Equity Release Mortgages: Irish and UK Experience 28 March 2019
Disclaimer The views expressed in this presentation are those of the presenters (Tony Jeffery & Andrew D Smith) and not necessarily of their current or former employers, nor of the Society of Actuaries in Ireland.
What is an Equity Release Mortgage? • Loan taken out by a property owner, secured on the property. • The loan is repaid when the borrower dies (or goes into long-term care). • Interest (eg at 5% pa) is often rolled up on the loan balance so the borrower, while alive, makes no interest payments. • No-negative-equity guarantee (NNEG): if loan balance on death exceeds the house value, then lender suffers the shortfall.
How big is the Market? • The ERM market has grown substantially in the UK; in 2018 alone nearly £40bn was lent, mostly on behalf of bulk annuity companies. • Irish market is (disproportionally) smaller; no recent lending and outstanding balances around € 300m.
UK Regulatory History: Discounting Annuities • Solvency I reliable yield; uses assets held. • Solvency II discount rate has evolved. – Liquid risk-free rate – Plus volatility / matching adjustment (MA) • ERMs initially excluded from SII MA – But now permitted with some restructuring – Discount rate boost higher for ERMs (2%) than any other asset class. • Ongoing NNEG valuation debate, with PRA on one side and Insurers + IFoA on other.
Key Valuation Assumptions (death fixed at T) 1.6 1.4 ERM Value / House Value q = -1% 1.2 q = 2% q < 0 1 0.8 Limit e -qT q = house deferment. 0.6 q > 0 0.4 0.2 Increasing house volatility 0 0% 30% 60% 90% 120% 150% Loan-to-Value ratio
Assumptions and Valuation Contours 25% Low ERM High NNEG 20% Eumaeus 19 15% Volatility Just 2018 CP 13/18 BE B&D Historic NWHosty RW Hosty RN Sportelli 10% CP 13/18 low 5% Tunaru Low ERM / High NNEG 0% -1% 0% 1% 2% 3% 4% 5% House Deferment Rate
Historic and Projected House Prices 1000 HPI RPI Cash HPI extrap RPI implied Cash implied HPI xs RPI HPI xs Cash 100 10 1 1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050
Historic House Index Volatility Historic House Price Volatility, based on Nationwide quarterly series 1952-2018 14% 12% Annualised Volatility 10% Raw HPI 8% HPI xs RPI 6% HPI xs Cash 4% Note: NNEGs depend on individual house volatilities, 2% which are (nearly always) higher than index volatility. 0% 0 1 2 3 4 5 Holding period (years)
Fair Value Approaches: Many Possible Models MV Observed? No Yes Frictions? High Low Medium MV Complete? Wanted? No Yes Yes No Dynamic Equilibrium Market Liquidity General Options Hedging Pricing value DCF models with Frictions (eg Black, (eg CAPM) SABR Heston) Increasing prescription
Returns on Bonds and on Houses 7% 6% 5% 4% 3% 2% 1% 0% Bond Hold to Maturity Bond Net House Hold Forever House Net Liquid risk free Risk premium Illiquidity premium Expected defaults Net expected return Illiquidity costs
Illiquidity and House Growth Assumptions 7% 6% Annual Return 5% 4% 3% 2% 1% 0% House Hold Forever ERM Assumption Liquid risk free Illiquidity premium Risk premium ERM growth assumption Dilapidation Index rental yield
Marking the Valuation Model to New Lending 5.0% Discount Rate r 4.5% 4.0% Δ P=0 3.5% Fix r-q Fix q 3.0% Fix r 2.5% 2.0% -1.0% 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% Deferment Rate q
Loan-to-Value Sensitivity: Calibration Methods 1.4 ERM Value / Mortgage Balance 1.3 Fix r-q Fix q 1.2 Fix r New lending 1.1 Imp Vol mark-to-model 1 0.9 0.8 0.7 0.6 20% 25% 30% 35% 40% 45% 50% Loan-to-Value
Are ERMs suitable for backing annuities? • Yield • Longevity hedge • Liquidity • Property risks – General – Specific – Dilapidation • Macro-economics.
Do ERMs hedge Annuity Longevity Risk? 65,000 HPI 4% HPI 3% ERM Value (PV @3% pa) 60,000 HPI 2% 55,000 50,000 HPI 1% 45,000 40,000 HPI 0% 35,000 0% 1% 2% 3% 4% Annual longevity improvement (70 y/o)
Deriving Irish Residential Property Stresses 100 Irish house price index (peak = 100) Dublin 90 IE exc Dublin 80 70 60 50 40 2005 2010 2015
Should individuals downsize? • Are geared investments really suitable for older people? • Is down-sizing better? • Are ERMs suitable for those who are either unable or unwilling to down-size?
Conclusions: Public Interest • Cash flow for asset- • Down-sizing eases rich, cash-poor. house shortage. • High yields may • Best care not flow to higher always in own individual and bulk home. annuity rates. • Dilapidation; • Cash for home younger owners improvements and likely to invest. green retro-fits. • Insurers reliant on house price growth.
Equity Release Mortgages: Irish and UK Experience 28 March 2019
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