Equity Release: Another Equitable in the Making

Dean Buckner and Kevin Dowd
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Dean Buckner: The Johns Hopkins Institute for Applied Economics, Global Health, and the Study of Business Enterprise
Kevin Dowd: The Johns Hopkins Institute for Applied Economics, Global Health, and the Study of Business Enterprise

No 129, Studies in Applied Economics from 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.

Keywords: no-negative equity guarantee; equity release; actuarial science; put option pricing; Equitable Life; prudential regulation (search for similar items in EconPapers)
JEL-codes: G22 G32 G38 (search for similar items in EconPapers)
Pages: 56 pages
Date: 2018-11
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Persistent link: https://EconPapers.repec.org/RePEc:ris:jhisae:0129

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