Explaining why, right or wrong, (Italian) households do not like Reverse Mortgages Elsa Fornero Mariacristina Rossi Maria Cesira Urzì Brancati Save PHF Conference on Demographic Trends, Saving and Retirement Security: Stylized Facts and Behavioral Responses Munich, 12-13 July 2012 University of Turin, CeRP-Collegio Carlo Alberto, and Netspar, (elsa.fornero@unito.it, http://web.econ.unito.it/fornero/) University of Turin and CeRP-Collegio Carlo Alberto (rossi@econ.unito.it) University of Tor Vergata and CeRP-Collegio Carlo Alberto.
What is the Reverse Mortgage? It is a loan (specifically designed for the elderly) against the home value, such that the value of the loan cannot exceed the present value of the house at predicted death An illiquid asset becomes a source of liquidity, mainly for consumption purposes Accumulating wealth, if not translated into consumption, should not affect utility Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 2
Why we need the Reverse Mortgage Because of the demographic trends, the saving behaviour of the elderly and their portfolio holdings are central to the policy debate Dependency ratios will rise dramatically in the next 30 years Population ageing puts strain on the public purse Many public retirement systems are very generous: replacement rates often come to exceed 70 per cent Reverse Mortgages can: Alleviate the burden of an ageing population on public budgets Increase income security in old age and allow better consumption smoothing Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 3
Theoretical framework: Modigliani and Bruemberg s (1954) lifecycle hypothesis Life is divided into a productive period and unproductive ones (childhood and in old age) The model highlights the role of savings for retirement and predicts a hump shaped wealth profile, and specifically dissaving by the elderly Empirical analyses have found that the rate of wealth decumulation is slower than the LCH model predicts (Venti and Wise, 1987; Ando et al., 1993; Chiuri and Jappelli, 2007; Angelini and Laferrère, 2010). Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 4
Possible motives for the low propensity to dissave Precautionary savings or buffer stock savings behaviour (Carroll et al. 1992) can emerge when consumers facing income uncertainty are both impatient and prudent target wealth stock Bequest motives: more wealth is held, and wealth trajectory is flatter. However, some empirical studies have found no bequest motive (Hurd 1986); Portfolio composition of the elderly, i.e. heavy presence of illiquid assets, such as housing (Mitchell and Piggott 2003) Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 5
Potential for Reverse Mortgages in Italy Italy has very high homeownership rates (around 78% among the elderly) Italian households hold most of their wealth locked up in housing Evolution of homeownership Housing Wealth over Net Wealth 74% Mean Median 72% 70% 68% 66% 64% 62% 1995 1998 2000 2002 2004 2006 2008 85% 80% 75% 70% 65% 60% 55% 50% 1995 1998 2000 2002 2004 2006 2008 Source: Bank of Italy s Survey on Household Income and Wealth (SHIW), 1995-2008 Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 6
Reverse Mortgage: product s main features RMs require no obligation of repayment until the individual (or spouse) dies, moves out, or sells the house RMs can be taken out as: lump sum through fixed monthly payments (tenure plan or life annuity) or as a line of credit the borrower can access any time. The amount of the loan depends on the age of the borrower (the older the borrower, the larger the loan) the value of the property (the more valuable the house, the larger the loan) the interest rate (lower interest rates means more money is available to the borrower). Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 7
Reverse Mortgage: historical overview (US) RMs were introduced by US Congress in 1987 as Home Equity Conversion Mortgages (HECMs) to facilitate the financing of consumption in old age (Rodda et al. 2000). From their inception in 1989 to the end of 2007, out of tens of millions of eligible homeowners, less than 400,000 loans were originated through the HECM program (Caplin, 2001) Trend has changed in recent years: In 2007, over 100,000 RM loans were originated through the HECM program (Shan 2009) RMs are often complex In order to help households make well-informed financial decisions, in 1989 the US law established that borrowers obtain financial counselling before they can apply for a home equity conversion mortgage (HECM) loan. Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 8
