The Commonwealth government has endorsed nearly all the recommendations from the Murray financial systems inquiry, which suggests superannuation fees will continue to be scrutinised and the Productivity Commission will develop criteria to assess the competitiveness of the superannuation system.
Superannuation trustees will be allowed to pre-select opt-in comprehensive retirement income products while impediments to product development will be removed.
How do the recommendations stack up for Challenger (CGF)? The government’s response supports growth in Australia’s annuity market, brokers agree. The most relevant recommendation for Challenger is the support for development of comprehensive income products for retirees.
The government’s proposals are in line with Deutsche Bank’s expectations and the implementation timeline for Challenger, including the government’s upcoming retirement income review, is now clearer.
Credit Suisse also believes Challenger is well placed to capitalise on the opportunities presented, with a strong brand and focus on increasing its distribution agreements. There is high growth potential in this market. If the share of flows from annuities into retirement income increases the total market could increase.
The broker calculates an example over a three-year period whereby, if the flow share into retirement income increases to 5-30% and Challenger can capture 25-65% of this additional flow, its annuity book could experience growth of 40-150%.
There is probably a 2-3 year window in which Challenger will operate with limited competition, Credit Suisse contends. This will close, so the company needs to continue securing distribution agreements to embed its leading position. The government intends to legislate on its retirement income review by 2017.
The recommendations reveal broad support for income products over account-based pensions. Credit Suisse believes the recommendations demonstrate that the recent decision by the Department of Social Security in regards to Challenger’s Care annuity product is just the impediment the government wants to prevent in future.
The recommendations do not include any mandatory requirement for retirement income products, which would lead to a more definite growth outcome for annuities. This would be less favourable for Challenger, the broker argues. Significant growth in lifetime annuities could create a rush to market by local and global players and put profit margins, potentially, under pressure.
There remains a risk that competition increases from alternative products as the market grows. Challenger could also be at a disadvantage if life insurance providers were able to offset the mortality risk in life insurance operatoins wth lifetime annuity products.
Challenger’s penetration of retail and industry fund platforms stands it in good stead for organic growth, UBS asserts. The government’s support of a requirement for trustees to develop and pre-select retirement income products was largely expected.
What was, perhaps, not as well anticipated is the proposed use of legislation to introduce a principles-based framework to guide design of these products, the broker notes. The guidance will be developed in consideration with the government’s white paper on tax and the retirement income review.
UBS expects a number of market participants will likely develop compliant framework for comprehensive retirement income products. There is some evidence this is occurring already, with annuities forming part of a solution currently being offered by VicSuper’s in-house advisers.
As Challenger is progressively increasing its penetration of platforms UBS believes the company is well positioned to facilitate early adoption of this retirement product structure.
The brokers reviewed above retain steady ratings and targets. FNArena’s database has five Buy ratings and three Hold for Challenger. The consensus target is $7.71, suggesting 1.8% downside to the last share price. Targets range from $7.10 (Morgan Stanley, Deutsche Bank) to $8.30 (Credit Suisse).