Analysis of Equity Release Products Robert Sorbello 2006 Actuarial Honours Thesis, Australian National University

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1 Robert Sorbello 2006 Actuarial Honours Thesis, Australian National University Robert Sorbello REFERENCE NUMBER: RSORB

2 Disclaimer The material in this report is copyright of Robert Sorbello. The views and opinions expressed in this report are solely that of the author s and do not reflect the views and opinions of the Australian Prudential Regulation Authority. Any errors in this report are the responsibility of the author. The material in this report is copyright. Other than for any use permitted under the Copyright Act 1968, all other rights are reserved and permission should be sought through the author prior to any reproduction. Acknowledgement I would like to acknowledge the support of the Brian Gray Scholarship (jointly funded by the Australian Prudential Regulation Authority and the Reserve Bank of Australia) which I have received for undertaking this thesis. REFERENCE NUMBER: RSORB / Page 2

3 Background and Motivation Equity release products allow elderly homeowners to access equity in their residential properties while continuing to reside in the property. Regular repayments are not required, as the funds are recovered through sale of the property when the homeowners exit. Exit can occur through death, relocation to aged care, or through voluntary means. Recent growth in the market for these products, both in Australia and overseas, has placed them firmly into the public eye. Behind the growth in these products is the retirement financing environment. In Australia, a three pillars system for retirement income is in place. It consists of compulsory saving (superannuation), voluntary savings (eg cash, shares, property), and government benefits (the Age Pension). The recommended level of income for retirees in developed countries is approximately two-thirds of average pre-retirement salary. However, it is widely regarded that a gap exists between actual and recommended levels of retirement income for many elderly in these countries, including Australia. This gap, combined with an ageing population, means that alternate sources of retirement income, namely equity release products, are becoming increasingly prominent. In addition, there are several issues around value for money, bequeathment and loss of savings that still concern many. Hence, the relative merits for consumers of the different product offerings need to be assessed in this context. Compared to ordinary mortgage lending, equity release providers face increased mortality, morbidity and property risks, as well as unusual repayment patterns. Other provider concerns include high initiation costs and lack of data or experience. Although ordinary reverse mortgages have been responsible for recent market growth, other equity release products have only recently emerged (with no more than a couple of Australian providers involved), and have had little attention from either academic or practical studies. Hence, the long term profitability for providers is also an issue worthy of detailed consideration. Furthermore, studies of equity release generally focus on only one of providers or consumers, potentially missing linkages between the two. For providers, studies generally have been either technically focused (as opposed to outcome focused) or technically deficient. In addition, few studies have involved Australia. REFERENCE NUMBER: RSORB / Page 3

4 Aims This study has several aims for both consumers and providers in the Australian context. Consumers - Quantify the size and extent of the retirement income gap for elderly Australians - Determine and assess the following outcomes from five equity release products, keeping in mind the trade-off between maximising payments and maximising remaining home equity (as increased payments must essentially come from sacrificing more equity): Outcome Goal Features Regular Payment Maximise Dollars per week, indexed at 3% p.a Proportion of Home Equity Remaining Probability of Zero Home Equity Remaining Maximise Minimise Measured on exit Applies to reverse mortgages only - Broadly assess the extent to which the retirement income gap could be addressed through equity release Providers - Determine and assess the following outcomes from five equity release products: o Expected profit o Standard deviation of profit o Skewness of profit o Probability of loss o Average size of loss - Adopt suitable methods and assumptions for modelling equity release products, and highlight key risks and characteristics of product types and features. REFERENCE NUMBER: RSORB / Page 4