Reverse Mortgage: historical overview (Europe) EU: RM market is thin and unevenly developed across countries with regards to volumes, lending methods, and range of products. Common criteria: minimum age requirements and minimum property value; protections for borrowers (no negative equity guarantee), obligations to carry out repairs and maintenance. 13 Member States had some form of RMs or Equity Release Scheme (ERS), compared to 14 with none UK, Ireland and Spain, have developed more significant markets In the Netherlands, Denmark and Finland, providers report that overdraft facilities and credit lines are the preferred forms In Germany, Italy, France, Belgium and Sweden, RMs are subject to wideranging debate, but have not yet been well developed. Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 9
Reverse Mortgage: historical overview (Italy) In Italy, RMs were formally introduced in 2005 under the name prestito vitalizio ipotecario, available to the over 65 whose housing equity exceeds 70,000. A few credit institutions offer RMs: Deutsche Bank s PatrimonioCasa and Euvis s Prestito Vitalizio (available only as a lump sum); Banca Monte dei Paschi di Siena: PrestiSenior for the over 70 as either a lump sum or an annuity for a maximum of 20 years. The product is new, complex and not well known. Can we expect to find high levels of interest among the population? Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 10
RMs literature: who should be more interested Some researchers emphasize a significant potential demand: Case and Schnare (1994): interest in RMs should be strong among the house-rich, cash-poor elderly homeowners; Mayer and Simons (1993): elderly could use them to pay off preexisting debts. Ong (2008): RMs have the capacity to lift out of poverty 95% of income-poor elderly Australians especially women aged 80 or over. Others see a limited scope for RMs: Venti and Wise (1987): low-income elderly generally have little housing equity available. Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 11
RMs literature: (some) reasons for the market s underdevelopment Transactions costs, high insurance fees, and uncertainty about future needs and preferences Caplin (2001), Davidoff and Welke, (2005) Debt aversion among the elderly Gibler and Rabianski (1993), Caplin, (2000) households may prefer a lower level of consumption in a debt-free house to a higher level in a debt-ridden one Financial illiteracy, lack of awareness of the product Gibler and Rabianski (1993), Leviton, (2002), Fornero and Monticone, (2011), Reed (2009. Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 12
Empirical analysis: The UniCredit Survey (UCS) UCS 2007 targets the bank s clients aged 21 75 with at least 10,000 in deposits. The survey elicits respondents opinions towards risk, investments and savings, and tests their level of financial education. Additional data have been extracted by Bank of Italy s Survey of Household Income and Wealth (SHIW) 2006 to compare the characteristics of our respondents with a representative sample of all Italian population. Why UCS and not SHIW? Only dataset, to our knowledge explicitly asking a specific question on RM Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 13
Summary Statistics: UCS vs. SHIW UCS SHIW Average age of household head 56.0 57.6 Female household heads 22.0% 37.0% Elderly household heads 29.6% 36.3% Higher education (degree or more) 24.4% 8.9% Pensioners 32.3% 36.1% Self-employed 29.4% 10.2% Homeowners 90.3% 71.2% Average household income 71,325 31,893 Average housing equity 387,367 215,418 # of observations 1,686 7,768 Source: Unicredit 2007 Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 14
Expression of Interest in RMs In order to have financial resources / income in old age, how interested would you be in a RM? (Respondents assign a value between 1 and 5) Interest in RMs (% of total) Under 65 Over 65 Male Female Male Female All Very interested 0.7 1.7 1.6 1.4 1.1% Quite Interested 6.6 7.2 5.3 4.2 6.2% Somewhat interested 14.1 14.4 9.2 12.7 12.9% Barely interested 20.3 19.4 20.7 22.5 20.4% Not interested 58.3 57.2 63.2 59.2 59.7% # of observations 686 180 304 71 1,241 Source: Unicredit 2007 Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 15
Distribution of Interest in Reverse Mortgage by Age, Gender Under 65, Male Household Head Under 65, Female Household Head 0 0 20 40 60 20 40 60 Over 65, Male Household Head Over 65, Female Household Head Percent Not Interested Barely Interested Quite Interested Very Interested Not Interested Barely Interested Quite Interested Very Interested Interested in Reverse Mortgage Graphs by Age Groups (>= 65) and Gender of Household Head Source: Unicredit 2007 Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 16
