112 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS OF AEGON N.V.  NOTE 3 are derived in the same way as the assumptions used to  measure insurance liabilities. These assumptions are reviewed at each valuation date, and  updated based on historical experience and observable market  data, including market transactions such as acquisitions and  reinsurance transactions. Since many of the assumptions are unobservable and are  considered to be significant inputs to the liability valuation,  the liability included in future policy benefits has been reflected  within Level III of the fair value hierarchy. Refer to note 45 for  more details about AEGON’s guarantees. Similar to embedded derivatives in insurance contracts, certain  investment products are not quoted in active markets and their  fair values are determined by using valuation techniques.  Because of the dynamic and complex nature of these cash  flows, stochastic or similar techniques under a variety of market  return scenarios are often used. A variety of factors are  considered, including expected market rates of return, market  volatility, correlations 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 (LIBOR) swap rates  and associated forward rates or the current rates on local  government bonds. Market volatility assumptions for each  underlying index are based on observed market implied  volatility data and / or observed market performance.  Correlations of market returns for various underlying indices  are based on observed market returns and their inter- relationships over a number of years preceding the valuation  date. Current risk-free spot rates are used to determine the  present value of expected future cash flows produced in the  stochastic projection process.  The following is a description of AEGON’s methods of  determining fair value, and a quantification of its exposure  to financial instruments measured at fair value.  Fair value is the amount for which an asset could be exchanged,  or a liability settled, between knowledgeable willing parties in  an arm’s length transaction. Financial instruments measured  at fair value on an ongoing basis include investments for the  The majority of valuation techniques employ only observable  market data, and so the reliability of the fair value  measurement is high. However, certain financial instruments  are valued on the basis of valuation techniques that feature  one or more significant market inputs that are unobservable  and, for such financial instruments, the derivation of fair value  is more judgmental. An instrument in its entirety is classified  as valued using significant unobservable inputs if, in the opinion  of management, a significant proportion of the instrument’s  carrying amount and / or inception profit (‘day 1 gain or loss’)  is driven by unobservable inputs. ‘Unobservable’ in this context  means that there is little or no current market data available  from which to determine the price at which an arm’s length  transaction would be likely to occur. It generally does not mean  that there is no market data available at all upon which to base  a determination of fair value.  The judgment as to whether a market is active may include,  although not necessarily determinative, lower transaction  volumes, reduced transaction sizes and, in some cases, no  observable trading activity for short periods. In inactive  markets, assurance is obtained that the transaction price  provides evidence of fair value or determined that the  adjustments to transaction prices are necessary to measure  the fair value of the instrument. The best evidence of fair value is a quoted price in an actively  traded market. In the event that the market for a financial  instrument is not active or quoted market prices are not  available, a valuation technique is used. In accordance with IFRS 7 AEGON uses the following hierarchy  for determining and disclosing the fair value of financial  instruments: general account, investments for the account of policyholders,  and investments designated at fair value and derivatives. Investment contracts Determination of fair value and fair value hierarchy  Assumptions on customer behavior, such as lapses, included  in the models are derived in the same way as the assumptions  used to measure insurance liabilities.  ■ Level I: quoted prices (unadjusted) in active markets for  identical assets or liabilities that AEGON can access at  the measurement date; ■ Level II: inputs other than quoted prices included within  Level I that are observable for the asset or liability, either  directly (that is, as prices) or indirectly (that is, derived  from prices of identical or similar assets and liabilities)  using valuation techniques for which all signifi cant inputs  are based on observable market data; and ■ Level III: inputs for the asset or liability that are not based  on observable market data (that is, unobservable inputs)  using valuation techniques for which any signifi cant input  is not based on observable market data.