There was much talk about the UKAR ‘bad bank’ selling a portfolio of ERM loans to Rothesay Life, an insurance company once owned by the good bank. See e.g. this report by Ralph and Pooley.
They write
Equity release mortgages have become increasingly popular with insurance companies because the long-term nature of the loans matches neatly with the liability profile of the annuities provided by life insurers
which is incredibly false. For a start, ERMs don’t really start paying off until later in the maturity structure, whereas conventional annuities have to be paid now. This can be fixed by using shorter term bonds to complement the ERMs, but the more serious problem is that longevity risk works against you on both sides. If annuitants live longer, you could reasonably assume that ERM borrowers will live longer too. But the longer the borrowers live, the more the ERM portfolio resembles a punt on the housing market, even though the longer-lived pensioners need paying too.1
The real story, though, is the incredible secrecy surrounding deals like this. Rothesay is managed by ex-Goldman people, so they won’t have made any deal unless there was a pile of loot to be made. Yet UKAR declined to provide any useful information about the sale. They told me that the quoted £860m was net of their own estimate of NNEG impairment of around £200m, so we can assume the total loan value, i.e. original amount lent accrued at the loan rate, probably about 7%, 2 is somewhat north of £1bn. Note that according to UKAR’s own financial statements (p.36), they are using the now-discredited HPI method to price the NNEG. But they won’t say (a) how much Rothesay paid (b) the average age and loan to value on the book, so it’s impossible to say how much the taxpayer has made or lost on the deal. I fired off a Freedom of Information request to the National Audit Office, so let’s see.
Why are Rothesay buying? They are clearly making a bet on whether the PRA will allow Matching Adjustment approval for the UKAR book. Eumaeus will be worrying about this next year, but essentially MA is a way of realising the future profits on the book. To find out, I fired off another FOI request to the Bank, to find out whether Rothesay have MA approval or not. I expect they will say it is ‘commercially sensitive’ or something like that, but once again let’s see. It is clearly sensitive for pension funds like BA, some of whose liabilities are managed by Rothesay, but that doesn’t count. We were told for ages about the revolution wrought by the Internet, information wants to be free and all that, but the information that matters is still a closely guarded secret.
I can understand why the location of UK missile bases cannot be made public. But why is the composition of anyones pension fund such a state secret?
We should be told. But we won’t be.
- There is another mistake which has been a constant feature of the misreporting of the PRA proposals. Ralph and Pooley write ‘The Prudential Regulation Authority has been scrutinising the amount of capital insurers should be required to hold against equity release mortgages’. This is not correct. The amount of capital required remains unchanged for the moment. What has changed is the amount of capital available to meet that same capital requirement. The PRA is saying in effect that firms have misvalued the NNEG, which will impact the book value of capital. For example, suppose the capital requirement is £1bn and the capital available is £1.5bn. That gives a solvency ratio of 150%. But then the PRA says ‘you have not been valuing the NNEG correctly, so the capital available is now only £900m’. Then the solvency ratio is now 0.9bn/1bn = 90%. The denominator is unchanged, i.e. the capital requirement is unchanged, it’s the numerator, i.e. the amount which is the problem which the PRA addresses
- The book is mostly ERMS sold by Bradford and Bingley, circa 2004-8)