APRA proposes scrapping one size fits all annuities approach

The Australian Prudential Regulation Authority is proposing to scrap the one size fits all illiquidity premium which applies to annuities as part of suite of measures to make annuities products more affordable.

The regulator has issued a discussion paper which acknowledges the issues which have hamstrung development of longevity products in Australia including relatively high capital requirements and a framework which is insufficiently risk sensitive.

Detailing its approach, APRA said it proposes to improve the capital framework for annuity products including the potential for lower capital requirements in return for reductions in risk by better matching cashflows from the assets and liabilities backing an annuities business.

“As currently designed, the illiquidity premium applies on a ‘one size fits all’ basis and is not risk sensitive. The discount rate applies regardless of the composition of the asset portfolio backing an annuity product or how closely cashflows from these assets are matched to liabilities,” the APRA discussion paper said..

“APRA proposes to allow a bigger illiquidity premium where cash flows from assets backing annuities are more closely matched to liabilities. Under this approach, the size of the illiquidity premium for a product could reflect the characteristics of the relevant asset portfolio. Closer matching of assets and liabilities would result in a higher discount rate and hence lower capital requirements.”

“For insurers who choose not to adopt the proposed changes to the illiquidity premium, with its corresponding risk controls, the existing illiquidity premium formula will still be available,” it said.

The illiquidity premium currently applies to particular retirement income products. Reflecting the origins of the illiquidity premium, it does not apply to products that are at higher risk of surrender by policyholders as the addition of withdrawal/surrender and death benefit features to products creates increased uncertainty over the timing of benefit payments.

APRA may consider broadening the type of annuity products to which the illiquidity premium applies, however we are seeking industry feedback on how this could be implemented for products with increased uncertainty over the timing and size of benefits while still ensuring that the illiquidity premium is appropriate and achievable under both normal and stressed circumstances.

In releasing the discussion paper, APRA said the proposals represented a response to industry calls to better align APRA’s requirements with those of other jurisdictions, creating a more favourable environment for the provision of annuity products.

“Over time, this initiative has the potential to improve annuity offerings to Australian retirees,” it said.