45 ANNUAL REPORT 2010   OUR BUSINESSES  RISK SHARPENING OUR FOCUS Risk overview 2010 Credit risk After initially narrowing during the first part of the year, credit spreads later widened,  reverting to levels seen at the start of 2010. Defaults and downgrades improved. During the  year, AEGON took a number of specific steps to reduce its exposure to credit risk:  ■ Restructuring of AEGON US’s investment portfolio and a reduction in high yield bonds.  ■  Reduction in exposure in the Netherlands through the sale of high yield investments, Dutch  residential mortgage-backed and other asset backed securities, as well as a further  reduction in exposure to lower-rated European countries.  ■ In the United Kingdom, increased investment in lower-risk long-term UK government bonds.  Equity market  risk and other  investment risks Equity markets were volatile throughout the year. During 2010, AEGON further extended its  program of hedging equity risk at its US and Dutch operations to protect the company against  a possible deterioration in equity markets. Interest rate risk Interest rates continued to decline for most of 2010 from already low levels. Falling rates  particularly impacted investment income and margins on financial guarantees included in  certain policies. AEGON took several de-risking initiatives to reduce exposure to movements in  interest rates. In the United States, a number of interest rate sensitive products were repriced  and product features adjusted to decrease interest rate risk. Fixed annuity sales in the United  States, meanwhile, were de-emphasized. In addition, in the United Kingdom, steps were taken  to direct investments to lower risk long-dated UK government bonds.  Currency exchange rate risk As an international company, AEGON is exposed to movements in currency rates. However,  AEGON does not consider this exposure to be material. The company holds its capital base in  various currencies in amounts that correspond to the book value of individual country units,  thus mitigating currency risk. AEGON does hedge cash flows from operating subsidiaries as  part of its broader capital and liquidity management. Liquidity risk AEGON has a strong liquidity management strategy in place. Since the early 1990s, AEGON  has been constantly refining and developing its approach to liquidity management. As part  of this approach, AEGON regularly considers the most extreme liquidity stress scenarios,  including the possibility of prolonged “frozen” capital markets, an immediate and permanent  rise in interest rates, and policyholders withdrawing liabilities at the earliest conceivable  date. In addition, the company has highly developed liquidity stress planning in place. In  2010, AEGON further increased its holdings of cash and highly liquid assets as a precaution  against liquidity risk. AEGON’s liquidity management strategy ensures the company will not  be a forced seller of assets even in a severe stress scenario. Stress tests show that available  liquidity would more than match the company’s liquidity requirements for at least the next  two years, even if market conditions were to significantly deteriorate from current conditions. Underwriting  risk AEGON’s earnings depend, to a significant degree, on the extent to which claims experience  is consistent with assumptions used by the company to price products and establish technical  liabilities. Changes in, among other things, morbidity, mortality, longevity trends and  policyholder behavior could have a considerable impact on AEGON’s income. AEGON believes  it has the capacity to take on more underwriting risk (providing it is correctly priced) in line  with the company’s broader strategy to capitalize on growth opportunities in its main life  insurance and pension markets. Operational risk Like other companies, AEGON faces risks resulting from operational failures or external  events, such as changes in regulations, acts from personnel and natural or man-made  disasters. AEGON’s systems and processes are designed to support complex products and  transactions and to avoid such issues as system failures, financial crime and breaches of  security. AEGON is constantly working on analyses studying such operational risks and  regularly develops contingency plans to deal with them.