5 Products The following five equity release products are considered: Product Reverse Mortgages (RMs) 1 Reverse Mortgages with NNEG Insurance Home Reversion Schemes Shared Appreciation Mortgages (SAMs) Pension Loans Scheme (PLS) Description - A loan is provided to the homeowner (either an income stream or a lump sum). The principal and interest are capitalised until exit from the property, at which time the loan is repaid from selling the property. - RMs come with a No Negative Equity Guarantee (NNEG), meaning if the sale proceeds are less than the accumulated loan, the homeowner is not liable for the shortfall. - RM where the cost of the NNEG is insured by a third party, in exchange for a premium. - Four types of NNEG insurance are assessed: o Complete o Excess o Reverse Excess (the insurer covers the shortfall up to a certain amount, liability then passes to the provider) o Proportional - A lump sum is provided to the homeowner in exchange for selling a portion of the property value to the provider, taken on exit (as opposed to an accumulating loan). - The portion of the property value received in the lump sum is at a significant discount to the portion the provider eventually takes. - A lump sum is provided to the homeowner in exchange for the homeowner repaying the lump sum and a share of the capital gain of the property on exit. - A reverse mortgage that is only able to available to part pensioners as a form of income stream. It allows them to top-up their fortnightly pension payment to the full amount. 1 Reverse mortgages taken as income streams do not attract means testing due to the small incremental nature of the payments. Means testing refers to the assessment of the value of assets held by retirees, in order to determine what pension benefits are received, if any. Proceeds from home equity products taken as lump sums (above $40,000) are subject to means testing, hence amounts drawn above this threshold will act to reduce any pension benefits. This becomes important in the comparison between different types of products. REFERENCE NUMBER: RSORB / Page 5

6 Methodology Model Inputs Equity release product cash flows are calculated and analysed using a micro-simulation model, tailored for each of the five products being studied. To construct a model of product cash flows, property price paths need to be modelled, and other components such as loan-tovalue ratios (LVRS), mortality rates and interest rates must be assumed. Property Prices Developing a property price model with appropriate assumptions is a key component in equity release modelling. The conventional view is that it can either be done using a random walk model which is simple and reasonably accurate, or an economic driven (time series) model, which captures autocorrelation, better reflects future market conditions, and is potentially more accurate. Both types of model are used in the analysis. Property price data from Allhomes, the Real Estate Institute of Australia (REIA) and the Housing Industry Association was obtained in order to assess the characteristics of property prices. It was found that there were no statistically significant differences in property growth characteristics across regions in Australia over the recent 25 year period. Volatility in prices varies depending on the type and value of the property being modelled. For the random walk model, a lognormal distribution and a mean growth rate of 6.5% p.a. are assumed, as a balance between recent historic mean growth of over 8% p.a., and future forecasted growth and economic conditions. The price at time t in this model is determined as follows: log(p t ) = α + log(p t-1 ) + ε t, where α is a constant and P is the property price. The time series model adopted for property prices at time t is as follows: Δ log( Pt ) = CPI t CPI Δ log( P ) + ε t 2 t t RMR t RMR where CPI is the Consumer Price Index and RMR is the continuous Real Mortgage Rate (ie RBA standard mortgage rate, CPI adjusted). Although the data available for this model, and its level of complexity, are not ideal, movements in price will on balance be positively related to inflation and negatively related to real interest rates, consistent with economic intuition. More sophisticated approaches may use some form of Vector Autoregression (VAR), where all variables are allowed to depend on t 2 REFERENCE NUMBER: RSORB / Page 6

