Dean’s article “Just one in the Eye for Age UK?” (22 Aug 2019) tells an interesting story from the latest issue of Private Eye about a mystery shopper who contacted Hub financial via the Age UK website, enquiring about an equity release mortgage (ERM). When he took Age UK’s advice to “dip his toe” into equity release, his enquiry was channelled through Hub’s independent panel of lenders and he was offered an ERM loan from one particular firm. This offer came as a bit of a surprise to the toe tipper, however, because he had already been offered an ERM loan from another firm that was also on Hub’s panel, and in his opinion, this previous offer from the other firm was a better one. So one wonders what is going on.
These articles got me thinking: how would one go about establishing the potential loss to an ERM borrower from going with one lender, when an alternative lender would have given them better terms?
Let me emphasise first that this posting is purely a methodological piece to illustrate the issues involved in carrying out such a calculation. Our legal adviser has advised that I should emphasise that any resemblance to any real world case is purely coincidental, as they say in the movies.
She also suggests that I should refrain from giving any but the sparsest details of any actual calculation, lest any coincidences amongst those details be inadvertently taken to refer to some real world case. So for once, I depart from our usual practice of giving sufficient information for readers to be able to reproduce the results for themselves, and instead merely sketch out the main issues involved in the calculation.
Finally, to cover my legal P’s and Q’s, let me say that this posting is written without sight of the letter that our mysterious mystery shopper supposedly wrote to Age UK’s chair of trustees, according to the Eye article.
So let me consider two firms A and B. Firm A offers better loan terms in terms of the loan advance and the loan interest rate than does firm B, but the borrower (for whatever reason) chooses to borrow from firm B instead of from firm A. The question is: how much does the borrower lose by going with the ‘wrong’ ERM lender?
The methodology goes as follows. Lender A offers an ERM loan based on particular terms, i.e., loan rate and Loan to Value Ratio. Lender B offers an ERM loan based on their terms, which by hypothesis are worse for the borrower than those offered by lender A. So we take each offered loan amount, and project those over time by the offered loan rate. We then obtain the exit probs, the probability of repayment for each loan, for each future time t. Combining the two, we obtain the expected repayments for each loan, for each future time t, and we discount those by the risk free rate. As a further nuance, we would adjust the expected payments for the impact of the NNEGs, but if we base these adjustments on recent hpi rates used by prominent UK ERM firms, the impact of this adjustment should be minor. The loss for the borrower is then the difference between the present values of the expected loan repayments offered by the two firms.
Regarding the calibration, we have an ERM loan of £320k, and two different loan rates from two different lenders, and both loan rates, one might say, are well within the range of ERM loan rates available on the market, i.e., the alternative loan rates are not unreasonable from a market perspective. As usual, I assume a risk-free rate of 1.5% and work with Andrew Cairns’s, David Blake’s and my M5 CBD mortality model to obtain projected exit probs, and the model is calibrated to our usual LLMA deaths rate data over sample years 1971:2017 and sample ages 55:89. I fill in the other details as best I am able to under the circumstances.
Based on these calibrations, the net loss in present value terms to our mystery shopper is £197.6k, which is almost 86% of the loan amount. This estimate might strike some readers as a bit high.
It struck me that way too.
To put this number into perspective, this loss is roughly equivalent to 659 new washing machines, 99 new patios and 40 luxury Caribbean cruises for two.
My main point however is that the potential losses to the borrower from choosing the ‘wrong’ (from the borrower’s point of view) ERM lender can be large, and a lot larger, say, than choosing the wrong energy supplier (see Eye passim – and here).
There is, thus, a conduct of business issue here, and one might have thought that this issue might be a priority for the FCA. Then again, the FCA has been plenty in the press recently and for all the wrong reasons, so we can understand why they might have not had their eye on the ERM ball either.
As for the ERM industry, it is in no one’s interest to see a potentially worthwhile and certainly growing sector exposed to groundless accusations of malpractice, not to mention the UK’s leading charity for the elderly.