Challenger Limited (CGFPC.AX) Earnings Call Transcript & Summary

Good morning, everybody, and welcome to those in person and online to Challenger's 2025 Full Year Results Briefing. I'm Mark Chen, Challenger's General Manager of Investor Relations. We're coming to you today from 5 Martin Place in Sydney. Before we begin, I would like to acknowledge the Gadigal people of the Eora Nation, the traditional custodians of the land on which we are hosting this event today and pay my respects to elders, both past and present. We have an hour with you this morning. Today's presentation will be provided by our Chief Executive Officer, Nick Hamilton; and Chief Financial Officer, Alex Bell. It will then be followed by a Q&A session. You can answer -- answer -- you can ask your question either in person via the online portal or via the telephone. As you'll see from today's presentation, Challenger delivered a strong financial performance and delivered against its targets. We continue to demonstrate our standing as a leader in the retirement industry, delivering record lifetime in Japanese sales. We built retirement partnerships with superannuation funds and platforms, and we continue to broaden our range of innovative income solutions as well as our investment capability. The business is in great shape. With regulatory and prudential reforms ahead of our digital transformation, which is well underway, we are a simpler and higher returning business that's positioned for growth. I'll now hand over to Nick to get us underway.

Thank you, Mark, and good morning to everyone. Thank you for joining us today. So this year marks Challenger's 40th anniversary, a significant milestone. And I'm pleased to say that today, our company lives and breathes our purpose of helping Australians achieve financial security for a better retirement. We have quite literally decades of experience understanding retirement, which gives us today a contemporary and valuable perspective with so much focus on developing the retirement phase of superannuation. As well, our experience as an investor and trusted brand are essential attributes for success as we look ahead. We anticipate the retiree needs and in turn demand for our capabilities will only grow from here for those approaching, those entering or planning wealth transfer or in the care years of retirement. 2025 has been a year of strong performance, strategic progress and delivery against our targets. Today, I'm joined by our CFO, Alex Bell, to deliver our FY '25 financial result. In our presentation, we'll cover the key drivers, our outlook with the overall objective of meeting the growing needs of our customers and continuing to deliver sustainable, profitable growth. Let me start with the FY '25 headline numbers. Earnings were up 9%, driven by momentum across the organization and actions to simplify our business model. Group return on equity continued to improve and exceeded the target. The business is strongly capitalized with significant current and future financial flexibility. And we've grown the dividend 11%, reflecting confidence in the business. This performance was powered by focused delivery of our strategy. Sales remix has lengthened the tenor of liabilities and is supporting stronger, more sustainable returns. The steps we've taken to streamline and focus our business are starting to deliver benefits. We strengthened our existing customer relationships and built new partnerships across the retirement market. We've expanded our leading asset origination capability and our new income platform and LiFTS notes underlines our capacity to innovate. Importantly, we achieved this financial result before the benefit of our new retirement partnerships on sales prior to our digital customer and data transformation coming online, ahead of regulatory and government reforms and whilst Australia's retirement market is still formative. Over the last 3 years, we've reset Challenger and are ready for the future. Building a financially strong business has been a priority. We have evolved our balance sheet investment strategy to best meet the current capital standards. This has materially strengthened the balance sheet, which has reduced capital volatility and improved financial flexibility. We've made year-on-year progress towards achieving our ROE target. Importantly, we've achieved this whilst investing for growth. We also took a strategic decision to focus on our core strengths, where we see most opportunity for growth, retirement, investment management and asset origination. As a result, Challenger is becoming a simpler, more contemporary business. We're now seeing the outworkings of our strategy to drive growth and sales momentum. Our focus on longer tenure, more valuable sales has improved the maturity rate, supporting high-quality book growth, which supports higher returns. The restructure of our business around the customer and steps we've taken to better understand our customer needs has expanded our impact and driven improved growth with advisers and clients. Whilst the adviser channel remains central to our strategy, we've opened up new customer channels and secured some of the first retirement partnerships post RIC as well as strengthening engagement with platforms and wealth managers. Over the last 3 years, we've made meaningful progress in building Challenger's financial strength, simplifying the business model and delivering profitable growth. This is demonstrated by the near double-digit earnings and EPS growth, exceeding the ROE target in FY '25 and year-on-year dividend growth. But this is only the beginning of what our business is capable of. FY '25 has been another year of focused execution. Two years into our new brand and marketing campaign, we've seen a material improvement in engagement with our target customer market. We've also continued to strengthen relationships across the retirement market and support the wave of innovation in retirement underway. Most recently, we secured a pivotal partnership with Insignia Financial. This demonstrates our ability to deliver innovative retirement solutions for large clients at significant scale. Our Lifetime sales continue to perform extremely well, and the opportunity here will only improve as we look ahead. Our strong partnership with Mitsui Sumitomo Primary Life, which we extended early in FY '25, delivered record Japanese annuity sales. Very pleasingly, we are progressing new product and partnership opportunities with MSP that will expand the ways we work together. Last week, we announced Challenger's innovative new income platform and LiFTS note, which was significantly oversubscribed. The first-of-its-k note structure leverages our balance sheet and asset management expertise and reflects our focus on expanding our range of income solutions. Our listed income note will be the first in an ongoing series, providing a market-leading solution into the rapidly growing income market. Asset origination capability is core to our growth plans, and this past year has seen us materially increase our private credit origination. Investing to grow origination, which now includes direct whole loan origination and servicing has delivered attractive yield for the balance sheet and clients. We've now completed the launch of a new Japan Property Trust, Challenger Life Essentials Property Fund, cornerstone by 2 leading Japanese institutions and seeded by property assets we owned through the Life company. Fidante also welcome System Capital, a global long/short manager as investors increasingly seek high-quality alternative investment capability. Challenger's digital transformation journey will future-proof our business and is well underway. Our multiyear investment to uplift our customer technology will accelerate sales growth and see us integrate our retirement offering across the financial system. To provide some context of the scale of our customer transformation, it covers 70 systems and applications and 60 legacy and contemporary products. The program will be launched in 2 phases. Our new core registry will be running internally ahead of Christmas and end-to-end functionality will be launched before the end of the financial year. The partnership and transition of investment administration and custody to State Street continues at pace. Our investment operations team, custody back office and invest administration services for equity managers have now transitioned in a program that accelerates our path to a highly scalable administration platform. 2025 also saw material changes to our strategic shareholders. We welcome TAL Dai-ichi as a strategic shareholder, a business very aligned to Challenger's. And we also look forward -- and sorry, we also see it as further endorsement of our strategy. Retirement is different to accumulation and is not a single life event. Retirement and the retirees' needs can phase and will change over 20 to 30-plus years. Developing a market that supports the various stages of retirement is now a priority for regulators, government and industry. Most of our country's wealth sits with those preparing for and in retirement. This will only grow as Australians retire with more years of compulsory super savings and in ever greater numbers. If proof needed that retirement is a megatrend, retirement assets within the super system will grow from $1 trillion today to almost $4 trillion over the coming 20 years. Whatever success we've achieved, we have a lot left to do. Today, less than 1/3 of Australians feel confident about retirement. And only 40% of Australians aged over 65 receive an income stream from their superannuation, which is why the next stage, developing a system that provides financial security for the millions of Australians entering and in retirement is so critical. More broadly, Challenger's operating environment will continue to evolve in FY '26 and beyond. Looking at credit markets, whilst they remain broadly supportive with low credit losses, credit spreads are at historic lows. Equally, whilst RBA interest rate changes generally do not have a material impact on absolute annuity sales, they can influence the tenor. The inverted yield curve has driven customer preference for shorter-term sales. Reverting to an upward sloping yield curve will support longer-term annuity sales. We see credit spreads as largely cyclical and in line with broader risk markets like equities. We will use the breadth of opportunities we can access to mitigate the impact and remain disciplined on pricing. Legislative reform underway, including current consultations on advice and retirement product suitability, will provide the framework for Australians to receive the education, guidance and help to retire with financial confidence. APRA's capital standard reform marks a fundamental change for issuers of annuities. Improving financial resilience, quality of earnings, the industry's capacity to innovate as well as improving customer outcomes. The reform agenda will lay the foundations for Australia's future retirement ecosystem, and Challenger is engaged in every stage of the process. Improving advice outcomes will change how advice is delivered for retirement. And for millions of Australians, that will mean Lifetime income becomes a building block in their retirement plans. We're drawing on our decades of retirement expertise to partner with superannuation funds, wealth managers, platforms, advice technology providers to maximize our opportunity in the growth of the system. More broadly, business models across our industry are evolving. The established institutional savings model will be replaced by a customer or member-focused model that reflects the individual personal needs of Australian retirees. The future will be a retirement system that provides Australians with retirement plans, tools and advice to turn their savings into regular income and a paycheck for life. And Challenger has the expertise and capability to help deliver this. I'll now pass to Alex, who will provide the detail of our full year results.

