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Risk Analysis for Reverse Mortgages with Different Payout Designs

Author

Listed:
  • Cho Daniel

    (Swiss Re, Sydney, New South Wales, Australia)

  • Hanewald Katja

    (Australian School of Business, University of New South Wales – ARC Centre of Excellence in Population Ageing Research (CEPAR), Sydney, New South Wales 2052, Australia)

  • Sherris Michael

    (School of Risk and Actuarial Studies, University of New South Wales, Sydney, New South Wales, Australia)

Abstract

We analyze the risk and profitability of reverse mortgages with lump-sum or income stream payments from the lender’s perspective. Reverse mortgage cash flows and loan balances are modeled in a multi-period stochastic framework that allows for house price risk, interest rate risk and risk of delayed loan termination. A vector autoregressive (VAR) model is used to simulate economic scenarios and to derive stochastic discount factors for pricing the no negative equity guarantee embedded in reverse mortgage contracts. Our results show that lump-sum reverse mortgages are more profitable and require less risk-based capital than income stream reverse mortgages, which explains why this product design dominates in most markets. The loan-to-value ratio, the borrower’s age, mortality improvements and the lender’s financing structure are shown to be important drivers of the profitability and riskiness of reverse mortgages, but changes in these parameters do not change the main conclusions.

Suggested Citation

  • Cho Daniel & Hanewald Katja & Sherris Michael, 2015. "Risk Analysis for Reverse Mortgages with Different Payout Designs," Asia-Pacific Journal of Risk and Insurance, De Gruyter, vol. 9(1), pages 77-105, January.
  • Handle: RePEc:bpj:apjrin:v:9:y:2015:i:1:p:77-105:n:4
    DOI: 10.1515/apjri-2014-0012
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    References listed on IDEAS

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    Cited by:

    1. Kim, Joseph H.T. & Li, Johnny S.H., 2017. "Risk-neutral valuation of the non-recourse protection in reverse mortgages: A case study for Korea," Emerging Markets Review, Elsevier, vol. 30(C), pages 133-154.
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    3. Michael Sherris, 2021. "On Sustainable Aged Care Financing in Australia," Australian Economic Review, The University of Melbourne, Melbourne Institute of Applied Economic and Social Research, vol. 54(2), pages 275-284, June.

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    More about this item

    Keywords

    reverse mortgage; income stream; equity release; vector autoregressive model; stochastic discount factor; risk-based capital;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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