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Equity Release: Another Equitable in the Making

Author

Listed:
  • Buckner, Dean

    (The Johns Hopkins Institute for Applied Economics, Global Health, and the Study of Business Enterprise)

  • Dowd, Kevin

    (The Johns Hopkins Institute for Applied Economics, Global Health, and the Study of Business Enterprise)

Abstract

A major problem emerging in the UK equity release sector is the undervaluation by firms of their No-Negative Equity Guarantees (NNEGs), which cap borrowers’ repayments to the maximum of the rolled-up loan value and the value of their property at the time of repayment. This undervaluation arises from the common use by firms of an incorrect valuation methodology, the Discounted Projection or Real World approach, in which valuation is based on projected future house prices. The correct, Market Consistent (MC), approach uses forward house prices as the underlying variable in the relevant put option pricing equation. Results indicate that the MC approach produces much higher NNEG valuations and suggest that firms have considerably undervalued their NNEGs. Our analysis reinforces recent analysis by the UK Prudential Regulation Authority and especially their Good Practice Principles for the management of equity release mortgages. This NNEG undervaluation story bears a number of similarities to the Equitable Life fiasco of almost two decades ago and suggests that some of the problems present in the Equitable saga – especially the undervaluation of opaque long-term guarantees and the undermining of actuarial practice by commercial interests – have still to be resolved.

Suggested Citation

  • Buckner, Dean & Dowd, Kevin, 2018. "Equity Release: Another Equitable in the Making," Studies in Applied Economics 129, The Johns Hopkins Institute for Applied Economics, Global Health, and the Study of Business Enterprise.
    • Handle: RePEc:ris:jhisae:0129
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    References listed on IDEAS

    as
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    4. Kevin Dowd & Andrew Cairns & David Blake & Guy Coughlan & David Epstein & Marwa Khalaf-Allah, 2010. "Backtesting Stochastic Mortality Models," North American Actuarial Journal, Taylor & Francis Journals, vol. 14(3), pages 281-298.
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    More about this item

    Keywords

    no-negative equity guarantee; equity release; actuarial science; put option pricing; Equitable Life; prudential regulation;
    All these keywords.

    JEL classification:

    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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