Distribution of Interest in Reverse Mortgage by Gender, Status Not widower, Male Not widow, Female 20 40 60 0 Percent 20 40 60 Widower, Male Widow, Female 0 Not interested Barely interested Quite interested Very interested Not interested Barely interested Interested in Reverse Mortgage Quite interested Very interested Graphs by household head's marital status (widow) and gender Source: Unicredit 2007 Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 17
Interest in Reverse Mortgages by housing quintiles I Quintile <180,000 II Quintile 180,000-250,000 III Quintile 250,000-350,000 Percent 0 0 20 40 60 IV Quintile 350,000-500,000 V Quintile >500,000 Not interested Barely Interested Quite Interested Very interested 20 40 60 Not interested Barely interested Quite interested Very interested Not interested Barely interested Quite interested Very interested Graphs by housing value quintiles Source: Unicredit 2007 Interested in Reverse Mortgage Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 18
Financial Literacy questions An indicator of financial literacy has been build by using the following questions: Inflation: suppose a bank account yields a 2% interest per annum (after expenses and taxes). If actual inflation is 2% per year (assuming you did not access your account) after two years, the amount deposited can buy you (select one answer): More than it can buy today; less than it can buy today; the same as it can buy today (correct); don t know. Interest rates: imagine having a tip and knowing for certain that in six months interest rates will rise. Do you think it is appropriate to purchase fixed rate bonds today? Yes; no (correct); don t know. Diversification: In relation to investments, people often talk about diversification. In your opinion, to have proper diversification of one s investments means (select one response): To have in one s investment portfolio bonds and shares; to not invest for too long in the same financial product; to invest in the greatest possible number of financial products; to invest simultaneously in multiple financial products to limit exposure to the risks associated with individual products (correct); to not invest in high-risk instruments; don t know Source: Unicredit 2007 Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 19
Financial Literacy Answers Under 65 Over 65 (% of correct answers) Male Female Male Female All No correct answers 16.7 19.9 20.1 21.9 18.3 1 correct answer 37.2 38.7 34.0 48.6 37.4 2 correct answers 32.1 32.3 32.5 25.7 31.9 3 correct answers 12.8 8.7 13.2 3.8 11.7 # of observations 921 266 394 105 1,686 Male, less than 3 correct Male, 3 correct 20 40 60 Percent 20 40 60 0 Female, less than 3 correct Female, 3 correct 0 Source: Unicredit 2007 Not interested Barely interested Graphs by Female and finlit_3d Quite interested Very interested Not interested Interested in Reverse Mortgage Barely interested Quite interested Very interested Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 20
Risk aversion A simple indicator for risk aversion has been build taking advantage of one of the riskrelated questions in the UCS, specifically: Imagine you are in a room from which you can exit through two doors: if you choose the correct one, you win 10,000, if you choose the wrong one, you win nothing. You may also choose a backdoor and withdraw a fixed amount. (The interviewer offers progressively increasing amounts of money) Respondents were awarded one point for every extra question before they chose the fixed amount, the result was then reversed and divided by 10 in order to get a index of risk-tolerance ranging between 0.1 and 1 From 0.6 to 1 the respondent can be defined as risk-averse; 0.5 corresponds to risk neutrality 1 From 0.1 to 0.4 the respondent could be defined as risk loving RA i 10 j 1 ra 10 i j Source: Unicredit 2007 Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 21
Interest in RMs by Risk-aversion and Gender Under 65 Over 65 Male Female Male Female All Risk averse 52.2% 50.8% 58.6% 61.9% 54.0% Risk neutral 16.4% 15.4% 15.2% 18.1% 16.1% Risk loving 31.4% 34.2% 26.1% 20.0% 29.9% Male, Risk averse Male, Risk neutral Male, Risk lover 20 40 60 80 Percent 20 40 60 80 0 Female, Risk averse Female, Risk neutral Female, Risk lover 0 Not interested Barely interested Source: Unicredit 2007 Quite interested Very interested Not interested Barely interested Quite interested Very interested Interested in Reverse Mortgage Not interested Barely interested Quite interested Very interested Graphs by Female and Risk aversion (gain) Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 22
