Challenger has expressed strong support for the raft of proposals made by APRA for improving the capital settings for annuities.
In its latest financial results, the investment management company said the prudential capital treatment of long-term insurance liabilities in Australia was overly conservative compared to global standards and in need of adjustment.
“[The current settings result] in relatively high regulatory capital levels, but more significantly, regulatory capital requirements that spike during periods of increased market volatility. This is primarily due to the manner in which illiquid liabilities, such as annuities, are valued for capital purposes,” it said.
Challenger said a shift to a more risk-sensitive capital framework, as proposed by APRA, would “improve the financial resilience of life insurers by reducing the pro-cyclicality they face during market downturns and establish a more favourable environment to grow the annuity market”.
APRA commenced its consultation on capital settings for annuity products back in June this year after identifying some issues with the current framework.
The prudential regulator considers the capital requirements in Australia to be relatively high in comparison with other jurisdictions, making annuities more expensive than they might otherwise be.
APRA said the current framework is also insufficiently risk-sensitive, which could exacerbate procyclicality by requiring life insurers to liquidate assets during a market downturn.
The consultation paper indicated that APRA would like to shift to a more market-sensitive illiquidity premium with appropriate risk controls.
Under the current framework, Challenger said it is required by APRA’s prudential standards to value assets at fair value, while annuities are valued using a discount rate based on the Australian government bond curve plus an illiquidity premium or allowance for “illiquidity”.
“It is this allowance that is small and relatively static in Australia relative to other markets and gives rise to fluctuating valuation movements on assets and policy liabilities being recognised in the regulatory capital balance sheet,” the annuity provider said.
APRA proposed a number of changes for redesigning the liquidity premium, including adjusting the discount factor, broadening the universe of credit assets for determining the benchmark reference point and increasing the long-term rate implementation.
It also suggested increasing the long-term illiquidity premium rate, increasing the illiquidity premium cap and aligning the calculation of the illiquidity premium under capital stress scenarios with the calculation of the base illiquidity premium.
Challenger said the proposals outlined in the consultation paper represent “a significant improvement on Australia’s current prudential capital settings”.
A more risk-sensitive capital framework that produces closer alignment between asset and liability cash flows would create a more appropriate environment for the provision of annuity products, Challenger said.
If adopted, Challenger said the regulatory reforms would lead to further development in Australia’s retirement income market by “promoting innovation, supporting greater take-up of lifetime income products and enabling greater choice and certainty for retirees”.
“Work to amend Australia’s capital settings for annuity products is a significant step forward and will contribute to a larger, more attractive lifetime income market that helps ensure guaranteed income becomes an integral part of the retirement process,” it said.
The investment management company said it would continue to engage constructively with APRA after submitting its response to the consultation last month.
Further consultation on draft prudential standards and guidance is expected to occur in the second half of the 2025 calendar year, with APRA aiming to finalise changes in the first half of the 2026 calendar year.