Thank you, Nick. And a very good morning to everyone. It's a pleasure to be here today to present our FY '25 financial results. This year's performance reflects the strength of our strategy and the discipline of our execution. We've delivered for shareholders, navigated a challenging macroeconomic environment and laid the groundwork for sustainable growth. What you'll see today is not just a strong set of numbers, but a business that's evolving, becoming more efficient, more focused and more confident in our ability to deliver long-term value. Let's begin with the headline group results. We delivered normalized net profit after tax of $456 million and normalized earnings per share of $0.663 per share, both up 9%. Statutory NPAT of $192 million was up 48%. Our normalized return on equity of 11.8% is above our target, and we have increased our FY '25 dividend by 11% to $0.295 per share. This performance reflects a combination of higher Life spread earnings, strong funds management fee income and disciplined cost management. Expenses growth was contained to just 1% year-on-year, improving the cost-to-income ratio by 150 basis points to the bottom end of our target range. Importantly, we've structurally reshaped our expense base, not just by cutting costs, but by investing in the right areas to support future growth. This is a result that's not only strong in the moment, but sustainable over time. Return on equity is one of the clearest indicators of value creation. And I'm pleased to say we've exceeded our normalized ROE target of the RBA cash rate plus 12%, which is then reported after tax. In the second half of the year, normalized ROE reached 12.1%, up 130 basis points on the prior comparative half. This uplift was driven by strong Life performance, higher funds management earnings and a cost-to-income ratio at the bottom end of our target range. We are confident in sustaining normalized ROE above our target and through the cycle. Against the backdrop of multiyear inflationary pressures, we have made a permanent shift in our cost base. Total expenses were up 1% to $316 million, and that includes strategic investments for growth. Our cost-to-income ratio improved to 32.3%, the lowest it's ever been for a full year, reflecting our focus on capturing efficiencies. Our technology and investment operations partnerships with Accenture and State Street delivered net savings of $8 million so far, and we reinvested $6 million into growth and regulatory initiatives. This reflects not just discipline but a scalable platform that allows us to grow without growing costs at the same rate. As a reminder, our expense base also includes annualized transition costs of approximately $9 million, which we've reported as a separate line item in the analyst pack. These are the costs associated with our legacy investment operations platform, which will cease upon full transition to State Street towards the end of FY '27. We've reported these separately to show the further step change that it will create in our cost base once complete. In significant one-off items this year, we reported $8 million of one-off costs associated with our customer technology uplift program and the transition to State Street. I'd like to take a few minutes to walk through the key reconciling items from our normalized to statutory NPAT. The first bar shows $102 million of adverse AASB 17 timing differences on the accounting valuation of our life insurance liabilities. These relate to new business strain and the life risk portfolio, which is impacted by changes in relative interest rates and exchange rates. Both of these are noncash and will unwind over time and are great examples of why a normalized framework is so important as it gives a clearer view of the underlying economics of our business. Positive other liability experience of $67 million is driven primarily by the change in mortality assumptions in our Australian portfolio as mortality improvements have been more modest than expected. We saw an $80 million underperformance from our property portfolio, which is made up of $38 million of normalized growth as well as $42 million of net revaluations downwards at 30 June. Pleasingly, we saw property values in retail, industrial and Japan all appreciate, but this was offset by domestic office properties falling 3.8% in fair value. Absolute return funds underperformed their long-term assumption this year, which is based on actual performance in the medium term, but still delivered a 2.7% total return for the year and outperformed benchmark indices. The Life business continues to evolve and is benefiting from a higher quality sales mix, balance sheet diversification and capital strength. Normalized NPAT of $461 million, up 6%, driven by higher cash operating earnings. We maintained pricing discipline in a challenging rate environment and continue to focus on longer duration, higher quality sales. This result reflects a business that's not just growing, but growing in the right way with quality, resilience and long-term value in mind. In FY '25, we delivered another $5.2 billion in annuity sales, which translated to 4.9% annuity book growth with record retail lifetime sales of $1.1 billion and record Japanese sales of $984 million. While total Life sales were down 6%, this was a deliberate shift away from shorter tenor business. We're seeing strong demand for guaranteed income, especially in retirement and aged care, and our remix strategy is working. The outlook for Index Plus sales remains positive after we won another large long-dated mandate with a leading global investment manager that was partially funded in the fourth quarter with the remaining funding in the first half of FY '26. As you heard from Nick, this is a market with structural tailwinds, and we're well positioned to lead it. This slide shows the impact of our ongoing remix strategy. Longer duration sales liabilities now make up 81% of our annuity book, up from 72% in FY '22. The average tenor of new sales is 6.3 years, and the maturity rate is down to 24%, improving book quality and supporting sustainable growth. In FY '26, we expect the maturity rate to fall modestly again to 23%. The Life COE margin for FY '25 was 3.19%, up 7 basis points on the prior year. This reflects higher investment yields across an optimized asset allocation, including higher life risk income. The second half, like FY '24, was elevated for the seasonality of cat bond distributions. The analyst pack contains more details on these movements period-on-period. This is a business that's delivering consistent high-quality returns despite the persistently tight credit spread environment. Now turning to the balance sheet. Our asset allocation remains steady with 74% in fixed income, 13% in alternatives, 11% in property and 2% in equities and infrastructure. Our fixed income exposure is 77% investment grade, above our target of 75%. The portfolio is high quality, diversified and resilient with strong credit performance and low default rates, which are inside our normalized assumption of 35 basis points. This period, 4 investments were downgraded. And as per our policy, all investments rated below B- are treated as being in default. Looking ahead, we expect to see more deployment into whole loans and private credit, which offer attractive risk-adjusted returns. Today, alternatives remain a necessary part of our diversified portfolio. We continue to see alternatives as a source of diversification and resilience, particularly in volatile markets. Property now represents just 11% of the portfolio following the sale of 3 retail assets. Now turning to the strong result for Funds Management. Normalized NPAT was $53 million, up 41%, driven by higher net income and lower expenses. Performance fees rose 57% and the cost-to-income ratio improved to 60%, down 9 percentage points as we capitalize on the benefits of our scalable platform and strategic partnerships. This is a business that's growing, becoming more efficient and expanding its reach, particularly in Europe and Japan. Our Fidante distribution powerhouse had solid flows in retail equities and alternatives, and we're seeing particular momentum in Europe. During the year, headline net flows were impacted by low-margin institutional outflows in fixed income and equity affiliates. These outflows, together with higher-margin growth sales, improve the outlook for Fidante FUM margins going forward. We've also reported strong performance across our affiliates with 77% of FUM outperforming over 5 years and 82% of strategies rated as either recommended or highly recommended by research houses. Challenger Investment Management drives the majority of the Life company's balance sheet and is making significant progress winning third-party business. Challenger IM manages $16 billion in fixed income, which includes $6 billion in private credit, $3.8 billion of which was originated in FY '25. We continue to invest in our asset origination capability and our mortgage servicing platform. As Challenger IM evolves to meet the demands of income and private credit exposure, we are launching our new innovative ASX-listed notes. The strong demand for our first issuance sets the stage for further notes in the near term. This is a business with deep expertise, strong relationships and a clear growth trajectory. We remain strongly capitalized with $1.7 billion in excess capital and a PCA ratio of 1.6x the minimum requirement. Whilst the PCA ratio moderated 7 basis points year-on-year, it was steady on the half. It remains in the top half of our target range and reduced because the PCA requirement increased, not because our capital base got smaller. We're holding significant liquid capital, giving us dry powder to deploy into attractive opportunities. Our capital base is a source of strength and a strategic competitive advantage. In June this year, APRA initiated a pivotal consultation on capital settings for annuity products and stated its desire to move towards a more market-sensitive illiquidity premium with appropriate risk controls. This marks a significant evolution in the regulatory landscape and is set to be the most meaningful change in capital settings since the introduction of Latigo. The proposed changes to APRA's capital framework are expected to materially reduce capital intensity and improve alignment between the capital valuation methodologies for assets and liabilities. This alignment will not only lower capital volatility and reduce our cost of capital, but also unlock greater flexibility for product innovation across the retirement income sector. Even with a well-matched portfolio, the current capital standards unduly exacerbate financial stress during market events. The proposed changes directly address this imbalance, removing structural barriers that have historically constrained the development of innovative, competitively priced longevity solutions. In our submission to the APRA consultation, Challenger advocated for changes to the determination of the illiquidity premium to remove these -- the procyclical nature of the capital standards. The expected day 1 benefits from a more market-sensitive illiquidity premium include an increase in the capital base as well as a lower PCA requirement. Coupled with lower capital volatility, this will meaningfully reduce Challenger's cost of capital. The day 2 benefits arise as we write less capital-intensive business and transition our asset allocation towards more fixed income. We welcome these reforms and are actively engaged in the consultation process. This is a positive development for the industry and particularly for Challenger as it reinforces our ability to deliver sustainable, capital-efficient retirement income solutions to Australian retirees. This slide provides an insight into our capital allocation framework. We prioritize investment in organic growth as well as the payment of sustainable fully franked dividends. In the event that we have capital in excess of our immediate organic opportunities, we will look to return surplus capital via buybacks, subject to market conditions or pursue inorganic growth where it enhances our core business. We remain disciplined and focused on delivering shareholder value, demonstrating that we are good allocators of capital. Looking ahead to FY '26, we're guiding to normalized earnings per share as we see this as a better reflection of the shareholder outcome. It is important to note that the guidance and the outlook that we're providing today is based on the current prudential settings. Our normalized EPS guidance range of $0.66 to $0.72 per share assumes normalized NPAT of $455 million to $495 million and no material change in the total number of issued shares. The midpoint of the range represents 4% growth on FY '25. Our through-the-cycle targets of normalized ROE, cost-to-income, the dividend payout ratio and PCA ratio all remain consistent. We enter FY '26 with confidence in our strategy, our execution and our ability to deliver for shareholders. In summary, FY '25 was a year of disciplined execution and strategic progress. We've delivered strong financial results, improved returns and positioned the business for sustainable growth. Thank you for your time today. And I'll now hand back to Nick and look forward to taking your questions.

