Annuities struggle to gain traction in Australia but change may be coming

If there is one retirement product that Australians have really struggled to embrace, it is annuities.

There are some cases in which annuities can be of strong benefit to retirees – particularly those who are close to being in the sweet spot to claim a part pension as well as withdrawing from their super.

However, even that concessional treatment of annuities has failed to grab more than a decorative percentage of Australia’s close to $4 trillion superannuation pie.

Instead of buying annuities, retirees have been using account-based pensions which are seen as more flexible, although if only minimum withdrawals are made they often result in retirees failing to spend enough during their retirement years.

Popularity set to rise?

The popularity of annuities, which currently account for just 3.5% of assets held in pension accounts, could be set for a big boost with the Federal Government, super funds and annuity providers all looking to introduce more appealing products to ensure more successful retirements.

The main super regulators – Australian Prudential Regulation Authority and the Australian Securities and Investments Commission – wrote to funds in June asking them to introduce better retirement income products.

Annuities could fit the bill, as long as they are less complex and more appealing so that they can offer retirees guaranteed income for a set number of years or for life.

APRA ringing in the changes

That opportunity could be arriving this year with the prudential regulator APRA recently outlining in a new corporate plan that it will “support life insurers to increase the availability of retirement products for retirees” this financial year.

Part of that will be to examining what is working in offshore markets to see whether it could be applied to Australia.

That could include some relaxation of the capital requirements for annuity providers, to allow for greater flexibility.

At the moment, Australian requirements for annuity providers are seen as too onerous compared to established markets in the US and Europe.

Making more flexible capital rules

In simple terms, assets are marked to market while the liabilities, which include the present value of future payments, are valued using risk free rates plus an allowance for illiquidity.

Nobody wants to see a situation in which any annuity providers go broke, given their important function in providing a safe and reliable form of retirement income but under the current rules the test is seen as too “tight” compared to offshore rules.

If a larger allowance could be made for illiquidity, it would allow annuity providers to offer more appealing products that might increase the popularity of annuities.

Changes to the capital requirements would also take some of the volatility out of annuity underwriters’ business operations, which could lead to more attractive returns for customers and shareholders, and potentially a bigger and more competitive annuities sector.

Could investors benefit too?

At the moment, when markets are stressed and an Australian annuities provider’s assets drop in value but its liabilities remain relatively unchanged, assets may need to be sold to raise equity or there may be a need to hold more regulatory capital all the time.

Offshore those assets and liabilities are more closely matched and there is more of an allowance for volatility.

Of course, you don’t need to be in the market for annuities to benefit from any changes, with the biggest locally listed player Challenger (ASX: CGF) a potential big beneficiary of any relaxation in the capital rules around annuities.