Capital settings for longevity products

Executive summary
 

APRA is committed to removing unnecessary obstacles to the development of more innovative and competitively priced longevity products. This is consistent with the Government’s objective of expanding options for retirees to manage longevity risk. 

In response to industry feedback, APRA has identified two key issues with its prudential framework for annuities. First, it imposes relatively high capital requirements compared to some other jurisdictions, making annuities more expensive than 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.

This paper outlines proposals to improve the capital framework for annuity products and address these issues. The proposals consist of a redesigned illiquidity premium in conjunction with additional risk controls on the governance, reporting and assets supporting an annuity portfolio. The proposals aim to strike an appropriate balance between maintaining adequate capital to mitigate risk to policyholders and rewarding sound risk management practices.

APRA seeks feedback from industry participants and other relevant stakeholders on proposed changes to components of the illiquidity premium formula, including replacing the current ‘one size fits all’ approach with a new approach that can reflect the riskiness of different asset portfolios. APRA also seeks feedback on associated risk controls that would be appropriate and practically achievable for industry to implement. 

While APRA does not expect the proposals to transform the market for annuities in Australia, they should facilitate more competitive pricing without unduly increasing risks for policyholders. The proposed changes address the call from industry to better align APRA’s requirements with other jurisdictions and to establish a more favourable environment for the potential growth of annuity products.

APRA invites written submissions in response to this paper by 25 July 2025.

Glossary
 

Chapter 1: Overview

Policy background

In recent years, there has been an increased focus on broadening financial options for Australian retirees, including through the introduction of a Retirement Income Covenant (RIC) for RSE licensees.¹ One objective of the RIC is to improve retirement outcomes for individuals by increasing the availability of retirement income products that more efficiently manage longevity risk.

One of the ways that APRA can support this objective is by recalibrating its prudential framework to address unnecessary impediments that prevent life insurers from offering annuity products or reduce the attractiveness of their pricing. Recalibrating the capital settings for annuities is also an opportunity to improve product risk sensitivity and move closer to comparable international jurisdictions that have better established and more competitive annuity markets. 

Adjustments to the capital framework for annuity products will be guided by the following objectives:

• APRA’s capital requirements for life insurers are not a disincentive to the development and competitive pricing of annuity products 
• maintaining the financial resilience of life insurers
• improving alignment with comparable peer jurisdictions.

The proposed adjustments also take into account the small size of Australia’s annuities market, which suggests that substantial changes to the current framework (e.g. the introduction of a Solvency II style Matching Adjustment) are not justified at this time. 

While adjusting the capital settings may remove some barriers to the development of more attractive annuity products, we do not expect that changes proposed in this consultation will by themselves generate substantially increased take-up of annuity products. Weak demand for annuities remains the primary challenge in boosting take-up of longevity products. This is likely driven by several factors, including limited consumer understanding in Australia around the potential benefits of annuity products. APRA encourages industry to continue its efforts to enhance consumer financial literacy around longevity solutions.

Role of annuity products in retirement and issues with the current prudential framework

Most Australian retirees who draw an income in retirement currently use account-based pensions. Annuity products could play a larger role in helping Australians optimise their retirement income by offering a guaranteed income stream to help manage longevity risk. These products could provide retirees with more confidence to draw down their account-based pensions without the risk of exhausting their financial resources. 

In July 2024, APRA held a CEO roundtable on the challenges facing life insurers in delivering competitive longevity solutions for retirees. Industry participants provided feedback that elements of APRA’s capital framework for annuities are more restrictive than in other comparable countries. Given the need for insurers to generate a return on capital, higher capital requirements reduce the annuity yields insurers can offer to potential consumers. APRA accepts that the current capital requirements for annuities are more stringent than many comparable jurisdictions and that there is scope for them to be recalibrated without undermining the prudential soundness of life insurers. 

Another issue is that current capital requirements provide limited incentives for life insurers to manage risk by matching asset and liability cashflows. This can result in unduly procyclical portfolios, potentially forcing annuity providers to sell assets backing long-term liabilities during short-term stress events to replenish capital buffers. 

Matching liabilities against hold-to-maturity assets provides for risk reduction during short term credit volatility and is a desirable risk management practice consistent with the prudent operation of a life insurer. Since the development of APRA’s capital framework for life insurers in 2013, various international peers such as the EU, Bermuda and UK, have for this reason, introduced more risk sensitivity in their capital regimes by requiring annuity providers to match asset and liabilities.

Chapter 2: Proposals

Summary of proposed amendments

This paper contains proposals to improve the capital framework for annuity products. These proposals offer the potential for lower capital requirements in return for reductions in risk by better matching cashflows from the assets and liabilities backing an annuity business. The proposals have been informed by feedback from industry and aim to create a more risk sensitive prudential capital framework that facilitates more competitive annuity pricing.