7 lagged values of all other variables. This can more appropriately capture economic interactions. LVRs The LVR is the proportion of the current property s value that a consumer receives. It typically is higher for older borrowers, for males compared to females, and for singles compared to couples. This reflects the longevity and other risks faced by providers. SAMs have higher potential LVRs than RMs, and reversions in turn may have higher LVRs than SAMs. Table 1 outlines LVRs assumed for 65 year olds, as determined by a review of Australian and other market information during mid Table 1: LVRs for 65 year olds LVR Type Information Male Female Couple Standard LVRs SAM gearing ratio 2 = 1.7:1 22% 20% 16% Reversion % property sold = 50% Maximised LVR: SAM Maximised LVR: Reversion SAM gearing ratio = 1.7:1 35% 30% 27% Reversion % property sold = 100% 44% 38% 34% Mortality, Morbidity and Voluntary Exit Rates Assumed mortality rates are standard Australian Life Tables rates with 100 year mortality improvements. Although annuitant mortality is suggested elsewhere, it is arguable that people in poor health have just as much incentive to use equity release as do people in good health. Aged care rates assumed are those derived in Standard and Poors (2005); improvements are 50% of mortality improvements. For voluntary exit, of the several types possible (eg remortgaging), only personal relocation was directly accounted for (in line with Equity Release Working Party, 2005). However, more recent market information suggests voluntary discharges are becoming increasingly common. The decrements are combined assuming independence. 2 The gearing ratio defines the share of the capital gain that the provider receives. If the LVR is 20% and the gearing ratio is 1.7:1, then the provider takes 34% of the capital gain of the property. REFERENCE NUMBER: RSORB / Page 7

8 Interest and Discount Rates According to Australian market information during 2006, a fixed RM loan rate of 8.5% p.a. is assumed. Variable rate RM loans are assumed to begin at 8.25% p.a. Variable interest rates are simulated using a Markov transition matrix based on recent historical Australian interest rate movements. Given the loan rates, the discount rate is set to reflect the cost of funds of the provider; in mortgage lending funds can be raised from securitisation. Observing this, an appropriate (fixed) rate in Australia for RMs (mid-2006) is around 7%; ultimately the rate should be greater than the risk-free rate, yet less than the RM loan rate. This rate applies across all products modelled. SAMs or reversions may in fact attract higher cost of funds given their risk/return profiles, however this is an area of uncertainty, as the market is small. Other Components Expenses incurred by providers are assumed to be the same as the fees charged to consumers. This was due to the limited and differing information available regarding actual expenses incurred. Charges include an origination fee of $1000, 3% sale costs, as well as small ongoing, termination and other fees. For capital adequacy purposes, 11% of risk-weighted assets is assumed to be held as capital by providers. Insured RMs, or those having low LVRs, can attract a 50% risk-weight, however all other products attract a 100% risk-weight. Capital held may in fact need to increase with time, for example as the NNEG begins to bite in certain loans, however this was not considered here. The cost of this capital under CAPM is approximately 11%. Model Construction Scenarios The analysis is conducted under several scenarios. These are essentially determined by mixing different borrower (and other) characteristics, outlined below: - Housing Wealth Scenario (HWS) 3 : 1 (default), 2, 3 - Entry Age: 65 (default), 75, 85 - Property Type: Houses (default), Apartments - Location: Melbourne (default), Sydney, Adelaide - Status: Males (default), Females, Couples 3 A measure of the asset and property wealth of the retiree(s) - defined in Table 2 in the Results section. REFERENCE NUMBER: RSORB / Page 8

9 - Payment Type: Lifetime (default), Life Expectancy, Lump Sum - Property Model: Random Walk (default), Time Series - Loan Interest Type: Fixed (default), variable (RMs only) Each of the five products was considered across several possible scenarios. The outputs from each scenario are aggregated from 10,000 separate Monte Carlo simulations of the scenario itself, where one simulation represents one borrower ; their property value, repayment amount, and time of exit are simulated according to the model inputs. Hence, the probability of exit in any given quarter is given by 1 (1 qx )(1 mx )(1 vx ), where q, m and v are (quarterly) mortality, morbidity and voluntary exit rates for a borrower aged x (extensions apply to couples). Product cash flows are calculated quarterly for a maximum of 45 years (up to age 109). Consumer Outcome Calculations Payments are determined using ordinary life annuity formulas, with assumptions as stated. The proportion of equity remaining is determined by the final property value on exit less the repayment to be made under the product terms. Profit Calculations Reverse mortgage Profit = T PV min( PT, LT ) ( Q E C), where t = 0,1,,T t= 0 - PV indicates the present value of all cash flows are taken, at the specified 7% discount rate - T is the quarter when exit occurs, ranging from 1 to 180 (ie from age 65 (min) to age 109) - P t is the property price at time t (net of transaction costs on sale), simulated as previously specified - Q is the vector of payments made to the consumer under the product, such that: Q = LVR. P 0 (lump sum at time 0), or Q t = LVR. P 0.F (annuity payment at time t, for some annuity factor F) L L 0 = Q0 - is the accumulated loan amount at time t, according to the RM loan rate. t - E is the vector of expenses (net of fee income) incurred by the provider REFERENCE NUMBER: RSORB / Page 9

