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Chapter
25 /
Financial In struments: Recognition and Measurement
(lAS
39)
281
The effects of applying hedge accountin g are as follows:
For fair value hedges of existing assets and liabilitie s, the hedged portion of the asset or
liability is recognized in the balance sheet at fair value. The gain or loss from remea suring
the hedged item at fair value is recognized in profit or loss and is offset by the effective por–
tion of the loss or gain from remeasuring the hedging instrument at fair value.
For cash flow hedges, the portion of the gain or loss on the hedgin g instrument that is
dete rmined to be an effecti ve hedge is recognized directly in equ ity-becau se the change in
the fair value of the hedged portion of the underlying item is not recogni zed in the balance
sheet- and the ineffective portion of the gain or loss on the hedging instrument is recognized
in profit or loss. Amount s recogni zed directly in equity are subsequently recognized in profit
or loss in the same period or period s during which the hedged item affects profit or loss.
9.2 AEGON NV, Annual
Report
2006
18.3 Critical Accounting Estimates an d J udgemen t in Applying Accounting Policies
Fa ir Va lue of Investments and Der ivatives Determined Using Va luation Techniques
Financial instruments
In the absence of an active market, the fair value of nonquoted investments in financial assets is
estimated by using present value or othe r valuat ion technique s. For example, the measurement of in–
terests held in nonquoted investments fund s is based on the fair value of the underl ying assets. The
fair value of nonquoted fixed interest debt instruments is estimated by discounting expected future
cash flows using a current market rate applicable to financial instruments with similar yield, credit
quality and maturity characteristics. For mortgage and other loans originated by the Group, interest
rates currently being offered for similar loans to borrowers with similar credit ratings are applied . The
fair value of floating interest rate debt instruments and assets maturing within a year is assumed to be
approximated by their carrying amount.
Financial derivatives
Where quoted market prices are not available , other valuation techniques, such as option pricing
or stochastic modeling, are applied. The valuation techniques incorporate all facto rs that market par–
ticipants would consider and are based on observable market data when available. All models are
validated before they are used and calibrated to ensure that outputs reflect actual experience and com–
parable market prices.
Fair values for exchange-traded derivatives, principally futures and certain option s, are based on
quoted market prices. Fair values for over-the counter (OTC) derivative financial instruments repre–
sent amount s estimated to be received from or paid to a third party in settlement of these instruments.
The se derivatives are valued using pricing models based on the net present value of estimated future
cash flows, directly observed prices from exchange -traded derivatives, other OTC trades, or externa l
pricing services. Most valuations are derived from swap and volatility matrices, which are constru cted
for applicable indices and currencie s using current market data from many industry standard sources .
Option pricing is based on industry standard valuation models and current market levels, where appli–
cable . The pricing of comple x or illiquid instruments is based on internal models. For long-dated il–
liquid contracts, extrapolation methods are applied to observed marke t data in order to estimate inputs
and assumption s that are not directly observable. The values for OTC derivative s are verified using
observed market information , other trades in the market and dealer prices, along with management
jud gement.
Derivatives embedded in insurance and investment contracts
Certain bifurcated embedded derivati ves in insurance and investment products are not quoted in
active markets and their fair values are determined by using valuation techniques. Becau se of the dy–
namic and comple x nature of these cash flows, stochastic techniqu es under a variety of market return
scenarios are often used. A variety of factors are considered, including expected market rates of re–
turn, market volatility, correlation s of market returns, discount rates and actuarial assumptions.
The expected returns are based on risk-free rates , such as the current London Inter-Bank Offered
Rate (UBOR) forward curve or the curre nt rates on local government bonds . Market volatility as–
sumptions for each underlying index are based on observed market implied volati lity data or observed
market performance. Correlations of market returns across underlyin g indices are based on actual ob–
served market returns and relationships over a number of years preceding the valuation date. The cur–
rent risk-free spot rate is used to determine the present value of expected future cash flows produced in
the stochastic projection process.