APRA proposes 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. 

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. 

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.  

Table A sets out potential changes to the components of the current formula in LPS 112 that is used to calculate the illiquidity premium. APRA seeks general feedback on this approach as well as answers to the specific questions relating to each of the options listed in Table A to ensure the parameters remain appropriate and consistent with the objectives of this paper. 

Table B outlines the introduction of proposed risk controls that would have to be satisfied by life insurers that use the redesigned illiquidity premium in LPS 112. The purpose of these risk controls is to ensure that reductions in capital are balanced by commensurate safeguards to protect policyholders’ interests. Under these options, a life insurer’s Appointed Actuary would play a key assurance role. APRA seeks general feedback on the appropriateness and effectiveness of each risk control as well as answers to the questions listed in Table B. 

The introduction of risk controls allows for more risk sensitive parameters and increased discretion from the Appointed Actuary and insurer in determining the appropriate illiquidity premium within the framework outlined in Table A.

Whichever approach is adopted to redesigning the illiquidity premium, it should support life insurers to increase the availability of annuities while balancing APRA’s financial safety and competition mandates. APRA considers the new formula must have sound justification, give appropriate results in both normal and stressed situations and should be based as far as possible on objective data.

 Table A – Proposed changes to redesign the illiquidity premium

Prudential Standard LPS 114 Capital Adequacy: Asset Risk Charge (LPS 114) currently allows for a 30 bp increase to the illiquidity premium, for the first 10 years after the reporting date, when calculating the stressed illiquidity premium in the credit spread stress component.

APRA proposes to redesign the calculation of the stressed illiquidity premium so that it is explicitly dependent on the components of the illiquidity premium formula. This is to ensure that the stressed illiquidity premium under the credit stress provisions in LPS 114 is consistent with the changes to the illiquidity premium formula under LPS 112.

Table B – Proposed risk controls

Other issues

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.

Chapter 3: Consultation

Next steps

Recognising the Government’s priority of removing unnecessary barriers to the take-up of longevity risk products and the industry’s interest in this topic, APRA’s aim is to expedite this review where possible. Timely feedback in response to the questions in this paper will help us develop specific proposals for further consultation later this year that are consistent with the objectives of this project. 

APRA requests submissions on the framework design, expected impact and other implementation considerations relevant to the proposed approach. 

Further consultation on draft prudential standards and guidance is expected to occur in H2 2025 with the aim of finalising changes in H1 2026.

Request for submissions

APRA invites written submissions on the proposals and accompanying questions set out in this Paper. Written submissions should be sent to policydevelopment@apra.gov.au by 25 July 2025 and addressed to:

General Manager
Policy Development 
Policy and Advice Division
Australian Prudential Regulation Authority

To ensure proposals for the next consultation are developed in a timely manner, APRA will only grant extensions to the due date for submissions in exceptional circumstances.

Important disclosure information – publication of submissions

All information in submissions will be made available to the public on the APRA website unless a respondent expressly requests that all or part of the submission is to remain in confidence. Automatically generated confidentiality statements in emails do not suffice for this purpose. Respondents who would like part of their submission to remain in confidence should provide this information marked as confidential in a separate attachment.

Submissions may be the subject of a request for access made under the Freedom of Information Act 1982 (FOIA). APRA will determine such requests, if any, in accordance with the provisions of the FOIA. Information in the submission about any APRA-regulated entity that is “protected information” under section 56 of the Australian Prudential Regulation Authority Act 1998 (APRA Act) can only be disclosed or produced for an authorised purpose under section 56 of the APRA Act and is likely to be exempt from production under the FOIA.

Request for cost-benefit analysis information

APRA asks that all stakeholders use this consultation opportunity to provide information on the compliance impact of the proposals, and any other substantive costs including business costs. Compliance costs are defined as direct costs to businesses of performing activities associated with complying with government regulation. Specifically, information is sought on any changes to compliance costs incurred by businesses as a result of APRA’s proposals.

Consistent with the Government’s approach, APRA will use the methodology behind the Regulatory Burden Measurement Framework to assess compliance costs. It is available at Regulatory Burden Measurement Framework.

APRA requests that respondents use this methodology to estimate costs to ensure the data supplied to APRA can be aggregated and used in an industry-wide assessment. When submitting cost assessments to APRA, respondents should include any assumptions made and, where relevant, any limitations inherent in their assessment. Feedback should address the additional costs incurred as a result of complying with APRA’s requirements, not activities that institutions would undertake due to foreign regulatory requirements or in their ordinary course of business.