10 - C is the vector representing the monetary cost of capital, which equals the amount of capital held at each quarter multiplied by the 11% cost of capital, net of investment earnings RMs with NNEG insurance The profit calculation under complete insurance, for example, is: T Profit = PV LT ( Q E C W ), t= 0 where W is the vector of premium payments to the insurer. Premiums are set as a percentage of the RM lump sum, such that the net present value of the insurer s cash flows equals the market consistent cost of the NNEG 4. The percentage cost of capital for the private insurer is assumed to be the same as for a private provider. The insurer s profit under complete insurance can be calculated as follows: T Insurer s Profit = PV ( W max(0, LT PT ) E * C *), t= 0 where E* and C* are corresponding vectors of expenses and capital costs. SAMs Profit = PV min T T ) t= 0 - g is the gearing ratio (ie 1.7) T ( P,max( Q, Q + g( P Q) )) ( Q E C - Q = LVR. P 0 (lump sum at time 0) 4 This involves the use of risk-neutral valuation techniques, consistent with derivatives pricing. REFERENCE NUMBER: RSORB / Page 10

11 Reversions T Profit = PV γ PT t= 0 ( Q E C) - γ is the proportion of the property sold to the provider - Q = LVR. P 0 (lump sum at time 0) REFERENCE NUMBER: RSORB / Page 11

12 Results Retirement Income Gap To assess precisely how large the retirement funding gap is, the recommended and actual income levels for elderly Australians is established. According to the ASFA/Westpac Retirement Living Index for over 65s (adjusted to March 2006), $650-$680 per week is a comfortable (or recommended) level of income 5. For couples, $890-$905/wk is comfortable. The actual income level of current retirees (in real terms) can be calculated from converting all superannuation, pension payments, and other non-home assets into an income stream 6 (Table 3). The Age Pension provides a maximum of $249.85/wk for singles and $417.20/wk for couples (as at July ). Table 2: Housing Wealth Scenarios Scenario (HWS) Pension Non-Home Assets % Aus Elderly Home-owning Population % Median property value 1 Full - 15% 75% 2 Full Min 7 40% 92% 3 - Max 8 55% 105% The analysis is conducted using three Housing Wealth Scenarios (HWS) described in Table 2; the information in this table was adapted from FaCS (2005) and, for display purposes, is averaged across status and age groups. 5 $330-$350/wk for singles is referred to as a modest amount, while $480-$490/wk is modest for couples. 6 The entire stream is indexed at inflation (3% p.a), the interest rate is assumed to be 7%, and the payment term is either life expectancy (LE) or whole of life. The stream for couples has been calculated on a last survivor basis. It should be noted that this basis is not appropriate for pension payments once one partner has died, as the surviving partner would revert to a single s pension. 7 Under the Assets Test for Homeowners, singles may have $161,500 worth of non-home assets before their pension payment is reduced. 8 The maximum allowable assets for homeowners to receive any pension payments ($330,000 for singles). REFERENCE NUMBER: RSORB / Page 12

