APRA plans to remove 'unnecessary obstacles' for longevity products

APRA has proposed changes to its prudential framework for annuities, committing to removing unnecessary obstacles to the development of more "innovative" and "competitively priced" longevity products.

The regulator identified two issues with its existing framework.

Firstly, it imposes high capital requirements compared to some other jurisdictions, "making annuities more expensive that they might otherwise be."

Second, the framework is "insufficiently risk sensitive" and may "exacerbate procyclicality" by requiring life insurers to liquidate assets during a market downturn.

APRA has subsequently proposed to redesign the illiquidity premium in Prudential StandardLPS 112 Capital Adequacy: Measurement of Capital (LPS 112).

The illiquidity premium in LPS 112 increases the discount rate that life insurers use to calculate liabilities for certain annuities under APRA's capital framework.

"Increasing the discount rate has the effect of reducing liabilities and hence the amount of capital they require. This benefit reflects the fact that relevant annuities are characterised by low surrender risk to life insurers, which gives them more scope to invest in more illiquid but higher yielding assets to back these liabilities," APRA said.

As currently designed, APRA said the illiquidity premium applies on a one size fits all basis and isn't risk sensitive.

APRA proposed allowing 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," it said.

APRA said it doesn't expect the proposals to transform the annuities market, however, "they should facilitate more competitive pricing" without increasing risks for policyholders.

The regulator added that the proposed changes address a call from industry to better align its requirements with other jurisdictions and to establish a "more favourable environment" for the potential growth of annuity products.