Budget Signals Positive Outlook For Lifetime Annuities

This story features CHALLENGER LIMITED, and other companies. For more info SHARE ANALYSIS: CGF

-Clear path to develop DLA products
-Multiple premium payments allowed
-Minimal impact from super limits
 

By Eva Brocklehurst

Several initiatives in the 2016 federal budget will impact on insurers and providers of superannuation products. Of significance are the reforms which extend earnings tax exemptions to longevity risk products, which supports deferred lifetime annuities (DLAs) and other pooled risk products. Additional rules specifically for lifetime products will allow a tax exemption, provided the value of any potential capital withdrawal declines over time.

The changes were widely canvassed but brokers consider the budget confirmation is particularly positive for Challenger ((CGF)) as it provides a clear path for the development of the company's DLAs. The next step will be government consultation on how these will be treated vis-a-vis the age pension means test, ahead of the reforms being introduced in July 2017.

The reform proposals clear the way for new long-duration products at a time when fixed term annuities are becoming less attractive in a low interest rate environment, but Deutsche Bank notes it may also enable increased competition to Challenger's DLAs.

An unexpected positive, the broker observes, is that multiple premium payments will be allowed for a retirement income stream. This would prevent clients from being locked in at prevailing interest rates with a single lump sum premium.

The changes to the tax status of deferred annuities is a win for Challenger, Morgans agrees, as it opens up a new product for sale. The company has signalled that the proposal for a very flexible deferred annuity market should help its DLA product reach a material size.

The regulation changes need will mean these products cannot be launched until FY18 and Deutsche Bank also flags the uncertainty that exists in terms of demand and profitability. Still the broker de-risks the DLA upside in its valuation and raises the target for Challenger to $8.25 from $7.85.

Bell Potter also finds it difficult to quantify the short term earnings impact, given more detail is needed to be sure how the new products will work. Still, the broker believes DLAs over time could be as meaningful to Challenger as the company's existing term annuity book. The broker also notes from the budget announcement that it appears the DLAs will be able to sit inside superannuation, or be purchased outside of super with similar benefits.

A feature of existing annuities that allows for the draw-down of both income and capital will also be extended to DLAs. DLAs may also be purchased at any stage, either before or after retirement. Bell Potter, not one of the eight brokers monitored daily on the FNArena database, raises its target for Challenger to $11.00 from $10.40, with an unchanged Buy rating.

While the government introduces new limits on superannuation contributions and higher taxes, the impact on the likes of AMP ((AMP)) is expected to be minimal in terms of flows and funds growth. The threshold at which the tax rate on super contributions increases to 30% was lowered to $250,000 from $300,000. The annual cap on concessional contributions has also been reduced to $25,000, with a new lifetime non-concessional cap of $500,000.

Deutsche Bank envisages the changes will affect high net worth self managed super funds more than AMP's mass market client base. The new non-concessional cap and the introduction of a $1.6m cap on transfers to retirement products were less widely expected, UBS maintains, yet these measures appear to tie into the government's stated objective for super being a substitute for, or supplement to, the age pension.

Morgans considers the changes to superannuation as a net negative, given this reduces concessional contributions. Yet, the broker concedes it is only higher net worth indiviuals that are affected, with 96% of individuals in superannuation unaffected.

Moreover, the broker observes AMP is historically more a middle market player in super so concurs the budgetary impacts should be more muted. For Perpetual ((PPT)), while its higher net worth clients may be more affected, it remains hard to quantify the exact effect on flows, the broker maintains. Morgans makes no changes to forecasts in the wake of the budget, retaining Add ratings for AMP and Challenger and a Hold call on Perpetual.

Challenger has four Buy ratings and five Hold on FNArena's database with a consensus target of $8.96 that suggests 3.3% downside to the last share price. AMP has seven Buy ratings and one Hold with a consensus target of $6.25, suggesting 6.6% upside to the last share price. Perpetual has eight Hold ratings. The consensus target is $43.68, signalling 5.8% upside to the last share price.
 

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