AEGON GROUP ANNUAL REPORT 2003 38 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. 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. 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. 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. DERIVATIVES RISK Table 9 Table 10 SENSITIVITY ANALYSIS OF NET INCOME AND SHAREHOLDERS’ EQUITY TO EQUITY AND REAL ESTATE MARKETS 1,2 Approximate effects on Movement of markets  Approximate effects on net income shareholders’ equity Increase of equity and real estate markets of 10% EUR 70 million EUR 455 million Decrease of equity and real estate markets of 10% EUR (55) million EUR (470) million Decrease of equity and real estate markets of 20% EUR (270) million EUR (965) million Shift down 100 basis points of long-term equity DPAC assumptions EUR (65) million Year-end 1999 2000 2001 2002 2003 S&P 500 1,469 1,320 1,148 880 1,112 Nasdaq 4,069 2,471 1,950 1,336 2,003 FTSE 100 6,930 6,222 5,217 3,940 4,477 AEX 671 638 507 323 338 $^{1}$Basic assumptions: no correlation between markets and risks; unchanged conditions for all other assets and liabilities; limited management actions taken. All changes are relative to net income and shareholders’ equity. Effects do not tend to be linear and therefore cannot be extrapolated for larger increases or decreases.  The approximate effects on shareholders’ equity excludes the effects on net income, which is presented above separately. $^{2}$The effect of movements in equity and real estate markets is reflected as a one-time increase or decrease of worldwide equity and real estate markets on January 1, 2004. RISK MANAGEMENT AND RISK FACTORS