13 Table 3: Real incomes implied from non-home assets for 65 year olds under several Housing Wealth Scenarios ($/wk). HWS 1 HWS 2 HWS 3 Payment Term Life/LE Life LE Life LE Male Female Couple The tables show that it is only under HWS 3 where the comfortable level of income is close to being achieved. This indicates that a funding gap exists for more than half of the Australian elderly population who own their own homes. Consumer outcomes The results displayed in Tables 4 and 5 are assuming the random walk property model and fixed interest loans only. Table 4: Consumer outcome comparison under standard LVRs Product Status HWS City Age Payment $/wk Expected % Equity Remain Pr. Zero Equity RM Male 1 MEL % 3% SAM Male 1 MEL % - Rev Male 1 MEL % - RM Female 1 MEL % 2% RM Couple 1 MEL % 3% RM Male 1 SYD % 3% REFERENCE NUMBER: RSORB / Page 13

14 RM Male 1 ADE % 3% RM Male 1 MEL % 9% SAM Male 1 MEL % - Rev Male 1 MEL % - RM Male 1 MEL % 11% RM Male 2 MEL % 3% SAM Male 2 MEL % - Rev Male 2 MEL % - RM Couple 2 MEL % 2% SAM Couple 2 MEL % - Rev Couple 2 MEL % - RM Male 3 MEL % 3% SAM Male 3 MEL % - Rev Male 3 MEL % - Table 5: Consumer outcome comparison under maximised LVRs Product Status HWS City Age Payment $/wk Expected % Equity Remain Pr. Zero Equity SAM Male 1 MEL % - Rev Male 1 MEL SAM Male 1 SYD % - Rev Male 1 SYD SAM Female 1 MEL % - Rev Female 1 MEL REFERENCE NUMBER: RSORB / Page 14

15 SAM Male 2 MEL % - Rev Male 2 MEL SAM Couple 2 MEL % - Rev Couple 2 MEL SAM Male 1 MEL % - Rev Male 1 MEL General With reference to Tables 4 and 5, there are several points to note: - Life annuity payments can constitute a significant proportion of retiree income (more than 20% of the pension for singles in HWS 1). - Differences across cities are highly significant, with most payments in Adelaide being only half of those in Sydney. - Females receive $10/wk less than males, and the gap widens with age, given life expectancies. Couples receive less than males, suggesting their combined wealth is insufficient to generate larger payments due to the longer expected product life (based on two lives). - As with all products, larger payments are received for older individuals (having a shorter life expectancy) and wealthier individuals (having properties of greater value). Reverse Mortgages - The expected equity remaining on exit is generally the highest of all products (under the same LVR), being typically greater than 50%, though reducing with age. Expected equity remaining is higher for annuities than lump sums (approximately 5-10% of the property). - The probability of zero equity remaining is similar across payment types, starting at low levels of 2-3% for 65 year olds and increasing to 7% or more with age. - Outcomes for consumers under NNEG insurance are identical to ordinary RMs, as it is assumed that they are not affected by the insurance arrangements. SAMs and Reversions - When LVRs are maximised, annuity payments are in the order of twice the amount (per week) of those under RMs, however significantly more equity must be sacrificed to achieve this in the case of reversions. REFERENCE NUMBER: RSORB / Page 15

16 - SAMs also generate slightly higher weekly payments than RMs under maximised LVRs ($20- $30/wk, increasing with age and wealth), though it is with somewhat less remaining equity in most cases (20% or more). - Reversions have the advantage over RMs that the proportion of equity remaining is fixed and known at origination, however at the same LVRs, the expected equity remaining is much higher for RMs. - The Assets Test has a significant reducing effect on annuity payments relative to RMs for HWS 2 and 3. However, this can clearly be offset by higher LVRs for both products (should they be offered by providers), though coming at the expense of greater equity sacrificed. Pension Loans Scheme (PLS) There are several points to note about the PLS which make it relatively unattractive for consumers: - Total payment amounts are comparable with reversions, however the pattern of payments is inappropriate for retirement financing. Payments are at their highest when non-home assets are high, ie when the top-up to the full pension is largest. As non-home wealth is run-down (arguably when other income sources are needed), the pension increases to some extent via the Assets Test, however the top-up is then reduced. - The scheme is unavailable to the poorest consumers (full pensioners). - The scheme prevents owners of valuable properties using all of their wealth by limiting the payment to pension top-ups. Sensitivity tests reveal that in lower interest rate and high property growth environments, RM loan sizes remain small and hence expected equity remaining is relatively higher compared to SAMs and reversions. However, in higher interest rate or low property growth situations, the opposite is true. REFERENCE NUMBER: RSORB / Page 16

