IPPR

1. IPPR Lifetime Mortgages Extending Equity Release Downwards 9th January 2006 Keith Haggart

2. AGENDA • The potential market for lifetime mortgages • Lifetime mortgages - market constraints • Access to advice • Transactional costs • Minimum's • Property and longevity risks • Funding • US market for lifetime mortgages (reverse mortgages) • Open session - how could the market for lifetime mortgages be extended downwards?

3. LIFETIME MORTGAGESTHE EQUITY RELEASE MARKET HAS SEEN CONSIDERABLE GROWTH IN RECENT YEARS, INCREASING FROM £665M IN 2002 TO £1,210M IN 2004. • The average house value in the UK has soared from £10,489 in 1973 to £182,882 in Q2 2005. This is even greater in London (£265,403) and the South East (£228,116). • For over-65 year-olds, 66 per cent of their wealth is in their homes. This is worth up to £693 billion according to B&W Deloitte Research. Prudential predicts that the lifetime mortgage market could grow from the £1 billion advanced per annum today, to £6.9 billion in 2008, according to research done in conjunction with Datamonitor. Below are statistics from the Council of Mortgage Lenders showing growth in 2002–3, and 2003–4. Lifetime Mortgage market expected to grow to £6.9 billion by 2008 , according to Datamonitor and Prudential.

4. LIFETIME MORTGAGESTHIS GROWTH IN THE LIFETIME MORTGAGE MARKET IS LIKELY TO CONTINUE IN THE YEARS AHEAD According to research conducted by Prudential in conjunction with Datamonitor, the Lifetime Mortgage market could grow from the £1bn advance per annum today to £6.9bn in 2008. This growth is going to be driven by a number of factors; • Demographics • Life expectancy for a male age 65 has increased from 77 in 1950 to an estimated 84 today and to a projected 86.7 by 2050. • The average male retirement age fell from 67.2 in 1950 to 63.1 in 1995, but it is rising again. • Inadequate Saving • 9.6 million people aged 35 and over in work are not saving enough for retirement. 54% are not contributing to a private pension at all and the remaining 46% are contributing at an inadequate rate • Active membership of Defined Benefit schemes is expected to have shrunk from 5.2m in 1995 to 2.3m in 2004. • In Britain in 2002-03, 11.3 million people in work were not making contributions to any private pension scheme. These non-contributors included about 1.7 million self-employed people • Opportunity for Alternative Retirement Solutions • Non-pension financial wealth amounts to around £1,150 billion (net of £150 billion of consumer debt) • Housing wealth is now about £3,000 billion at the gross level, and £2,250 billion net of mortgage debt • At present, owner-occupation is highest among 45-59 year olds (78%) • Only around 1% of pensioner households currently use equity release products • Opportunity for Maximising Tax Relief • Only 44% of people claim good or reasonable understanding of pension issues • Only 17% of basic rate tax payers and 28% of higher rate tax payers were able to correctly identify the tax relief rate

5. LIFETIME MORTGAGESUNITED KINGDOM GOVERNMENT’S CONCLUSION ON DEMOGRAPHIC CHANGE The Pensions Commission concludes that the continuing demographic changes causing the shortfall in pensions and savings could be mitigated by the following options: • Pay More Tax • Save More • Work Longer Which is fine if you’re still young. However, for people aged 50+ today, these options have come too late. Equity Release is the only viable solution to realising retirement dreams.

6. LIFETIME MORTGAGE MARKETCONSTRAINTS • Access to advice • Transactional costs • Minimum's • Property and longevity risks • Funding

7. ACCESS TO ADVICE • Traditional life and pension advisers are reluctant to enter the lifetime mortgage market due not only to the inequitable risk/reward profile associated with lifetime mortgages but also the additional complication of regulation under Financial Services Authority (FSA), Mortgage Conduct of Business Rules (MCOB) • Consequently there are advice supply issues in the lifetime mortgage market and this is the main contributory factor as to why the lifetime mortgage market has failed to grow year on year, for the first time since 1998 • Five specialist intermediaries control 60% of the lifetime mortgage advice market • Of these five, only one offers face to face advice • All five charge fees in a range of £300-£800 for a consultation irrespective of whether or not the customer purchases a product

