developments equity release market

8/3/2019 Developments Equity Release Market

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Developments in the Equity Release Market

Brian Morrissey, KPMG

2003 Life Convention

9-11 NovemberHilton Birmingham Metropole Hotel


2/23

Agenda

I Equity Release products in UK

I Regulation

I Risks

I FundingI Financial Modelling

I Discussion


3/23

Equity Release in the Press in October

Equity release home loans move

for Standard Life arm

North East spiraling house pricespublic

appetite for equity releasemajor cause

for concern according to BoE.

Fragility in housing marketreinsurers to

boycott itthey will no longer underwrite the

risk that prices may fall

Finance the great escape,,,record number cashing

in equity on properties to purchase second home

abroad

Providers concentrated too heavily on

top end of property market ignoring

needs of pensioners with moderate

amounts of equity

NU faces problem over equity release

early surrender charges

IFAs predict more sales scandals

with profits bonds and perhaps

equity release mortgage cases

FSA not protecting people from

risks of lifetime mortgages

Mortgage Express move intoequity releaseWhat IFAs should do to

protect themselves and their

clients

Easy money? equity release marketto become more vibrant so why are

advisers reluctant to take advantage


4/23

What do we understand by equity release?

I Financial product that allows homeowners to release part of

value of own property above amount owed on a mortgage:

The unlocking of some or all of the equity tied up in the property,

without the owner having to move house or being able todemonstrate that the finance generated can be repaid out of

income

[CML definition]


5/23

Context: house prices have risen substantially

I Datamonitor estimates (2001 values):

I Older home owners (age 65+) hold over 460bn worth of equity in property

I Less than 1% of equity realised

I Home ownership is the main way many people create their personalwealth, especially in the UK

Average Property Prices 1970-2003

0

2 0 0 0 0

4 0 0 0 0

6 0 0 0 0

8 0 0 0 0

1 0 0 0 0 0

1 2 0 0 0 0

1 4 0 0 0 0

1 97 0 1 97 5 1 98 0 1 98 5 1 99 0 1 99 5 1 99 8 1 99 9 2 00 0 2 00 3

Source: Norwich Union/CML/Nationwide

Ave rage Equity per dwelling among age 65+

118,000

88,500

73,00072,500

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

1991 1996 1998 2003 E

Source: CML/ English House Condition Survey

Estimate beyond 1998 from Datamonitor


6/23

Market potential for equity release

I Outstanding equity release market worthless than 4bn

I Estimate to grow to at least 50bn by 2008I Source: CML The Market For Equity

Release Schemes Oct 2001

I Drivers feeding this growth:

I Property price inflation

I Increased longevity

I 67% of pensioners live off state pensiononly

I Diminishing pressure to retain 100% equityinheritance

I Debate on the funding of long-term care

I Registered Bodies involvement indeveloping mechanisms for low income

clients

Income

(for living or fun)

Long Term Care

Tax

Avoidanc

Equity Release

Usually sold on three key themes


7/23

Awareness of equity release high

I Nearly 70% of house owners aware of equity release products

I 15-20% of homeowners believe they will at some time use them

I June 2001 Mintel survey of adults aged 65+

I 68% disagreed when asked whether it was a good idea to raise money on

own home

I A further 23% were not sure whether equity release was a good idea or not

I Often viewed as a last resort to a distress sale

I Recognised need for greater positive image creation to overcomeprevious schemes legacy

I Elderly views on inheritance will impact future potential product take up


8/23

Evolution of equity release products in the UK

1980s

I Popular method of borrowing in the

1980s

I

Poor packaging of equity releaseproducts

I Originally only reversion plans offered

I Unsuitable products offered based on

investment bond schemes and roll upplans with variable interest rates

I Home income plan scandal placed

many elderly people in financial

difficulty

1990s 00s

I Outlaw by FIMBRA of High Risk HIP

I Industry self regulation (SHIP and CML

mortgage code)

I Shared appreciation mortgages introduced

I New entrants few and far between

I Equity release gains favour again

I Involvement of non commercial entities in low

income client base e.g. Help the Aged

I Norwich Union Equity release securitisation

I 500m new business sold (H1 2003)

Lack of impartial advice available for potential clients

Relatively few different products on the market


9/23

Typical Equity Release product types

Home Reversion

ICash Reversion Plan

IIncome Reversion Plan

Lifestyle Mortgage

IRoll Up Mortgage Cash Plan

IRoll Up Mortgages Income Plan

ITraditional Home Income Plan

IShared Appreciation Mortgage Plan

Products can be split into two main types


10/23

Safe Home Income Plans

I 1991, Safe Home Income Plans (SHIPs) set up as a voluntary code of

practice to promote safe equity release schemesI Membership of SHIP requires the following commitments

I Lenders should provide clear, fair and simple presentations of their plans to

consumers

I Offering a no negative equity guarantee to all customersI Providing a SHIP certificate that will clearly state the main cost to the

householder's assets and estate

I The homeowners solicitor will be required to sign a certificate to the effect

that the scheme has been explained to the clientI No guidance on:

I Sales processes employed by the lenders

I Defining the suitability of the product


11/23

Formal Regulatory Environment

I Statutory regulation patchy as scope to fall between defined regulations

I Not all lenders are members of SHIP

I No formal regulatory power

I Consumer Credit Act

I Lays down minimum information requirements, including the amount andrate of interest

I Only applicable on loans of size < 25,000I Certain secured loans for home improvement are exempt from the CCA

I FSA Regulation

I CP 186, with effect from October 2004

I Applies to Mortgage based equity release Lifestyle MortgagesI (According to the 2000 FSMA) FSA may only regulate financial products