Thank you, Alex. So looking ahead, our strategy will unlock growth and capitalize on structural market drivers. We're on a journey to become a more capital-light business that generates strong growth and more fee-related income. This includes continuing to expand our offshore reinsurance capabilities, which has the potential to deliver spread and fee-related earnings. APRA's capital standard reform marks a very positive development that will see Australia's prudential framework come into line with the rest of the world. Through our digital transformation, we'll have a contemporary and highly scalable operating model. We will grow our investment platform. This includes increasing our asset origination capability to maximize investment returns and support our growth ambitions. The need for high-quality dependable income as Australians prepare for and enter retirement presents one of the most exciting opportunities in the market. We will leverage our trusted brand as an income provider and build a catalog of income solutions. In Fidante, we have a world-class set of managers today and supporting their growth is a priority. We will also bring new managers to our multi-affiliate platform, prioritizing income and private markets capability to meet rapidly growing demand. Our modernized customer platform will see us integrate our retirement products and solutions across the financial system and enable innovation. We have a strong pipeline of retirement opportunities today that will see us extend our partner network and deliver retirement at scale. To win in the growing retirement income market, we will lead with customer experience. That means offering a full range of innovative retirement and income solutions through a seamless digital interface, supported by excellent customer service. To close, over the last 3 years, we have reset the business to focus on our financial strength, core capabilities and drive growth. This has delivered a marked improvement in our financial performance and customer and shareholder outcomes. 2025 demonstrated another strong financial result where we delivered against our targets. We now have a unique and contemporary core business that has the capability and ambition to meet the retirement megatrend. We will maintain our financial discipline, deliver a compelling customer experience and broaden our range of retirement and income solutions. This will drive profitable growth and shareholder value. I look forward to sharing more detail on our growth plans at next month's Investor Day. Finally, thank you to the Challenger team for their hard work and their energy, and Alex and I now look forward to taking your questions.