Interest in RMs by Willingness to sell the house UCS question: should you want/need to have extra income for the future, would you sell this house? A binary variable takes the value of 1 if respondent chooses either quite or very likely (19.9% are willing to sell their home) Male, No Male, Yes 20 40 60 Percent 20 40 60 0 Female, No Female, Yes 0 Not interested Barely interested Quite interested Very interested Not interested Barely interested Quite interested Very interested Source: Unicredit 2007 Interested in Reverse Mortgage Graphs by gender and Willing to sell the house (dummy) Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 23
Interest in RMs by Perception of Housing Risk UCS question: on a scale from 1 to 5, how risky do you think investing in housing is? A binary variable takes the value of 1 if respondent chooses either quite or very risky (9.9% see housing as risky) Male, Not Risky Male, Risky 0 20 40 60 20 40 60 Female, Not Risky Female, Risky 0 Percent Not interested Barely interested Quite interested Very interested Not interested Interest in Reverse Mortgage Barely interested Quite interested Very interested Source: Unicredit 2007 Graphs by Female and Properties' perceived risk Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 24
Interest in RMs by Retirement Expectations UCS question: How worried are you about your standard of living in old age /after you retire? A binary variable takes the value of 1 if respondent chooses either quite worried or very worried (38.2% are worried) Male, Not Worried Male, Worried Percent 20 40 60 0 20 40 60 Female, Not Worried Female, Worried 0 Source: Unicredit 2007 Not interested Barely interested Quite interested Very interested Not interested Barely interested Interest in Reverse Mortgage Quite interested Very interested Graphs by Female and Worry about retirement Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 25
Interest in RMs by Debt Averse/Not Debt Averse UCS question: What is your opinion about borrowing? A binary variable takes the value of 1 if respondent chooses the option I d rather not have debts (70.6% averse to debt) Male, Not averse to debt Male, Averse to debt 0 20 40 60 20 40 60 Female, Not averse to debt Female, Averse to debt 0 Percent Not interested Barely interested Quite interested Very interested Not interested Interest in Reverse Mortgage Barely interested Quite interested Very interested Source: Unicredit 2007 Graphs by Female and debt aversion Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 26
Estimating the monetary value of a Reverse Mortgage Payments to borrowers are calculated according to: the principal limit factor (PLF) Italy ranges from roughly 20% of the housing equity for 65-year-olds to roughly 50% for those over 90 the age (or life expectancy) of the (youngest, in a couple) borrower is set at 100 minus current age, multiplied by 12 (Rodda et al. 2000) the mortgage interest rate 6.8% per annum (0.55% per month), an average of DB (7.3%), MPS (7.9%), and the HUD HECM (5.5%) RM rates the adjusted property value. calculated from our sample homeowners. Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 27
Estimating the monetary value of a Reverse Mortgage (cont d) The monthly payment to the borrower under the tenure plan can be computed as an annuity, using the following formula¹ A i = HD r (1+r) e i+1 (1+r) where A i = monthly payment to (household) borrower i HD i = housing value at predicted death r = monthly interest rate (approximated). e i = life expectancy (in months) ¹ Based on Ong (2008) and Rodda et al. (2000) Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 28
Application of the sinking fund formula to the UCS Average housing equity Maximum loan advance RM annuity Average household Income % gain in income from RM All 376,989 94,247 7,661 71,325 11% Housing equity quintile I quintile 141,792 35,448 2,881 54,211 5% II quintile 222,309 55,577 4,517 63,128 7% III quintile 310,992 77,748 6,320 77,568 8% IV quintile 445,139 111,285 9,046 77,622 12% V quintile 905,217 226,304 18,395 77,409 24% Age Category 65 69 years 416,875 93,797 7,624 80,413 9% 70 74 years 429,384 139,550 11,343 61,434 18% 75 80 years 339,500 127,313 10,348 42,738 24% 80 years or over 433,333 173,333 14,089 44,180 32% Household Income Unit Couple 387,358 96,840 8,306 76,223 11% Single male 342,116 85,529 7,336 66,633 11% Single female 358,432 89,608 7,686 52,116 15% Geographical Area North 356,826 89,206 7,652 66,482 12% Centre 421,820 105,455 9,045 76,674 12% South 381,476 95,369 8,180 76,181 11% Source: Unicredit 2007 Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 29
