aegon had EUR 135 million outstanding under these programs. 

To support its commercial paper programs and need for letters of credit (LOCs), and to enhance its liquidity position, Aegon maintains backup credit and LOC facilities with international lenders. The company’s principal arrangement is a EUR 2 billion syndicated revolving credit facility maturing in 2019, and additional LOC facilities of USD 2 billion, of which USD 1.5 billion matures in 2015 and USD 0.5 billion matures in 2017. In addition, Aegon also maintains various shorter-dated bilateral backup liquidity and LOC facilities in both committed and uncommitted format. 

## Operational leverage 

Although operational leverage is not considered part of Aegon’s total capitalization, it is an important source of liquidity and funding. Operational leverage relates primarily to financing Aegon’s mortgage portfolios through securitizations and warehouse facilities, and the funding of US Regulation XXX and Guideline AXXX redundant reserves. 

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Aegon enters into reinsurance agreements for risk and capital management purposes with several affiliated captive insurance companies (captives). All captives are fully consolidated for IFRS reporting. 

The captives are utilized for a number of purposes which may include: 

■ Financing term life insurance (subject to Regulation XXX reserves) and universal life insurance with secondary guarantees (subject to Regulation AXXX reserves) to support lower-risk statutory reserves at a lower cost for policyholders and shareholders; 

■ Managing variable annuity hedging programs; 

■ Managing and segregating risks; 

■ Monetizing embedded value. 

All external financing provided to captives to support statutory reserves is disclosed in note 41 (Borrowings) to the consolidated financial statements to the extent that it has been funded. 

Letters of credit issued by third parties provided to captives to provide collateral to affiliated insurers are disclosed in note 51 (Commitments and contingencies). These letters of credit have been provided by third parties for the benefit of the affiliated company whose liabilities are reinsured. 

## Liquidity management 

## Strategic importance 

Liquidity management is a fundamental building block of Aegon’s overall financial planning and capital allocation processes. Aegon aims to have sufficient liquidity to meet cash demands even under extreme conditions. The company’s liquidity risk policy sets guidelines for its operating companies and the holding in order achieve a prudent liquidity profile. 

Liquidity is coordinated centrally and managed both at Aegon N.V. and at country unit levels. Aegon maintains a liquidity policy that requires all operating units to project their sources and uses of liquidity over a two year period under normal and severe business and market scenarios. This policy ensures that liquidity is measured and managed consistently across the company and the liquidity stress management plans are in place. 

## Sources and uses of liquidity 

Aegon’s subsidiaries are primarily engaged in the life insurance business, which is a long-term business with relatively illiquid liabilities and generally matching assets. Liquidity consists of both liquid assets held in investment portfolios, as well as inflows generated by premium payments and customer deposits. 

These are used primarily to purchase investments, as well as to fund benefit payments to policyholders, policy surrenders, operating expenses, and, if the subsidiary’s capital position so allows, to pay dividends to the holding. 

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