Okay. Just as a matter of process, we'll take questions from the floor first in person, then we'll move to the telephone. And then if there are any questions via the online port, we'll take those. [Operator Instructions] Let's begin. Let's go with Sid first.

Sid Parameswaran from JPMorgan. Two questions, if I can. First, just on the guidance. I was hoping you could just maybe provide just a bit of color around what you're assuming for the midpoint, both in terms of cash rate cuts and also maybe if you could just flesh out your expectations around the COE margin there. I know that you did mention a few things around competition. I think the competitive backdrop from -- I think from an inverted yield curve -- sorry. And also, I think you're growing in wholesale. I was just hoping you could provide a little bit of color on those 2 components of guidance.

So I'll take them in 2 parts. So maybe if we talk about the guidance first. So first of all, to say we've obviously moved to the EPS guidance range, but we've provided insight on what the numerator and denominator are there. The midpoint would see us growing 4% year-on-year and the sorts of things that move us around the range are the same sorts of things that we have had in previous years. So things like the variability of performance fees and transaction fees in our funds business as well as some of our asset returns. Specifically, we don't make any forward assumptions around the cash rate when we provide the guidance. And so at the start of the year, we don't assume any movements upwards or downwards from an interest rate change perspective. When we think about COE margin, so COE margin is now up at 3.19% for the full year. What we did call out on the slide is that we have in the last 2 years, seen some seasonality in the second half of the year, which is a function of some of the timing of when cat bond distributions come through. In the second half of the year, you also saw those 2 rate cuts impact some of our interest expense in the COE margin, too. So that's probably the key things to note.

Okay. No problems. Okay. If I could just ask a second question just around capital. And I mean, you provided a helpful slide on some of the main possible impacts from the capital changes. But I was hoping if you could just help provide us maybe a little bit more quantitative feel for what the midpoint of the current draft standards from APRA might mean in terms of capital relief? And if you can't provide that, maybe if you could just at least help us think strategically what you're going to do if we do get capital coming out of your business or capital requirements coming out of your business. Will you use that to grow? Or will you use that to -- will you keep the ROE higher?

So let me take that. So maybe just if we take a step back and remember what it is that APRA is actually trying to do with these capital standard changes. They're trying to ensure that we are more aligned with some of our global peers in the jurisdictions, the capital standard jurisdictions offshore, remove the obstacles for other players and Challenger to develop more innovative retirement income solutions and at good pricing outcomes for customers and then also remove that procyclicality. So if you think about the challenges we've had as a business historically, in times of market stress, we've needed to take management action on our balance sheet, which is not representative of the long-term view that we take of holding assets. And so the changes that they proposed directly address those. And so clearly, we're very, very supportive. It would be premature to put any definitive numbers around it at this stage. APRA is still reviewing the responses to the consultation. And obviously, as soon as we hear anything more definitive, it might even be by Investor Day. But obviously, as soon as it is, we'll provide some more detail around that. But a way to think about our reflections internally is in the sort of day 1 and day 2 buckets. So on day 1, without making any changes to our balance sheet, we will have more capital. Our capital base will be higher and our PCA requirement will be lower. And so depending on where APRA finally lands, that does feel likely that we will be in a surplus capital position at that point and could be in a position to return some capital. Then in a day 2 sense and probably the more exciting part in some ways is how we can then grow more organically because we'll be able to write business in much larger quantums of business but at a much less capital-intensive way. And so you can see that sort of self-sustaining capital flywheel being much more effective under the changes that APRA is proposing.

There'll be a mixture, but part of it will go to customers to encourage growth and part of it will basically be taking for shareholders?

I think if you think about one of the reasons of having the capital allocation slide that we had today was to just give people a sense that, obviously, you would -- management would assess what all of those opportunities are, what does the growth look like immediately in front of us, but to also give shareholders confidence that if we find ourselves in an excess capital position, we're not going to sit on that capital that would be deployed if we don't have those opportunities right in front of us.

Can we go to Freya and then to Kieran?

Freya Kong from Bank of America. Just following up on the APRA changes. What's the time line that you are expecting on this, i.e., when is the earliest you can anticipate making the day 2 changes?

Well, I'll give Alex a breath taking the first 2. So at this stage, APRA has completed the formal part of the consultation. They're in formal discussions with the insurers who have made submissions around the standards. We're expecting to have pretty firm direction of travel by the year-end with implementation at the end of this financial year is our sort of working assumption.

