THE EUMAEUS GUIDE TO EQUITY RELEASE VALUATION
Restating the Case for a Market Consistent Approach
The 180 page guide, by Dr Dean Buckner (Eumaeus) and Professor Kevin Dowd (Durham University and Eumaeus) is the most comprehensive work on the valuation of equity release mortgages to date.
The guide emphasises the team’s previous warnings about poor valuation practice in the equity release sector. “As far as we are aware, not a single equity release firm is valuing its No-Negative Equity Guarantees (NNEGs) correctly,” said Dowd.
The result is a guarantee-undervaluation problem akin to that we saw two decades ago in the Equitable Life fiasco.
Key findings include that:
- This NNEG under-valuation problem is on a large scale and implies correspondingly large over-valuations of Equity Release Mortgages (ERMs).
- The Discounted Projection or ‘Real World’ approach used by the equity release industry is inherently flawed and produces valuations that violate bounds that are known to be inviolable.
- The only scientifically valid valuation approach is the Market Consistent approach, which is also the only approach compatible with accounting principles and technical actuarial standards.
- Market consistent valuations cast doubt on the profitability of ERM loans especially to younger borrowers.
The guide develops the team’s previous work on the valuation of the guarantee embedded in equity release mortgages. There is a new mathematical derivation of the ERM “deferment rate” from first principles. “The deferment rate is important not only for the valuation of equity release mortgages, but also for the valuation of leasehold extensions,” said Buckner. “Equity release is a form of lease to the borrower, and this work shows how both can be valued in an objective and scientific way, unlike existing approaches.”
The report also contains results on the complex mathematics of the volatility used in the option formula underlying the guarantee, as well as new work on property dilapidation, mortality and long-term care, drawdown, prepayment and ERM stress-testing.