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Risk Analysis for Reverse Mortgages with Different Payout Designs

Cho Daniel (), Katja Hanewald () and Sherris Michael ()
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Cho Daniel: Swiss Re, Sydney, New South Wales, Australia
Sherris Michael: School of Risk and Actuarial Studies, University of New South Wales, Sydney, New South Wales, Australia

Asia-Pacific Journal of Risk and Insurance, 2015, vol. 9, issue 1, 77-105

Abstract: We analyze the risk and profitability of reverse mortgages with lump-sum or income stream payments from the lender’s perspective. Reverse mortgage cash flows and loan balances are modeled in a multi-period stochastic framework that allows for house price risk, interest rate risk and risk of delayed loan termination. A vector autoregressive (VAR) model is used to simulate economic scenarios and to derive stochastic discount factors for pricing the no negative equity guarantee embedded in reverse mortgage contracts. Our results show that lump-sum reverse mortgages are more profitable and require less risk-based capital than income stream reverse mortgages, which explains why this product design dominates in most markets. The loan-to-value ratio, the borrower’s age, mortality improvements and the lender’s financing structure are shown to be important drivers of the profitability and riskiness of reverse mortgages, but changes in these parameters do not change the main conclusions.

Keywords: reverse mortgage; income stream; equity release; vector autoregressive model; stochastic discount factor; risk-based capital (search for similar items in EconPapers)
JEL-codes: G12 G21 G32 (search for similar items in EconPapers)
Date: 2015
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DOI: 10.1515/apjri-2014-0012

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