Okay. And then on the annuity sales outlook, because we have the yield curve inverting hopefully in the next 12 months, have you seen any pickup in demand for the longer-term annuity sales yet?

Okay. I might pick that one up. So when we talk about the impact of the yield curve, you're tending to talk about it through the term book. And so what you've seen until we've seen that we've seen 3 rate cuts now come through, we've actually got a positively sloped pricing curve in our term business. If you looked at that 6 months ago or 12 months ago, the longer-dated term product was at a lower rate than the 1 year. So when we talk about the impact, that's just natural consumer behavior. It sort of brings it short. When you think about the longer-dated business, the lifetime business, that's not impacted by the base rate. It's impacted by longer-term moves in the yield curve. And indeed, with inflation expectations, the yield curve has backed up a bit. So the challenger annuity in the lifetime product this week is getting more than a challenger in the lifetime product 12 months ago, and you've had 3 base rate cuts. There's different pricing dynamics. So what we saw when we had a steep yield curve in the term book back in '22, '23 was we were able to push the sales there longer. One observation I'd make, one of the things we're so excited about with the new Lifts product is it gives us under the Challenger brand, a product that actually probably sales benefit as rates go down because the spread that we can offer over the base rate increases. So we've got -- we're building a really blended portfolio of product there that can manage through different interest rate cycles and shapes of the curve.

Okay. And one final question, just on the big difference between the statutory and normalized earnings, around $220 million drag from asset underperformance versus normalized assumptions. Any comment on how it's tracked year-to-date? And are you still confident in the normalized assumptions you're using?

Yes. Thanks, Freya. So I think we've provided a lot of detail around all the sort of the individual drivers between the normalized and statutory profit. And one of the things I would just emphasize is that post the implementation of AASB 17, it probably highlights the need for that normalized framework more than ever so that the sort of sometimes slightly counterintuitive impacts of AASB 17, which will unwind over time, don't cloud what is our underlying performance. And that really is a huge part of that difference. And cumulatively, we now have nearly $700 million before tax of new business strain and AASB 17 adjustments that we've had in the last few years. So that's the most material driver. To your point around normalized assumptions, we absolutely look at those every year. So for the absolute return funds, which underperformed our normalized assumption this year, that was just in FY '25. If you look from COVID to FY '24, they performed in line with our normalized assumption. So we have seen that dip below that in FY '25, and we revisit that each year. We don't sort of move it around sort of from 1 year to the next. Obviously, if we saw another year of the same sort of performance, we'd reconsider it. But equally, it could bounce -- it could easily bounce back.

Kieren?

Kieran Chidgey, UBS. I might just start again on the APRA capital changes. You've had a bit of time to look at it, and I'm not asking for sort of dollar estimates of what's going to change. But the one thing I'd like a view on is the market focus very much on the standardized illiquidity premium definition of 50% to 65% of the credit spread, but APRA also flagged potential for a more internal model. Just interested in your views on how much more beneficial that internal model could generate relative to that standardized approach?

Yes. I think where the 2 models differ, if 50% to 65% is still an incredible move on from where we are today. And so that would be extremely positive for us. But a risk-free -- risk -- sorry, risk-based adjustment to a benchmark or a more representative credit portfolio would be, again, less procyclical, particularly in a point of market extreme. And so we advocate for the latter would be a better outcome, but the former would still be a very, very good outcome from where we are today.

Okay, Nick. And if you were to sort of characterize the internal model sort of under a standardized framework as a percentage of a credit spread, could you give us a feel for how much higher that percentage would move?

I think...

Looking at Tom.

It's hard to say until they come out definitively, but the percentage will be much smaller. So what we've advocated for what we've advocated for is a risk adjustment that is a fixed deduction in a basis point sense rather than a percentage because if you leave it as a percentage, you still have an excessively conservative sort of impact during times of stress. So if you have a basis point assumption for defaults that is fixed because your default experience should be the same through time, that will be the great end of the outcome spectrum, and that could be more in the teens in terms of less than 100. So you get more up to sort of 80% plus of the credit spread...

And second question, just on capital. Alex, you flagged reduction in capital volatility here. Can you talk about how you're thinking about your PCA target range given that reduction in volatility?

Yes. Thanks for the question. So it's fair to say that just as a reminder, the PCA ratio is an outworking of our internal capital model. So it's not a target as per se that we are aiming to achieve. And so as you can imagine, those capital models will be entirely revisited. And depending on where APRA lands on the various components, there are actually scenarios in which the PCA could go down or up. So it's actually premature on that one, but we will definitely give our out workings on that as soon as we've got them.

And just a second, a lot of questions on the cost outlook you flagged, I think, in the account $7 million of [indiscernible] transition costs. And I think you mentioned in your slides that you're expecting those costs to go through to the end of '27. Can you give us a feel for how much is embedded in the '26 guidance and what we should expect into '27?

Thanks, Kieran. So the transition costs that you're talking about there are the costs associated with the team of technology people that we've still got in the Challenger business running our legacy Dimension platform whilst we're in the process of migrating everything to State Street. So in FY '25, that was $6 million, and that will annualize to about $9 million. So we will have that full $9 million in our cost base for all of FY '26. And by the end of FY '27, those costs will drop off once the transition is complete. still get that step change.

Okay. And just the last sort of partly expense-based question, but more on your systems, ALIP annuity system integration. Nick, it sounds like that has been delayed. You previously flagged potentially the ability to launch that post this '25 year-end, but now it sounds like part of it will be here by the end of this calendar year, part of it by the end of the '26 financial year. So just wondering what the issues are around the slippage?

Sure. So bring it back and explain what we're doing with ALIP. It is part of a complete takeout of our existing registry and putting in place a whole new data architecture. So there is, as I noted in my remarks, is about 60 systems that are -- or 70 systems, I should say, that are being impacted by it. We've built ALIP. ALIP is now most of the way through testing with our partner, Accenture. That will go live this side of the year. Now what is pushed into next year are some of the customer portals. Now customer portals, we don't have today because we don't have customer journeys. Everything is as we do it today. Some of it's form-based, some of it has some limited interface to customers. So there's no impact on what we're doing today. The customer portals will come on in the new year. But I would say it's not stopping us doing partnerships and business. And so if I look at other companies undertaking these sort of transformations, we're certainly not alone but the complexity of these transformations does add time. But we've derisked the go-live by putting in ALIP this side of Christmas. So the team internally can be training on it, working on it with the portals going live. And actually, final comment the portals, the journeys have now been built in those portals. They're just not ready to put into market because we need to do it right because we are end of life an entire set of systems before turning over and flicking over the new systems. So it's super exciting. I mean, through this process with anything, our conviction in the program of work has only increased because there's no way that we can succeed in integrating ourselves into the financial system and being part of this -- what's happening across platforms and super funds unless we had the sort of technology that we're bringing into the business.

