Westpac's annuity challenger

Last Wednesday, Westpac launched an innovative new banking product and entered what had previously been the exclusive, although relatively unexploited, domain of life insurance companies. The bank launched an annuity deposit.

Annuities are typically provided by insurance companies and are backed by the insurer’s statutory fund, which in turn is supported by the capital of the company. Life insurers are regulated by APRA (the Australian Prudential Regulation Authority) and operate under a similar regulatory regime to banks.

And just as banks are adjusting to new capital and liquidity requirements being imposed under Basel III, life insurers are making similar adjustments under Solvency II.

In the past annuities have not been overly popular; they have tended to operate a bit like life insurance in reverse. The purchaser pays a lump sum up front and will receive regular periodic payments for the remainder of their life.

The payments usually are determined by the performance of the investments underlying the annuity contract, and progressive amortisation of the principal paid up front. For the purchaser this lifetime annuity contract is a gamble.

They may live longer than their actuarially assessed life span and therefore receive more payments than the life insurer had intended to pay. On the other hand, they may pass away earlier than expected, in which case the life insurer wins: the remaining unamortised principal is kept by the insurer.

More recently this problem has been addressed through the introduction of term annuities. A term annuity lasts for a fixed period of time, at the end of which annuity payments will cease.

With term annuities it is usually possible to break the contract early and have any remaining principal returned, subject to any break penalties.

Payments under term annuities can be structured with any frequency and with no partial or full amortisation of principal over the term. Payments can also be indexed to inflation or a fixed rate of indexation can be specified.

Challenger Limited, the larger provider of annuities, says it will provide term annuities up to 50 years but with earnings rates on annuities typically fixed, a 50-year term becomes problematical.

Westpac’s annuity deposit is a term annuity but it is being provided by a bank and it is a deposit. So not only is backed by the capital of Westpac, it is also covered under the Federal Government’s Financial Claims Scheme.

In other words, the annuity deposit will be guaranteed by the Commonwealth government up to an amount of $250,000, provided the annuity deposit holder has no other deposits with Westpac or any member of the Westpac Group, such as St George Bank, Bank of Melbourne, Bank SA etc. However, with most customers having more than one deposit account with a bank and the minimum deposit size of $50,000 for Westpac’s annuity deposits, coverage under the Financial Claims Scheme may be of limited value.

Annuity deposit holders should take more comfort from Westpac being one of Australia’s largest companies. It has been around for 196 years and the practical reality is that it is too large for the government to let it fail. It is a systemically important bank in Australia.

Westpac’s annuity deposit offers all the features of a term annuity as described above but is limited to a maximum term of 15 years. The problem for Westpac, and Challenger as well, is a lack of high-quality assets with a life span that goes beyond 15 years.

Challenger only quotes earnings rates for term annuities on its website out to 15 years. It is currently offering a rate of 5.4% for a 15-year annuity.

Westpac has not specified what its earnings rates will be but they should be competitive.

Annuities are typically used to provide holders with an income in retirement. If the government is keen to encourage greater use of annuities, then it needs to consider providing the type of high-quality assets required to hedge the annuity provider’s liability.

The practical limitation of 15 years for term annuities reflects the current term structure of Commonwealth government bonds, which ends at 15 years. With people likely to spend 30 years or more in retirement, perhaps we need a 30-year government bond.

However, Westpac probably has one advantage over a life insurer in providing term annuities. Depending on the success of the product and the level of demand that might exist for term annuities beyond 15 years, Westpac may be able to absorb the liability risk on its balance sheet and lengthen the maturity profile of its funding as a result.

APRA would be pleased.

Another one for the sophisticated

FIIG Securities Limited launched its third wholesale bond issue, aimed at its sophisticated investor (as defined under the Corporations Act) client base. FIIG’s first such deal was a $30 million, six-year bond issued by Silver Chef Limited in September last year, and then it brought a $50 million, five-year bond issue by Mackay Sugar Limited in March.

This latest issue comes from another Queensland-based company. G8 Education Limited (GEM) is an ASX-listed (childcare and education centre operator.

The company hopes to complete a minimum $30 million, six-year bond issue by the end of August. As has been the case with previous FIIG arranged transactions, the bonds will be unlisted, unrated, unsecured and subordinated to the issuer’s bankers.

The bonds will only be tradable through FIIG.

A coupon range of 7.35% to 7.75% is being targeted. The six-year Silver Chef bonds pay an 8.5% semi-annual coupon but interest rates have fallen since the bonds were issued.

The coupon on the five-year Mackay Sugar bonds was set at 7.25% per annum.

The minimum subscription amount for the G8 bonds is $50,000. The proceeds from the G8 bond issue will be used to acquire childcare and education centres.

Philip Bayley is a former director of Standard & Poor's and now works as an independent consultant to debt capital market participants. He also writes on matters concerning debt capital markets and banking for various publications and is associated with Australia Ratings.