17 Provider Outcomes Table 6: Provider outcome comparison under standard LVRs ($) Product Feature Scenario 9 Mean_Prof Std_Prof Pr_Loss Mean_Loss Skew RM % RM Age % N/A RM HWS % N/A RM Female % N/A RM Couple % N/A RM Annuity % N/A RM Time Series Model % N/A Fixed loan rate RM Variable discount rate % RM NNEG Complete insurance % RM NNEG RM NNEG RM NNEG RM NNEG Complete insurance (annuity) % Excess insurance ($2000 excess) % RevExcess insurance ($5000 excess) % Proportional insurance (75%) % Default scenario settings apply unless otherwise specified REFERENCE NUMBER: RSORB / Page 17

18 SAM % SAM Couple % SAM HWS % Rev % Rev Couple % Rev HWS % Table 7: Provider outcome comparison under maximised LVRs ($) Product Feature Scenario Mean_Prof Std_Prof Pr_Loss Mean_Loss Skew SAM % SAM Couple % SAM HWS % Rev % Rev Couple % Rev HWS % General With reference to Tables 6 and 7, several points are evident: - Most scenarios generate positive NPVs (above zero at the 95% significance level for RMs). This is an encouraging result, demonstrating that positive consumer and provider outcomes can co-exist under the current assumptions. - Profit increases with higher amounts of equity drawn, brought about by higher property values (affected by location and HWS) and increasing age. When the results from the consumer side are also considered, it appears the market for equity release could be most effective where older and wealthier borrowers are involved. However, risk of loss slightly increases with age. REFERENCE NUMBER: RSORB / Page 18

19 - The time series model reduces profitability and increases the chance of loss somewhat due to more numerous and severe adverse scenarios. - Products provided to females are only slightly more profitable than those to males, however couples are much more profitable than singles due to higher property values. RMs - Lowest expected profit of the three major products, though also having the lowest probability of loss. - Annuity lending is less profitable than lump sum lending, potentially due to adverse longevity risks in the long term or lower amounts of equity drawn in the short term. - Outcomes under variable interest rates depend greatly on the property model assumed. A fixed loan rate, variable discount rate situation creates an unfavourable funding mismatch that should be avoided. - PLS: In general, profits under the PLS are comparable to that of a provider of ordinary reverse mortgages. RMs with NNEG insurance - Expected profit is reduced by more than half compared to ordinary RMs, however extreme downsides are eliminated. - Profitability for annuity business under NNEG insurance is significantly affected. This can be seen in Table 6 by the 97% probability of loss for complete insurance. Profit is highly sensitive to the premium, meaning that setting premiums is extremely difficult. - Complete insurance is the least attractive for providers, while the other three insurance options are similar. - Insurer profitability is sound across all insurance types and product configurations. Reversions - Reversions generate the highest profits of all products, while probability and size of losses are greater than for RMs, reflecting the equity like nature of the product. - The time series property model has a significant adverse affect on profitability, more so than for the other products. SAMs - SAMs generate higher expected profits than RMs, though they are less than half the expected profits from reversions. However, the probability and size of losses are significantly greater under the assumed product configuration, so much so that the losses are in fact greater than those expected for reversions. REFERENCE NUMBER: RSORB / Page 19