Andrei?

Andrei Stadnik from Morgan Stanley. Can I ask my first question around the new listed notes, the leads? Can you talk a little bit about like where the revenue is going to be booked, which division? And also, do these notes represent kind of the Life and the funds management divisions working closely together for like holistic products? And do you expect more of that going forward?

Okay. So what is the list notes? It is definitely the latter. It is the Life company and the funds business working together. We had observed over a number of years, demand for income and been looking at what structure you could best put this type of private credit and public credit into that would give investors liquidity without giving them overexposure to equity market risk. And so typically, anything listed right now, you're getting a lot of equity market risk. So the structure of the 6 to 7 term is very advantageous for that. The Life company has played a critical role in 2 ways on this in being able to warehouse the assets to go into the structure, but also taking the junior note part of the structure of the Lifts. So it's definitely a great example of the power of having the balance sheet alongside the asset origination and funds management business.

But just to be clear, the revenue and the earnings are going to go with the funds management?

Well, it's revenue to funds management and as the holder of the notes, there's COE, there's income to life company. So both.

Is there like a clear skew? Or is it, I think, roughly 50-50?

It mostly the funds management business.

And second question, can I just revisit the guidance? So you're guiding 4% increase in normalized EPS, which seems kind of conservative in the sense that second half normalized COE margin was up by 15 basis points, quite a sharp pickup. So like what could be holding back guidance of like fairly modest EPS growth in light of how strong COE was in the second half?

Yes. Thanks for the question, Andrei. So we've spoken about some of the movements in COE margin. And I would just highlight again that seasonality of the second half of the COE margin. I think more broadly, the biggest thing that we stare into at the start of this financial year is just quite how tight credit spreads are with most of the balance sheet in fixed income and a lot of the earnings for FY '26 based on assets we would have originated in FY '25 that's really sort of the big macro headwind for us. But we're doing what we can from a tailwind perspective to make sure that we're being as disciplined as we can around costs, being right at that bottom end of our cost-to-income ratio and starting to see some real momentum in fee earnings in the funds management business. So that provides some counterbalance to that.

And look, maybe the last question, but can I ask a slightly kind of maybe boring question, but a real question. But you mentioned the $60 million positive gains were largely driven by mortality rate assumptions. Can you elaborate a little bit on that? Like what's changed? Is it just annuity products?

Yes. So one of the drivers between our statutory to normalized differences were mortality assumption changes that we put through on the Australian portfolio. So last year, you might recall that we put through mortality assumption changes on our U.K. book, so our Life Risk book, and this is just the same again, but on the Australian portfolio. So across the board, globally, mortality improvements, there are mortality improvements, but they're slower than had been originally estimated by those actuarial assumptions. And so in our business, that's a favorable outcome. And so you see a release of the liability valuation.

Okay. Operator, are there any questions online?

[Operator Instructions] You have a question from Simon Fitzgerald from Jefferies.

Sorry to harp on the APRA rules, but I just wanted to ask a little bit about how the contract liabilities are actually valued. From memory, it's an RBA rate plus an illiquidity premium. So I mean, any sort of rate cut could chew this up pretty quickly. Would that be a correct way to think about it?

Thanks, Simon. So the calculation uses the risk-free rate rather than the RBA cash rate. So you won't have that impact.

Yes. Okay. All right. And then also a day 2 effect again on the APRA rules. Do you envisage that, say, the normalized profits and statutory profits will start to converge a little bit closer at least, all things being equal, but the majority of investment marks in the past have been credit spread changes? And then also on that level, do you envisage there might be any sort of one-off adjustments for the fact that we have profits and losses from previous marks that will look to unwind as those securities start to approach maturity?

Thanks for the question, Simon, and quite detailed, and we'll definitely come back on for the full detail when we have the view. But I think to your question about the day 2 impact, if we kept the balance sheet exactly the same, then some of the differences that arise between statutory and normalized, which are created by our more capital-intensive assets, which can have return profiles that are more volatile would stay. But what we have signaled is that in a day 2 world, we expect to move the balance sheet away from some of those more capital-intensive assets towards more fixed income, which has a much more -- or a much less volatile earnings profile. And therefore, you would see those statutory and normalized positions start to come together in a more meaningful way during the period.

That's very helpful. And just one last question here. I'm just looking at the debt composition. The repos have gone up about 12%. I'm just trying to learn a little bit more about that. I understand that they are normally used to hedge interest rate risks. But just looking at, say, the contract liabilities are up 4% and then even the investment assets increased by 3.7%. Just want a little bit more color in terms of the larger balance on the repos?

Yes. Thanks, Simon. Look, in all honesty, a lot of that is just timing. At any particular balance date, we can have a larger balance of liquids and repos. So I wouldn't read anything more into it than just timing at the balance date.

Your next question is from Nigel Pittaway from Citi.

Just first of all, I wanted to sort of ask a question on annuity demand. I mean, obviously, if you look at what APRA says, they're saying their proposals will not change the market for annuities in Australia. So there's an implication that they don't think it's going to be a key demand stimulant yet. I noted when you went through the presentation, you were quite bullish demand will only grow from here. Life opportunities are only going to improve as we move ahead. So are you expecting any further initiatives down the pipeline maybe from ASIC and the like? And what's sort of building this confidence that demand is going to be so strong as we move forward?

