Author: db

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In the news

We learned on Friday that the High Court blocked the ‘Part VII’ transfer of a £12bn annuity portfolio from Prudential to Rothesay.  According to the judge, Justice Snowden, Rothesay was ‘a relatively new entrant without an established reputation in the business’, and that although its capital strength was as strong as that of Prudential, it ‘does not have the same capital management policies or backing of a large group with the resources . . . to support a business that carries its name’.

This decision is significant for a number of reasons, some of which we will have to leave until later. The main thing for now is that at least one part of the system is working. The PRA and the Independent Expert approved the transfer and saw no detriment to existing policyholders. But the judge saw detriment, and that was that.

Whether or not Rothesay’s capital position is as strong as Prudential is an interesting question we shall put aside for now.

In other news,  the shares of American insurer GE dropped last week after Madoff whistleblower Harry Markopolos claimed a $38bn fraud. Although whether it is fraud, or merely insurance accounting, is always difficult to say.

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Quids in

Kevin writes here

It also gets interesting if the firms use different valuation approaches from each other. In that case it would be theoretically possible for both parties to post a profit on the transaction or for both parties to post a loss on it.

He is referring to the approaches used to value the embedded put option in the ERM, and the actual put option used to hedge the ERM.

There is a troubling reminder here of what happened to AIG Financial Products in the run-up to the last financial crisis.

Continue reading “Quids in”

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Just hedging their bet

Since Just Group’s trading update last week, there has been much speculation about the ‘pioneering no negative equity guarantee (NNEG) hedging transaction’ announced by the firm. It is not clear whether the firm has put the hedge in place, or whether they are still waiting to establish ‘appropriate regulatory treatment’ with PRA. The current thinking is that the hedge will be transacted through a major reinsurer, and that it will be a purchase of some form of long dated put option on the housing index.

Continue reading “Just hedging their bet”

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The Eumaeus Guide to Equity Release Valuation

Published this morning

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.

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We thought it was organised by Age UK

A good story here in the Telegraph about the cosy relationship between Age UK and Hub financial (owned by Just Group). Behind a paywall, but in summary, a couple took out an equity release mortgage with Just (then Just Retirement) in 2012. They were told the service was ‘the Age UK equity release service provided by Just Retirement Solutions’, and the advisor’s identification would show as ‘Age UK’. In reality, the advisor was wholly employed by JRS and had nothing to do with Age UK. The customers took out a £300k loan (which would now be worth nearly £470k).

The couple now want to change the loan to one with a cheaper rate, which will cost them £30k. Yet the advisor supposedly told them (in 2012) that gilt rates would move in their favour (i.e. go up) over the next few years, so they would face no early repayment charges.

Of course it would seem natural in 2012 to think that rates, then at a long term low of around 3%, would go up. Just as natural as thinking, in 2019, that house prices will continue to rise at 3-4% a year for ever, the assumption which is the basis of the entire equity release market.