Participants in the UK equity release market – insurance companies, advisers and consultants – generally agree that the industry has something of an awareness challenge. Despite industry efforts in terms of media advertising, many in the over-55 cohort – those homeowners who can take out an equity release mortgage – either don’t know that the option exists, or might have come across it in passing, but haven’t taken the time to explore the nuances of the option.
The current macroeconomic environment is changing that, however. And, according to Rudy Khaitan, Managing Partner at UK-based later life lender Senior Capital, there’s an obvious reason.
“Homeowners who qualify for an equity release mortgage in the UK – those aged 55 years or more – that are coming to the end of their fixed-rate mortgages are faced with remortgaging into much higher interest rates than they’ve been paying in the past few years,” he said. “Equity release mortgages are less burdensome in terms of cash flow as the interest rolls up, and it isn’t usually repaid each month like a regular mortgage. This helps enormously with the cost-of-living challenges we’re seeing right now.”
Equity release market bulls say that the UK has the fundamentals for a sustained period of growth. The country has an aging population, with generally increasing house prices over time. Additionally, although many of the 55+ homeowning population are asset rich, they often have either low levels of cash savings or small pensions in the context of their remaining life. Activity in the space is driven mainly by a needs-based situation, like the requirement to access cash, or financial planning. Whilst the latter is more sensitive to macroeconomic factors, Khaitan says that overall, demand is fairly inelastic.
“Financial planning reasons generally include parents looking to accelerate the transfer of wealth to their children via a tax efficient mechanism, for example to help fund a deposit for their first property. This use case is more sensitive to interest rates because borrowers are able to release less cash in a higher rate environment relative to when interest rates are low. There remains an element of demand inelasticity however as interest on equity release doesn’t need to be serviced and there is always the option to refinance when rates come down.”
Investors such as hedge funds and private equity funds don’t play in the equity release space because of duration constraints, they can’t compete on price with insurers, and there isn’t a sufficiently developed secondary market to support trading liquidity. But the existing funding supply is currently dominated by UK life insurers because equity release mortgages are one of the few long-term assets that meet their particular investment objectives. There is a clear benefit to an insurer from investing in equity release mortgages, particularly when they are in the form of structured, matching adjustment eligible, rated notes when compared to other similar duration assets.
“Equity release mortgage-backed notes, when structured appropriately, not only offer attractive risk adjusted yields but crucially, much coveted long duration cash flows that align with insurers’ liabilities and regulatory requirements,” said Khaitan.
Insurers in the UK currently securitise their equity release mortgages exposure so that they can issue fixed cash flow notes in order to benefit from the Solvency II matching adjustment. The residual risk component of the securitisation sits in the ‘own funds’ section of the balance sheet, which requires an additional layer of capital capacity from a regulatory accounting perspective.
Securitising ERM portfolios externally is one area of potential growth which would release even more capital for even more deals. A third party sells the matching adjustment compliant notes to the insurer and holds the residual risk on their balance sheet. More activity in this area could be added fuel for the industry.
“This method of structuring equity release mortgages means that you’re not using the shareholder funds to absorb the capital requirements from holding the residual notes that aren’t compliant with the matching adjustment. An external party is the ultimate risk retainer, and this frees up that capital for other uses,” said Khaitan.
This is still all UK-based, however. What about Europe? Many countries in western Europe don’t really have much of an equity release market, if at all. There’s some activity in Spain and Sweden, but little anywhere else, and the activity that does happen isn’t structured the same in each country. Steve Kyle, Secretary General of trade body European Pensions and Property Asset Release Group (EPPARG), says that efforts are underway to try to grow the market overseas.
“The European equity release market tends to vary in each nation state. There are common elements and EPPARG members are as one in terms of looking to proactively put in place proportionate and relevant consumer protections and processes. Many of our European members see huge untapped growth potential and some of the cultural challenges now appear less significant, since an increasing number of homeowners are cash rich and income poor. In some markets the momentum for equity release is picking up, but greater awareness and funding would help. The current global economic issues have proved to be a double-edged sword, pushing up some demand, but increasing some of other risks. Our members remain positive regarding prospects for the medium term, and, in their home markets, many partners, customers and regulators welcome the direction of travel.”
As Kyle alludes, the demographics in western European countries are very similar in the sense of an ageing population. And there are cost of living challenges, albeit not as pronounced as in the UK. On the surface, western Europe would certainly seem like fertile ground for such a market, but according to Ben Grainger, a Partner at EY in London, it’s important that the anticipated growth in the market on the continent is driven by an effective model, something that’s not necessarily easy to implement.
“The funding models for equity release don’t exist in Europe the same way as they do in the UK. We have a good funding model in the UK, and it’s a case of engaging with stakeholders overseas to adopt something similar. It’s not a straightforward process to get everyone aligned,” he said.
There is a market in the US, of course. ‘Reverse mortgages’ have been a feature of the financial planning market in the US for many years. But for those in Europe, it’s a case of continuing to focus on the UK market for the time being.
“The total size of the ERM market in the UK is around £6bn,” said Khaitan. “But I think that can go to £10bn soon – years, not decades – so there is room for growth. And the explosion in bulk annuity risk transfer deals means there will be plenty of funding available to absorb the growth. There’s a mild dislocation in terms of supply at the moment because of the higher interest rate environment, but the fundamentals remain. More and more of the 55+ demographic will turn to their home in the coming years to access cash.”