I Reversion mortgages are not part of this regulationI Considered to be only contracts for sale


12/23

Equity Release in the UK today

I Regarded as niche products, marketed to elderly higher income people

by specialist providers

I Approximately 40 players and not all participate in SHIP

I Recent new entrants in 2003 including:

I Saga, Scottish Widows, Prudential, Newcastle, Zurich, Abbey, Standard Life,

London & County

I Mainstream providers expected to provide price competition

I Greater interest from providers in mortgage equity release as a result of:

I Customer demand

I Gap in product range (cradle to grave)I Higher margins than traditional mortgage products

I Poor market returns and endowment shortfalls on other investments

I Inheritance tax planning

I Distribution opportunities post depolarisation


13/23

Typical roll up mortgage cash plan

I Illustration of 25K equity release on 100K

property over 15 years

I Key Features

I Age of borrower 70

I Interest rate on loan 7.59% fixed

I Property Price Inflation and mortality risk can

be removed through SPV

I SHIP participation provides certain safeguards

e.g. no negative equity and no repossession

I The inheritor on death gains 131K instead of

207K

I Will required as part of product design

transfers ownership of property and debt to

inheritor e.g. children

I The lender is repaid 25K and rolled upinterest over 15 years of 51K

After 15 years the value ofproperty would increase to207K

Lender typically gain 2-3%margin per annum on theoriginal loan of 25K

Time

100K

25Kequityrelease

208K

5% 51Kinterest to

lender

25Kowed

to lender

Commencement of policy On Death

131Kequity to

inheritorAPR typically

7-8%


14/23

Complex and dynamic marketplace

Distribution Face to FaceHigh CostInvolvement of relatives

RegulationFSAAmbiguity

SHIP participation

Product DesignAwarenessHassle FactorCosts and ChargesRiskFunding

CompetitiveEnvironment

SocialDemographicsLife expectancyWealth

FinancialPerformanceInterest RatesProperty inflation

Mortality

BrandSuspicionReputation

GovernmentTaxationWelfare State

Future Aims


15/23

Equity release products reverse the traditional

mortgage risk model

Early Risk

LTV %

Years

Later Risk

LTV %

Years

I Substantial losses may occur where:

I No or modest capital appreciation e.g. less than 1% per annum over the averageduration of the loan e.g. 15 years +

I Level of LTVs where lender not confident in achieving sustained % HPI increase

I Early prepayment due to long term care requirements

I The longer the borrower lives the bigger the no negative equity guarantee exposure


16/23

Funding

Balancing the risks and

funding issues for equity

release pricing provides a real

challenge for providers

I Cost of loan

I Ongoing funding of loan

I Illiquid assetI Provisioning

I Potential shortfalls

Funding

Issues

Insurance

Options

Profit

Realisation

Securitisation


17/23

Securitisation

I Asset securitisation involves:

I Pooling of individually illiquid assets with the intent of obtaining third partyfinancing on the strength of the cash flows generated by these assets.

I Finance obtained by issuing asset backed debt securities that are primarily

serviced by the cash flows created by the pooled set of assets.

I Objectives of securitisation can be grouped around the following areas:I Obtaining a cheaper form of finance

I Gaining a beneficial of balance sheet for a specific funding mechanism

I When internally funded raises greater uncertainties about assets e.g. liquidity risk

IAs a minimum provides a cash injection up front and seeks to un bundle risks

I Sufficient pool of institutional investors e.g. admissibility issues?


18/23

Insurance options to mitigate shortfall risk

I Need for highly rated life and property reinsurers to cover unbundled

risksI Insurance to protect against shortfall losses NNEG (and/or longevity)

I By individual loan or aggregate

I Willingness of insurer to accept risk?

I Unbundle

I Selfinsure against the risk of NNEG (and longevity)

I Is it affordable?

I Previously seen as source of financing


19/23

Pricing - Financial Modelling

DeterministicI Prudent allowance for assumptions

I House Price Inflation including shocks

I Demographics - mortality & Long Term Care

I Funding Costs - fixed/ variable

I Expenses (including exit costs)

I Stress testing and Scenario analysis

I Gap between HPI (incl shocks) and Funding

Cost

I Longevity

I Volumes (hi/lo) and demographics

Option PricingI Limited use to date of stochastic modelling

I Development of reliable house price models

limited

I There is lagged relationship with economic

indicators HPI and wage growth

I NNEG viewed as put option in the hands of

the customer so can be valuedI Value using option pricing techniques

e.g. Black Scholes, requires house price volatility

assumption

IAs for Deterministic

Two approaches


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Key Assumptions - House Price Inflation

I Varies based on:

I

RegionI Type

I Occupants

I Age

I Set assumption with regard to:I Drop towards base level

I Shift in areas with highest inflation

I Influence of Speculative Bubbles

I Reliability of informationI Economic effects


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Key Assumptions Mortality/ Long Term Care

I Impact varies across different socio-economic groups

I Off-setting effects on risk of breaching the negative equity threshold

I Improving longevity cause higher proportion of loans to reach threshold

I Increased evidence of LTC reduces proportion of loans to reach the

threshold (depending on sale conditions)

I Risks further heightened under income plans

I Limited information on the Mortality and LTC experience of equity

release participants

I Impact of self selection?


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Discussion

I Appropriate vehicle

I Hedging risks

I Funding

I Modelling

I Distribution


23/23

Contact

Brian Morrissey

Principal Consultant

KPMG LLP020 7694 2145

[email protected]

developments equity release market

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