Yes. Thank you. Thanks, Nigel. So I mean just on the APRA point, their perspective is they can't control the demand. Their role is to support supply. And so it's not -- in some ways, as they've indicated, it's not for them to determine whether or not there will be significant demand. So I think where our confidence is coming from, and I don't want to put it just on the government policy because you don't want to be a taker of policy as to how you're going to run your business. But if you think about even our most recent announcement with Insignia Financial, that is an example of where similar to the other retirement partnerships, there is a real industry recognition that the retirement products of the future need to be developed, and they will incorporate a building block of lifetime income. And if you look at the treasury or the actuaries, the government actuaries who in their paper that they put out from treasury the other day on product design, if you read through that, the government actuaries state very clearly that a 15% to 30% allocation of lifetime income would materially improve the income outcomes the income of Australians in retirement. So I think there's a real government policy recognition building around that. But we're actually seeing it more importantly in the business that we're doing. The other point I would make is that retail advice has always been our stronghold. But until today, there has not been a retail advice system or process that has actually modeled retirement, including lifetime income products. So they tend to look at an asset allocation view of portfolio construction. You will see in the period ahead, and we'll talk about it at Investor Day, what that's going to look like. And so you're going to -- from right upstream, you're going to see the advice journey start to show the benefits of incorporating in retirement plans lifetime income. So there is some new new in that. But I definitely feel very confident around the direction of travel for growth of lifetime income for a whole range of reasons there, Nigel.

Okay. Great. Clear. And then maybe just one on the sort of maturities and the sort of improvement in tenor. I mean you mentioned -- or I think it was Alex that mentioned the maturity rates guided to come down just 1% from '24 to '23. And it looks like the sort of dollar volume is about the same. It's just obviously a slightly lower proportion. And I do note that sort of you did sort of pick up a bit in the shorter-dated institutional sales in fourth quarter. So I mean, just how are you feeling about the extent that still close to 1/4 of the book rolls off every year. It does cause negative book growth in some quarters. How do you feel about that? And is that something you'd be looking to improve upon as we move forward?

Thanks, Nigel. One of the numbers that Alex put in her presentation was that the dollar quantum of core longer-dated business we've done over the last 3 years of about $7 billion. It has been a real focus of the team. So if you look at the Lifetime sales, which are up 26-odd percent or the Japanese sales, we are getting a lot more longer-dated business in. The yield curve, particularly on the term side of the business has pulled the tenure of that book on new sales in that book shorter. But that's okay. That's sort of episodic. And for the reasons outlined around changes to the base rate, that could change. And if you look at our pricing today versus banks or versus where it was short to medium term right now, we've got an upward sloping all were more competitive than the banks today in pricing. So our ambition is to continue to grow longer-dated business. Final point I'd make, even where it is shorter dated business, we are very disciplined around our pricing and writing it to meet to support the ROE target.

Your next question is from Lafitani Sotiriou from MST Financial.

I'd like to start with Dai-chi and keen to understand how the relationship has commenced. And in particular, is Challenger exploring a reinsurance arrangement similar to the one with MS&AD? And is there anything preventing you guys from having reinsurance arrangements in place with both MS&AD and Dai-chi?

Yes. Thank you, Laf. So we certainly welcome Dai-chi shareholders. Their business model is very, very much aligned to ours. They've got a big core Life business. They're very active globally now investing into asset management, particularly around private capability, which is not dissimilar to what Challenger does in the Australian market. So that business model alignment is really important. And certainly, all the discussions that we have had, accepting that we've always done business with TAL locally. We've been -- we've managed assets for the TAL balance sheet for a number of years. So there's always been strong relationships between the business. But we've been extending those relationships into the Dai-Chi Group to understand what the opportunities are and how we could work together. If you look at what we've achieved with MSP, and I think I noted in my remarks about extending that relationship for another 5 years, putting out record reinsurance volumes with them this year. We've doubled the size of the fixed income mandate for their balance sheet that we run. We've done more properties in Japan for their balance sheet that we've originated, and we're managing for them in the past 12 months. So we broaden and deepen that relationship at a time where their parent MS&AD are no longer a shareholder. So I feel very confident in the MSP relationship. And, we don't -- we would really love to do business such as you note. That is very core for us. And to your point, there's absolutely nothing stopping us from them, whether it be Dai-Chi or whether it be any other regional insurer that we may wish to do that sort of reinsurance business with.

Yes. Got it. Can I follow up now on MLT and the partnership that's in place. Can you just go through in a little bit more detail how it will work, timing? Is it just going to be the front book? Or is there an element of the back book being transitioned? And in the same vein, can you talk to what the pipeline is like in that area?

Thanks, Laf. Yes. So the MLC announcement, which Insignia put out and some of you will have seen, spoke to them building a range of retirement solutions for their business. Now this is one of the largest in pension phase superfunds in the country and one of the largest super funds in the country. So they're very ambitious about their retirement strategy. And they've identified the needs of their customers, which incorporates into the product suite, what Challenger does well, the lifetime income products. So my comments when I spoke for them, retirement is not just one product. It's not one solution. There will be a range of pre-retirement and in-retirement solutions. So the pre-retirement solutions will come soonest. The in-retirement solutions will be coming out, we understand second half of '26. So really exciting given the size and the ambition of Scott's team over there at Insignia.

Sorry, is that going to be just front book? Or will there be a...

Yes, sorry. Okay. So when you say front book, these will be products that will be able to be sold to Insignia or advised into Insignia or MLC customers. They may be in pension phase or they may be approaching retirement phase, I should say. So it will -- it's not block business that we -- that partnership is not.

Sure. So no existing products will be collapsed into it. It's just any new business you win into those products.

Well, this will be MLCs, the retirement boost will be a range of new products for them, it's their retirement strategy.

Okay. Got it. And what's the pipeline market like now that there's been a few deals being announced? Is it still -- are there more players that are coming to market with RFPs or seeking solutions? Is it I know in the past, you've indicated that some have dragged their feet waiting for the regulatory landscape to become clearer. Has that changed?

Hopefully, I didn't use those words. But I think like the formation of any new industry, you would expect not everyone moves at the same pace. What you have seen again this year relative to last year is a far broader understanding that the retirement is not savings. So bringing the same solutions for savings will not solve for retirement. You've also seen the regulator become far more prescriptive in what is expected of trustees. The government consultations that came out last week are talking about a range of obligations on trustees around retirement income products and the way that they should fit into your strategy. So you are seeing a lot of scaffolding go up around it. But I think what's as exciting is that for a whole lot of the funds, they're not being dragged to this conclusion. The more they get to know their members as was asked of them by the regulator 3 years ago, the more they understand their needs and they need to develop retirement solutions. So the pipeline looks good. The discussions that we have right now with other big players are really prospective, and we're hopeful that there will be more to announce this year.

Your next question is from Julian Braganza from Goldman Sachs.