8. TRANSACTIONAL COSTS • The average direct consumer costs of setting up a lifetime mortgage is £1,000 • Whilst customers can add some of the associated transactional costs to the loan, some have to be paid in advance • Fee for advice (£300-£800) • Valuation fee (£250) • Typical customer fees include • Product provider administration fee £500 (split 50/50 to cover administration fees and the Provider’s legal costs • Customer’s solicitors fee £250 • Additional Provider Costs • Commission/procuration fees, average £1,000 (minimum £500) The high initial fixed costs of a lifetime mortgage purchase, places upward pressures on the minimum initial premium

9. MINIMUM PREMIUMS • High transactional costs are influencing product design • There are approximately 20 providers in the lifetime mortgage market; • Only two have a minimum initial loan advance of £10,000 or below • Only two providers will accept properties below £100,000 • Of all properties sold in England/Wales during Q1 2005, 20% were sold for a price below £100,000 - Source Land Registry Sales completed Jan/March 2005 - Source, Land Registry

10. PROPERTY & RISK MANAGEMENT • Negative equity (longevity risk) • the key risk faced by the provider is that of negative equity I.e. the loan has increased to a value greater than that of the property itself • Risk management • to manage the longevity risk, providers operate loan to value maximums, normally linked to age of the customer I.e. the older you are the more you can potentially borrow • as property prices fall, for the same premium, the risk profile increases since the LTV increases e.g. a customer looking to borrow £20,000 on a £100,000 property (20% LTV) is a greater longevity risk than someone borrowing the same amount on a more expensive property e.g. a customer borrowing £20,000 on a £200,000 property (10% LTV) • Property Portfolio • lifetime mortgage lenders ultimately will need the property sale proceeds to repay the loan. Consequently risk management has a greater emphasis on the quality of the property portfolio, ensuring that on redemption of the loan the lender has a quality assets that can be sold quickly and at a realistic price • Risk profile is very different from conventional mortgage products

11. FUNDING • Lifetime mortgages are considerably different from traditional mortgages; • fixed rate of interest for the life of the loan • no capital or interest repayments during the life of the loan • increasing loan to value exposure • longevity risks resulting in negative equity exposure • Securitisation • due to the unique nature of the cashflows associated with lifetime mortgages, securitisation would appear a logical route to follow when considering funding in this market • however, to work efficiently/economically, securitisation requires scale (£250 million minimum) • Interest rate • these funding risks have a direct influence on the lifetime mortgages interest rate

12. Consumer market issues access to advice associated costs of taking out the product exclusion by virtue of property type and value Provider market issues structure and costs associated with funding the product securitisation risks longevity risks SUMMARY

13. HOME EQUITY CONVERSION MORTGAGE FEATURES OF THE US REVERSE MORTGAGE • All applicants are required to meet with a Federal Housing Association approved counsellor to discuss their options before applying for a reverse mortgage - service is state funded and is free of charge at the point of purchase • Set up costs include the origination fee (which can’t exceed more than 2% of the loan value), appraisal costs and other mortgage charges. • The loan is ‘non-recourse’ - the borrower won’t ever owe more than the value of their home. The lender is not permitted to obtain any other assets of the homeowner if there is a shortfall when the home is sold. If there is a shortfall then the FHA compensates the lender. This is covered by an insurance payment made by the borrower to the FHA. The insurance premium paid by the borrower is 2% of the loan value (based on upfront value of loan but charged at closing) and 0.5% monthly on the loan balance

14. RISK MANAGEMENT • Reverse mortgages are insured by an ‘assignment option’. Under this, the FHA collects the insurance premium paid by the borrower. When the mortgage balance reaches 98% of the adjustable property value (also called the maximum claim amount), the lender assigns the mortgage to the FHA. After assigning the mortgage the lender then makes an insurance claim to the FHA for the remainder of the loan balance. • The FHA therefore absorbs all risk associated with borrower longevity, interest rates and property value changes. Pooling the loans can reduce risks associated with borrower longevity, however a downturn in national property values and changes interest rates are risks which the FHA must absorb. The programme is dependent on long-term property appreciation.

15. OPEN SESSION • How could the market for lifetime mortgages be extended downwards?