20 - Further analysis must be done in order to establish to what extent higher gearing ratios (or other product features) could make SAM profitability more favourable. However, the range is wide given the lack of providers and differing experiences to date. A sensitivity analysis reveals many of the preceding results are highly sensitive to property price and discount rate assumptions. Care must be taken in interpreting them, and it highlights the centrality of these two model components to this analysis. Retirement Income: Final Assessment Figure 1 shows the weekly retirement income from all sources under three equity release products for a 65 year old male in HWS 2, and the associated (expected) home equity remaining in each case. It shows outcomes under a maximised LVR for each product, in order to show the maximum retirement financing potential. The strong potential contribution of equity release to total retirement income is evident. Notably, it seems the increased payments under the LVR-maximised reversion come at a high price, in that all equity has been sacrificed. However, the increased payment would become more important to individuals with only pensions as their income. Figure 1: Real retirement income for males age 65 in HWS 2 Pension Non-home assets Equity release Retirement Incomes ($) % Equity Remaining RM SAM Rev RM SAM Rev Product Types 0 REFERENCE NUMBER: RSORB / Page 20

21 It can be seen from the figure that equity release can raise retirement incomes for male pensioners, in this situation, to near the recommended level for singles (>$650/wk). Although only males are shown here, the results are similar for females and couples in terms of the level reached. Considering the distribution of elderly homeowners shown in Table 2, it is thus estimated that approximately 14% of 65 year olds and 18% of over 75s, who were previously below the recommended retirement income levels in Australia, could reach these levels with the aid of equity release. A further 15% of all over 65s can reach the modest level of income using equity release who previously could not. REFERENCE NUMBER: RSORB / Page 21

22 Conclusion This study considered the outcomes for consumers and providers of five types of equity release product in Australia, and included a broader analysis of the retirement income situation facing elderly Australians. It has provided an indication of the extent to which equity release can address the retirement income gap, and it has highlighted provider sustainability and potential risks, demonstrating the need for adequate property and interest rate models to be used. For consumers, although equity release provides greater income for older and wealthier individuals, all homeowners can achieve significant improvements in retirement income, the more so the more they are willing to sacrifice their home equity. However, individuals need to balance this decision against their needs for equity, particularly supporting the cost of a place in aged care. Each product type has different repayment methods to suit different preferences, and different environments in which equity remaining will be greater. In addition, the reversion and SAM have the flexibility of a higher LVR, while the annuity option for RMs being free of means testing could well be equally attractive. Hence for consumers, no one product is better than another in all situations. For providers, reverse mortgages represent more ordinary loan-like returns, and are a more natural extension of existing lending activities. SAMs and reversions provide returns akin to a type of property investment, where clearly the returns are potentially higher, however the risks appear to be as well. It is a question of whether the profitability profile (highlighted in this study) is acceptable to providers, as among several factors, they may require greater reserves. Outcomes for SAMs in this study were more in favour of consumers, however this does not constitute evidence they are unprofitable, it merely highlights the need for more detailed analysis of the product. NNEG insurance appears costly for providers due to high premiums, though it may be worthwhile to consider whether the government could operate a NNEG insurance program affordably to encourage market growth (similar to the US Home Equity Conversion Mortgage program). Lastly, the PLS has several shortcomings which ought to be addressed. Looking forward, there are several additional points to be taken out of this research that may be relevant to the wider financial community: Need for research into capital for equity release products, paying particular attention to changing capital requirements over product life, and across different products. Reviewing the exemption of the home from the Assets Test and its consequences on equity release, the pension system and retirement incomes. Disclosure of NNEG risk management for RM providers. REFERENCE NUMBER: RSORB / Page 22

23 References Equity Release Working Party, 2005, Equity Release Report 2005: Technical Supplement, The Actuarial Profession. FaCS (Department of Family and Community Services) 2005, Home Equity, Retirement Incomes and Family Relationships, 9 th Australian Institute of Family Studies Conference, Melbourne. Standard and Poors, 2005, Australian and New Zealand Reverse Mortgage Criteria, Standard and Poors Structured Finance, September Westpac, 2006a, Westpac Retirement Living Standard Calculator, viewed 10 July 2006, < REFERENCE NUMBER: RSORB / Page 23