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The Actuary The magazine of the Institute & Faculty of Actuaries

Equity release the story so far

Following the publication of the UK actuarial profession’s report on equity release mechanisms (ERMs) in January 2001, the Social Policy Board agreed to convene a new working party, chaired by Ged Hosty, to assess the outcome of the nine recommendations of that report in a UK context.

– Recommendation 1
Providers should give better explanations of the ERMs and the advantages and disadvantages, risks and safeguards. Providers need to develop structures so that people can be confident that the arrangement is safe if the provider is bought, sold, or goes into liquidation.
The UK’s Financial Services Authority (FSA) will start regulating mortgages from October 2004, and the regulation will extend to the mortgage variants of equity release mechanisms (which the FSA has termed ‘lifetime mortgages’). Extending regulation to cover property reversion schemes would require primary or secondary legislation to give power to the FSA to cover these schemes, and the Treasury has produced a consultation document (‘Regulating home reversion plans’, November 2003) which addresses this. However, even without this potential extension of powers, the FSA has taken some steps in policy statement 186 by proposing that financial advisers will have to provide customers with information on property reversion schemes when framing advice for them on lifetime mortgages.

– Recommendation 2
Value for money and confidence could be improved if more major financial institutions came into the market with competitively priced products. New improved products are required to suit a larger sector of the population.
The UK equity-release market is now gaining momentum, and this has been supported by a number of major brands introducing products since the first report in January 2001. In the last six months, the Prudential and Saga have both introduced products, and Abbey National is currently piloting a mortgage scheme. Norwich Union have extended their product range, and the potential market, by introducing an interest roll-up mortgage where the interest rate is expressed as a margin over inflation, enabling higher loan to value ratios, and extending the minimum age to 55. Several medium-sized building societies (eg Stroud and Swindon, Portman) have also introduced schemes.
The market is becoming more competitive, but it still suffers bad press for being poor value for money. In fact, margins have reduced significantly over the past two to three years, and the value for money issue is now more a matter of perception than of reality. Headline rates on equity release mortgages are higher than those on standard mortgages, but there are some good reasons for this difference.
– Interest rates on equity release mortgages are usually fixed for life, and so should be compared with 10- to 20-year fixed rates rather than standard variable rates.
– The term of the mortgage is not known at outset, and this uncertainty will be reflected in the interest rate offered.
– All schemes include a ‘no negative equity guarantee’, which provides that the repayment will not exceed the property sale proceeds, even if the loan has grown to a higher amount. The cost of this guarantee must be met from the interest rate charged.
– Although there are a variety of practices, many providers quite properly provide full financial advice, and possibly a home visit, on an equity release mortgage sale. This is obviously a more expensive method of distribution than those common in the wider mortgage market.
However, profit margins on equity release mortgages do remain higher than those on standard mortgages. The relative size of the markets means that this will always be the case to some extent, but the introduction of more new products by major financial institutions would help to reduce the differential.

– Recommendation 3
The FSA should bring in regulation to cover all types of ERM and introduce CAT-marked standards on a voluntary basis. See recommendation 1 regarding the proposed regulations.

– Recommendation 4
Financial advisers should extend their advice to ERMs when considering retirement and inheritance tax planning, and also how ERMs can assist (or otherwise) in planning for long-term care costs. More training and knowledge on ERMs is required by financial advisers.
Regulation (see recommendation 1) will support this, but this is an area which would benefit from more attention. Age Concern has plans to provide training courses for financial advisers in this and other areas, and Northern Rock runs training courses for IFAs which are always oversubscribed. There is also an increasing number of industry equity release conferences targeting IFAs and mortgage advisers.

– Recommendation 5
New products at appropriate margins are needed so that elderly customers can afford home repairs, improvements and maintenance. CAT-marking is essential to give these customers confidence and so that the administration cost can be kept to a minimum.
There are two aspects to this. The first is the development of new products at appropriate margins. One new product worth mentioning is the Houseproud Scheme set up by the Home Improvement Trust and local authorities. The scheme gives advice and also provides approved builders, inspection of work, and finance if required (grants to cover fees, surveys, etc are usually available up to £500 maximum). See also recommendation 2.
The second issue is that of CAT standards, and it is interesting to review this recommendation in the light of experience in other markets where CAT standards have been introduced. Generally, CAT standards have not been widely adopted, and concerns are now being raised that they disenfranchise the less well-off sectors of society which is the core market for equity release. In view of these developments, the working party’s view is now that CAT-marking should not be introduced.

– Recommendation 6
Long-term investors and the Treasury should work together to develop a special-purpose investment vehicle so that the long-term investors can invest in residential property and mortgages on residential properties.
The working party understands that there was an attempt to action this recommendation, and that the Investment Property Forum put forward a proposal to the Treasury which was turned down. If anyone has more information, Ged Hosty would be delighted to hear from them.

– Recommendation 7
Government should reconsider the interface between income from ERMs and means-tested state benefits. The equivalent of pension credit for people with income just above the minimum income guarantee should be extended to income from ERMs.
This has now been adopted for annuity income generated by ERMs within the regulations for pensions credit (which replaced the minimum income guarantee in April 2003). However, there remain issues in relation to how capital generated by ERMs affects entitlements to pension credit and other means-tested benefits, and this is one area which the working party will be considering.

– Recommendation 8
The definition of quasi-derivatives under Regulation 56 of the Insurance Companies Regulations should be reviewed since the current interpretation has fallen behind valid developments in the market.
There has been some press commentary suggesting that there has been a change to the regulations to allow the inclusion of property index derivatives as admissible assets. In fact, there have been no changes to these rules since before N2 and they remain as set out in the FSA’s handbook of rules and guidance. The press articles stemmed from a number of insurance firms themselves, through the Association of British Insurers and the property derivatives users’ association, gathering sufficient evidence to satisfy themselves that simple derivatives met the objective tests. If you have a view on whether this is sufficient development to remove the barriers to creating suitable investment vehicles, or whether in fact further progress is desirable, Ged Hosty would again welcome your comments.

– Recommendation 9
Government should encourage and promote indices to show the change in value of residential properties. Research is required on how this could be accomplished. Several indices may be required for geographical area, type of property, and age of owner.
The UK government introduced a new house price index earlier this year, details of which are available on the Office of the Deputy Prime Minister’s website. Most previous indices had been based only on mortgage transactions, and therefore excluded cash purchases which represent around 25% of the UK market. The sample size of the new index is significantly larger, and suffers from less selection, than any other available index. The index is based on information taken at the Land Registry at the completion stage, and so is reliable, but it means that data is usually several months out of date as compared with deals being struck in the current market.

New areas for attention
As well as looking back at past recommendations, the working party will also be looking at the following new areas:
– market developments since 2001;
– barriers to the further development of the equity release market;
– developing the future market recommendations and approaches;
– integration of equity release schemes with long term care schemes; and
– providing schemes to lower value properties.
The full equity release working party interim report can be found at www.actuaries.org.uk/files/pdf/equity

The chairman of the Equity Release Working Party is Ged Hosty of In Retirement Services Ltd (email ged.hosty
.co.uk) and the secretary is Martin Hewitt
(email martinh