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Equity release lender stability and PRA oversight questioned by think tank

  • 07/08/2018
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Equity release lender stability and PRA oversight questioned by think tank
Equity release lenders may be on the hook for billions of pounds in losses by failing to properly value their non-negative equity guarantees (NNEGs), according to a report by the Adam Smith Institute.


It warned that the Prudential Regulation Authority (PRA) may have ignored concerns about the viability of NNEGs promised by lenders.

The report claims that the under-valuation of these guarantees in equity release mortgages is a ticking time bomb and that the PRA made only half-hearted attempts to address this.

However, in July the PRA proposed new requirements for equity release providers to change how they assess their liabilities which could require lenders to hold more capital to cover their lending.

This follows on from a series of speeches and policy tightening around equity release since 2015.


Overexposed loans

The free market think tank commissioned the research in association with the BBC.

Its analysis argued that lenders could find themselves overexposed due to the potential of people living longer and house prices declining or not rising fast enough to keep up with the loan value.

The authors conducted six stress tests to see how poorly an equity release loan would perform under severe economic conditions.

The two tests involving house price risk were conducted using a 30% and 40% crash in property prices, while in another test borrower longevity was increased by an average of two years.

In the 2008 house market crash, prices fell by around 16% before recovering to slight gains in 2009.

Report author Kevin Dowd, professor of finance and economics at Durham University, said the situation had echoes of that of Equitable Life which under-valued its long-term guarantees.

“Now the equity release sector is in deep trouble for the same reason,” he said.

“In both cases, the firms involved got into difficulties because they were using voodoo valuation methods that had no scientific validation. Same causes, same results.”


Prudent approach

The equity release industry rejected the assertions made in the report noting that it would continue to engage with the regulator’s consultations, while the PRA said it was not commenting on the issue.

An Equity Release Council spokesperson said: “This is a prudent and highly regulated area of financial services to ensure market stability and good customer outcomes.

“While the detail of pricing decisions are commercially sensitive, common factors in offering an NNEG include three fundamental lines of security: a prudent view of house price trends with allowances for future uncertainty; stress tests for very adverse scenarios; and significant extra risk capital to ensure that, in an extreme adverse event in the residential property market, providers remain able to meet future obligations to policyholders.

“We understand the general approach to NNEG pricing reflects current accepted rules and will continue to consult on this matter with the PRA as indicated.”

A spokesperson from Legal & General Home Finance noted that it was committed to growing the market in a safe and sustainable manner.

“We welcome the PRA’s consultation into the lifetime mortgage market,” he said.

“We believe in taking a prudent approach to all assumptions and calculations, including those relating to the NNEG, and as both the UK’s largest institutional investor and the leading provider of lifetime mortgages, the financial security of our customers is central to everything we do.”



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