APRA proposes scrapping one size fits all | Australian Markets

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

The regulator has issued a dialogue paper which acknowledges the problems which have hamstrung development of longevity merchandise in Australia together with comparatively high capital necessities and a framework which is insufficiently risk delicate.

Detailing its strategy, APRA stated it proposes to improve the capital framework for annuity merchandise together with the potential for decrease capital necessities in return for reductions in risk by higher matching cashflows from the property 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 dialogue paper stated..

“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 stated.

The illiquidity premium at present applies to specific retirement income merchandise. Reflecting the origins of the illiquidity premium, it doesn’t apply to merchandise which can be at larger risk of give up by policyholders because the addition of withdrawal/give up and death benefit options to merchandise creates elevated uncertainty over the timing of benefit funds.

APRA might contemplate broadening the kind of annuity merchandise to which the illiquidity premium applies, nevertheless we’re in search of industry suggestions on how this could possibly be carried out for merchandise with elevated uncertainty over the timing and size of advantages whereas nonetheless making certain that the illiquidity premium is suitable and achievable beneath each regular and careworn circumstances.

In releasing the dialogue paper, APRA stated the proposals represented a response to industry calls to higher align APRA’s necessities with these of different jurisdictions, creating a more beneficial setting for the availability of annuity merchandise.

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