A great piece here from BBC journalist Howard Mustoe, about an added cost on extending a leasehold with fewer than 80 years remaining, called marriage value.
Plummeting values of retirement homes
There was an excellent article in the Saturday Times yesterday, supported by a leader (see above).
Still doesn’t add up
I discussed the mathematics of the PRA proposal to tie the deferment rate to the real risk free interest rate here, linking to two earlier posts by Kevin with the detailed mathematics. But we can express our result without much of the detailed mathematics, as follows.
The Discounted Projection Approach
The standard approach used by UK ERM actuaries to value NNEGs and ERMs is the Discounted Projection (DP) approach, which its adherents like to call the ‘real world’ approach.
This approach is based on the use of a projection of future house price growth to value the NNEG. In particular, it replaces the forward house price as the underlying in the Market Consistent (i.e., correct) approach with some expected future house price ‘forecast’ that a cynic (not us!) might say was indistinguishable from a convenient guess.
Roll up and Other Misconceptions
Pete Matthew of Meaningfulmoney has an interesting series of videos on equity release. The one that caught my eye was this published on 24 Aug 2011. He writes,
One of the main concerns for those contemplating Equity Release is that the interest building up so fast, there’ll be no equity left in their home to leave to the kids. Here, I show that it’s really not as bad as all that by looking at some realistic examples.
He then goes through the mechanics of the hare vs. tortoise race between rolled up loan amount and house prices. He also gives examples based on an example case in which there is a house worth £200k, an ERM loan of £50k, a loan rate of 7% and an hpi of 3%, with discrete annual compounding.
His results for the Lifetime Mortgage case are shown in the following screenshot:
The key finding is that it takes an awfully long time for the house price to overtake the loan amount and push the loan into negative equity.
That might not be the whole picture, however.
Turning Japanese
Turning Japanese
In a previous posting, we discussed a type of stress test in which house prices fall immediately after an ERM contract has been entered into.
However most stress tests are passage-of-time stress tests in which we posit some hypothetical stress over time and then use our model to see how that stress would effect something we are interested in, over the passage of time.
For example, we might assume a hypothetical rate of growth of hpi and show how the ERM valuation would behave over time under the posited scenario.
A Back of the Envelope House Price Stress Test for ERMs
by Kevin Dowd
A scenario analysis is a hypothetical ‘what if’ exercise in which we examine what might happen to some variable of interest (e.g., a NNEG or ERM valuation) if some future scenario were to occur.
For example, we might examine what would happen according to our model if future house prices were to behave in a particular way.
A stress test is a scenario analysis in which the posited scenario is an adverse one (e.g., a large drop in house prices).
One type of scenario analysis/stress test is to model the impact of an immediate one-off house price fall. We assume that house prices fall five minutes after the ERM loan has been made. This exercise is ridiculously easy to carry out and can be very revealing. It should therefore be an essential tool in every ERM risk manager’s toolkit.
Continue reading “A Back of the Envelope House Price Stress Test for ERMs”
It’ll Never Happen Here
By DB and KD
Our friends Tony Jeffery and Andrew Smith have some wise advice that the PRA should consider in their new insurance stress tests. Our advice was not to bother, but assuming the PRA chooses for once not to follow our advice, they might look at the following passage from Andrew and Tony’s recent Society of Actuaries in Ireland (SoAI) report on NNEG valuation:
In 1995 a SoAI paper (Demographic Margins for Prudence – Jeffery & Quinn, 1995) suggested that a valid approach to setting margins was to consider how it would look to a public with the benefit of hindsight if it has gone wrong, noting that with the clarity that hindsight brings can be harsh.
Doom and gloom
If you have come to this blog looking for upbeat fluffy stories then you have come to the wrong place. If the market is up at record highs, then we say the bubble will burst, and it’s doom. If we are in the vasty deeps of a massive bear market and, well, it’s gloom all round.
We have been following the Aussie and Canada housing market for a while
Kenny on the Global Financial Crisis
Tom Kenny, chair of the Equity Release Working Party, Staple Inn 28 February 2019
… I would say what hasn’t come out of the paper is what the difference between those two approaches [i.e. Real World and Risk Neutral] is, and that’s something the working party wants to look at, to say .. what is the difference between the two approaches, and then have that policy debate, because, you know, market consistency is obviously where we are today in a large part of the financial industry, but market consistency doesn’t necessarily work. [The] global financial crisis was largely driven by the investment banks and the banking approach to modelling risk and that’s purely a market consistent approach.