Just a first one on capital. Just correct me if I'm wrong, but the initial comments around the benefit, I think you said for moving to a representative index is that the ratio would increase to about 80% on that point from 50% to 65%. But just also wanted to understand the other 2 factors that you proposed, which is extending the longer term just in terms of the application of the illiquidity premium, extending that for a longer term, what that would entail and also just the risk adjustment? And then just a last part on that, are you anticipating any changes to the actual stresses themselves in the asset charge for the stress as well?

Thanks, Julian. So maybe just to think about the 3 components of the changes that we've talked about. So the first one is to ensure what we're advocating for is that the credit spread index is more reflective of the asset portfolio of the insurer. So rather than just using the 3-year Australian Corporate Bond Index, which is very concentrated and very short term, what we're suggesting is that there is something that is more reflective of the actual asset portfolio that the insurer has. And in our case, that would be something that includes global securities as well as things that are more long-dated than just 3 years. Then that longer-term rate at the moment, it stops at 10 years. And so we're advocating for something that goes out ideally right to the very last date of the liability, but certainly longer than 10. So anything sort of 10 to 20, I think, was an APRA submission, but you could do it right the way out to the last date of the last liability. And then the risk adjustment, so we spoke about this a little bit earlier in response to Kieran's question. So you've got the risk-free rate plus the credit spread index and then reduce it for some sort of risk adjustment. In an ideal world, rather than having that be a percentage, we would apply a default deduction that is a fixed basis point allowance because we think that is the best representation of the actual experience that, that portfolio will have. So those are the 3 components of our recommendations in answer to APRA's specific questions.

Okay. No, that's clear. I might ask another question just on the book growth then into FY '26. Just how you think about the book growth, just given the maturity profile doesn't seem to be materially changing between FY '25 and FY '26? And also in terms of composition, should we be expecting a similar level of book growth in terms of composition, should we be expecting a similar level of growth that we saw in fourth quarter '25 into next year? Yes, -- or should we expect more of the longer duration annuities coming through?

Yes. So we don't specifically provide guidance to book growth or sales, but the strategy of sales remix doesn't change. We've made the comments about the pricing environment or the yield curve environment for term, which has brought some of that business shorter, which will push up the maturity rate. Reinvestment rate looks fine in the business that's been stable year-on-year. But focusing on longer-dated business remains absolutely a priority. We've spent a good part of the last 3 years working the book. I think Alex had the number, 81% of the book is now longer than 3 years with -- on the annuity side. We've announced another longer-dated index plus piece of business in this back end, there's more of that to come. So those are the areas of focus for us. And so we feel confident about book growth from here. And we've had, I think, 4 of the last 5 quarters have been positive book growth on the annuity side.

I think what we can add to that as well, Julian, is obviously, we'll remain disciplined in terms of the way we price and seek business. The strategy doesn't change. Nick alluded to in the presentation that obviously -- in the Q&A that obviously a steepening of the yield curve potentially has -- will benefit essentially longer duration, particularly on the term side of things. And you notice, obviously, in this year, index plus sales came back a little bit. So there is potential there to grow, particularly as we look to extend the tenor on that type of business.

And just one last question. I think you've called out there in your presentation in terms of allocation of capital inorganic growth opportunities. Just be interested in what the strategy would be around that, what that could look like.

Let me make a comment in relation to that. I mean in putting that up, we're not signaling one thing necessarily or another. We're trying to give you a framework to the extent there is excess capital, how we'll think of using it. So what -- the way Alex articulated it, notwithstanding every dollar of annuity business we write, we will be at a lower capital intensity than it is today. And so we'll be able to support a lot more growth of our capital base. We've been, I think, pretty clear with the dividend over the last 3 years and pretty directional on that as part of the ensuring we're delivering value for shareholders. And then you come into what you do with excess capital. Now we, like any business, we will look from time to time at investments that bolster our core. And by saying bolster the core, it's things that would support our growth. What you're not hearing us say is tangential investments. But what Alex spoke about there is around also the potential for capital return. And so that's just very much, as you can imagine, a Board consideration and a trade-off at a future point in time.

The next question is from Marcus Barnard from Bell Potter.

On the figures today. As an observation, I'd note your comments that the politicians might listen to the government actuaries. I like your optimism. I'm not sure I share that level of optimism. Two questions. Firstly, on asset allocation. As the APRA formula becomes more open to credit spread movements, are you likely to increase your asset allocation into corporate credit? I mean this could have real-world enhancements to the yield on the book over the long term, depending on defaults? And secondly, on your return on equity, I know you've only in the last year beaten your target, but I'm thinking if the balance sheet becomes more efficient, should you have a more demanding return on equity target?

Yes, sure. So from an asset allocation perspective, when we think about the capital standard changes, Marcus, we will see less need for some of the capital-intensive assets that we hold today that provide really access to liquid capital. So in the main, that's the absolute return funds. But to a certain extent, property is a capital-intensive asset, too, that we've been downgrading over the last few years, and you could envisage us continuing to do that. So that would mean more fixed income overall, and that will absolutely include corporate credit. To your point around ROE, we have been on a journey back to our ROE target. And so it's great to have the first full year meeting the ROE target. To Kieran's point earlier, I think there will be a need to revisit a number of our guidance metrics under the new capital standards. I'm optimistic that a lower cost of capital for Challenger should be a good out working such that you could see a world in which we could write more business that meets our ROE or is at least a meaningful improvement on a lower cost of capital. But you're right, that will be a consideration as we get those final changes from APRA.

There are no further questions from the phone at this stage.

Okay. One last question, Freya, and then we'll wrap up.

Freya Kong from Bank of America. Last question on the cost-to-income ratio target, which hasn't changed even though you're at the lower end of the 32% to 34%. Can I just ask what's driving this conservatism?

Thanks, Freya. So you might recall that we only changed the cost-to-income ratio for the beginning of FY '25. So it used to be at 35 to 37 basis points. We've brought it down to the 32 to 34. We see it as more of a through-the-cycle target than sort of specific in-year guidance. So we've opted to keep it the same for this year. But as you know, we're at the very bottom end of that guidance for this year and all the things that we've talked about from a cost perspective should keep us directionally there.

Okay. That wraps up today's briefing. Both Irene and I are available on the phones if anyone has any other questions. A reminder that Challenger Investor Day is on the 16th of September. So we'll take you through some further stuff during then and hope to look to see you there. Thanks for your interest today, and we'll bring this to a close. Thanks.