Equity Release Mortgages: Irish and UK Experience 28 March 2019 - - PowerPoint PPT Presentation

Equity Release Mortgages: Irish and UK Experience

28 March 2019

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. Disclaimer

• Loan taken out by a property owner, secured
• n 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. What is an Equity Release Mortgage?

• 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. How big is the Market?

• 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
• n one side and Insurers + IFoA on other.

UK Regulatory History: Discounting Annuities

Key Valuation Assumptions (death fixed at T)

0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 0% 30% 60% 90% 120% 150%

ERM Value / House Value

Loan-to-Value ratio q = -1% q = 2%

Limit e-qT q = house deferment. Increasing house volatility q < 0 q > 0

Assumptions and Valuation Contours

Historic NWHosty RW Hosty RN Sportelli CP 13/18 low CP 13/18 BE B&D Tunaru Just 2018 Eumaeus 19 0% 5% 10% 15% 20% 25%

• 1%

0% 1% 2% 3% 4% 5% Volatility House Deferment Rate

Low ERM High NNEG Low ERM / High NNEG

Historic and Projected House Prices

1 10 100 1000 1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 HPI RPI Cash HPI extrap RPI implied Cash implied HPI xs RPI HPI xs Cash

Historic House Index Volatility

0% 2% 4% 6% 8% 10% 12% 14% 1 2 3 4 5

Annualised Volatility

Holding period (years) Historic House Price Volatility, based on Nationwide quarterly series 1952-2018 Raw HPI HPI xs RPI HPI xs Cash

Note: NNEGs depend on individual house volatilities, which are (nearly always) higher than index volatility.

Fair Value Approaches: Many Possible Models

Market value General DCF Liquidity models Options with Frictions Equilibrium Pricing (eg CAPM) Dynamic Hedging (eg Black, SABR Heston) MV Wanted? Yes Complete? No No Yes Frictions? MV Observed? Increasing prescription Yes No Low High Medium

Returns on Bonds and on Houses

0% 1% 2% 3% 4% 5% 6% 7% 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

0% 1% 2% 3% 4% 5% 6% 7% House Hold Forever ERM Assumption Liquid risk free Illiquidity premium Risk premium ERM growth assumption Dilapidation Index rental yield

Annual Return

Marking the Valuation Model to New Lending

2.0% 2.5% 3.0% 3.5% 4.0% 4.5% 5.0%

• 1.0%

0.0% 1.0% 2.0% 3.0% 4.0% 5.0%

Discount Rate r

Deferment Rate q ΔP=0 Fix r-q Fix q Fix r

Loan-to-Value Sensitivity: Calibration Methods

0.6 0.7 0.8 0.9 1 1.1 1.2 1.3 1.4 20% 25% 30% 35% 40% 45% 50%

ERM Value / Mortgage Balance

Loan-to-Value Fix r-q Fix q Fix r Imp Vol

New lending mark-to-model

• Yield
• Longevity hedge
• Liquidity
• Property risks

– General – Specific – Dilapidation

• Macro-economics.

Are ERMs suitable for backing annuities?

Do ERMs hedge Annuity Longevity Risk?

35,000 40,000 45,000 50,000 55,000 60,000 65,000 0% 1% 2% 3% 4% HPI 0% HPI 1% HPI 2% HPI 3% HPI 4%

Annual longevity improvement (70 y/o) ERM Value (PV @3% pa)

Deriving Irish Residential Property Stresses

40 50 60 70 80 90 100 2005 2010 2015 Dublin IE exc Dublin

Irish house price index (peak = 100)

• Are geared investments really suitable for
• lder people?
• Is down-sizing better?
• Are ERMs suitable for those who are either

unable or unwilling to down-size? Should individuals downsize?

Conclusions: Public Interest

• Cash flow for asset-

rich, cash-poor.

• High yields may

flow to higher individual and bulk annuity rates.

• Cash for home

improvements and green retro-fits.

• Down-sizing eases

house shortage.

• Best care not

always in own home.

• Dilapidation;

younger owners likely to invest.

• Insurers reliant on

house price growth.

Equity Release Mortgages: Irish and UK Experience

28 March 2019