Will renewed capital settings launch a new age for annuities in Australia?

The number one provider of annuities in Australia today is the Australian Government, through a publicly funded means tested Age Pension. The latest report from the Australian Bureau of Statistics (ABS), based on 2022-2023 data, indicates that the government-funded pension is the primary source of retirement income for most retirees. The proportion of Australians receiving the Age Pension increases with age too, reaching around 80 per cent of people aged 80 according to the Retirement Income Review based on data as at 30 June 2019.

The foundational product for retirement incomes funded from superannuation is the account based pension which is a flexible and simple option for retirees, but leaves them largely to make their own decisions to manage longevity, investment and inflation risks.  Less than 2% of superannuation assets are allocated to an annuity as at 30 June 2024.  Higher balances as the superannuation industry matures mean that the Age Pension will play a lesser role in the future due to the means test. This, along with the aging population means there is a growing recognition of the need for additional retirement income products.

Annuities, which offer guaranteed income streams, present an alternative solution to address longevity risk and provide financial stability in retirement.  However, uptake of annuities has been held back by various headwinds, such as the perceived higher cost relative to the alternatives.

On 12 June 2025, APRA issued a consultation paper proposing modifications to the capital framework for annuities. These changes aim to allow reduced capital requirements for annuity products in exchange for enhanced risk management by life insurers, including closer matching of assets and liabilities. 

The proposed modifications to the capital framework for annuity products carry substantial implications for both customers and providers. These changes aim to enhance policyholder protection by ensuring that providers maintain financial robustness and are equipped to fulfill their long-term commitments. APRA's intent is that life insurers can offer more competitively priced annuities, potentially benefiting customers with better value products. However, the integration of certain components, such as adjustments to the illiquidity premium, remains uncertain, making the overall impact on pricing and availability a challenge for providers. Entities that offer annuities are tasked with navigating these regulatory requirements while simultaneously balancing customer expectations and needs. This situation underscores the ongoing challenge within the insurance sector of adhering to regulation while satisfactorily addressing customer needs in a competitive market environment.

The UK serves as a valuable case study on how improving the prices consumers receive can stimulate the growth in the market. Historically, annuities were mandated and therefore a cornerstone of retirement planning. 

The introduction of Pension Freedoms in 2015, removed the obligation to purchase an annuity and led to a decline in annuity sales, as retirees favoured more flexible income drawdown options (an important consideration for super fund trustees who also have to balance flexibility against risk management and income under the Retirement Income Covenant).

Post-Pension Freedom, annuities were often perceived as poor value, with low interest rates and increased life expectancy contributing to declining annuity rates. However, the UK has recently seen a revitalised annuity market, with data from the Association of British Insurers (ABI) showing a 34% increase in annuity sales in 2024 compared to 2023, reaching a post-Pension Freedoms high. Some potential drivers for this resurgence could be rising interest rates, which enhance the appeal of annuities by offering better returns for retirees. Additionally, there is a growing understanding of the benefits of annuities and the need for stable retirement income streams. The ABI’s data also indicates that more annuity purchases occurred after financial advice was taken in 2024, with 36% of buyers taking advice beforehand compared to 29% in 2023.

Australia can draw several lessons from the UK's experience:

1. Financial Education and Anchoring: The UK highlights the importance of financial education in influencing retirees' decisions to choose annuities. Enhancing guidance on retirement options can make annuities more attractive to those planning their retirement income.
2. Opportunities from Regulatory Changes: Changes prompted by APRA could boost annuity appeal without risking market stability. This can be achieved without mandating specific products or altering social security incentives.
3. Challenges from Alternative Income Streams: The availability of the Age Pension and other income products poses challenges to annuity sales. However, as account balances grow and means tests change, more super fund members may find annuities appealing, potentially expanding the market.
4. Product Innovation and Flexibility: Insurers must develop flexible annuity products that combine guaranteed income with features allowing for withdrawals or adjustments. Understanding retiree preferences and lifestyle needs is crucial to maintaining competitiveness.
5. Integration and Implementation: Successful integration of new annuity products with existing retirement planning tools is vital. Clear communication and user-friendly interfaces can enhance product adoption, with collaboration with financial advisors helping guide retirees effectively.

The ‘annuity puzzle’ is complex, and there are many reasons why these products have not had the same success in Australia as overseas.  Drawing from the UK's experience with Pension Freedoms and in conjunction with policy support to improve the value of annuities can better support retirees in achieving financial security throughout their retirement years. APRA's initiative to review capital settings for longevity products is a step in the right direction, paving the way for a more sustainable and diversified retirement income landscape.