Empirical Strategy Ordered probit The respondent s interest in RMs is measured on an ordinal scale, and the levels of interest are represented by a discrete variable that takes values y i = 1 if the respondent is not interested, y i = 2 if the respondent is barely interested, etc. We assume the discrete values are based on an underlying continuous and latent variable y* which is a linear function of all the explanatory variables: y i * = β x +ε for I = 1, 2,, N Let μ 1 < μ 2 < μ 3 < μ 4 be the unknown thresholds parameters or cutoff points. Then we observe that y i = 1 if y i* μ 1, y i = 2 if μ 1 <y i * μ 2 The threshold parameters are estimated together with the β values to help match the probabilities associated with each discrete outcome. Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 30
Empirical Strategy cont d The probabilities of y i being classified as not interested, barely interested respectively, are given by Prob(y i = 1) = Prob(β x + ε μ 1 ) Prob(y i = 2) = Prob(μ 1 < β x + ε μ 2 ) Prob(y i = 3) = Prob(μ 2 < β x + ε μ 3 ) Prob(y i = 4) = Prob(μ 3 < β x + ε μ 4 ) Prob(y i = 5) = Prob(β x + ε > μ 4 ) Both the cutoff points and β coefficients can be estimated as an ordered probit model Since the β values do not reflect marginal changes in probability, we calculate the marginal effects (at the mean value) to interpret results more clearly. Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 31
Estimation results main variables # obs: 1,071 Marginal effects on probabilities Pseudo R 2 : 0.062 y = 1 y = 2 y = 3 y = 4 y = 5 Coefficient (no) (barely) (somewhat) (quite) (very) Over 71-0.306 0.112* -0.043-0.043* -0.023* -0.004* (0.19) (0.07) (0.03) (0.02) (0.01) (0.00) Log of property value -0.125 0.048* -0.016* -0.019* -0.012* -0.002 (0.07) (0.03) (0.01) (0.01) (0.01) (0.00) City size (30,000 to 100,000) 0.317*** -0.123*** 0.037*** 0.049** 0.031** 0.006* (0.12) (0.05) (0.01) (0.02) (0.01) (0.00) Resident in the North (d) 0.230** -0.088** 0.029** 0.035** 0.021** 0.004** (0.09) (0.04) (0.01) (0.01) (0.01) (0.00) Financial literacy (0 to 3 ) -0.082* 0.031* -0.010* -0.012* -0.007* -0.001 (0.04) (0.02) (0.01) (0.01) (0.00) (0.00) Risk aversion (index) 0.298** -0.115** 0.038** 0.045** 0.027** 0.005* (0.13) (0.05) (0.02) (0.02) (0.01) (0.00) Real estate perceived risk (d) 0.395*** -0.155*** 0.039*** 0.062*** 0.045*** 0.009* (0.12) (0.05) (0.01) (0.02) (0.02) (0.00) Willingness to sell the house (d) 0.702*** -0.274*** 0.061*** 0.109*** 0.085*** 0.020*** (0.09) (0.03) (0.01) (0.02) (0.02) (0.01) Debt aversion (d) -0.379*** 0.147*** -0.043*** -0.059*** -0.038*** -0.007*** (0.08) (0.03) (0.01) (0.01) (0.01) (0.00) Negative retirement exp. (d) 0.240*** -0.092*** 0.029*** 0.037*** 0.022*** 0.004** (0.08) (0.03) (0.01) (0.01) (0.01) (0.00) The superscripts ***, **, and * indicate the 1%, 5%, and 10% levels of statistical significance, respectively Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 32
Estimation results (cont d) Predictors of higher interest: medium/small city size (between 30,000 and 100,000 inhabitants) being resident in the north a higher level of risk aversion housing perceived as risky negative post retirement expectations willingness to sell the house Predictors of lower interest: higher housing equity (low significance level) debt aversion financial literacy (not very robust) Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 33
Discussion RMs as a way to achieve consumption smoothing: 20% of sample households is willing to access their home equity and among them interest in RMs is comparatively higher Is the product an alternative to downsizing? RMs as a way to increase income security in old age: homeowners concerned with their standard of living after retirement express a higher level of interest what is their poverty alleviating potential? RMs as a way to ease the burden of ageing on public spending: given the foreseeable cuts and pension reforms, will RMs market grow? (as it did in the US) how RMs compare with similar products i.e. the sale of the bare ownership / naked property? Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 34
Conclusions Italian households hold most of their wealth locked up in illiquid assets The aim of accumulating wealth, both real and financial, is (should be?) to deal with periods in life in which income is low, such us retirement The elderly are reluctant to decumulate their wealth, and therefore they are not effectively using it Since real estate wealth is illiquid, households tend to consider it as non-wealth The introduction and spreading of financial products such as the Reverse Mortgage can solve this problem Fornero Rossi Urzí, Università Torino and CeRP CCA, Save PHF conference July 2012 35
Thank you