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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.

Continue reading “Roll up and Other Misconceptions”

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At Last, a Refereed Article on NNEG Valuation

… that uses the correct valuation approach. Disclosure: we are two of the co-authors, so we would say that.

The article, “The Valuation of No-Negative Equity Guarantees and Equity Release Mortgages” by Kevin Dowd, David Blake, Dean Buckner and John Fry has just been accepted by the well regarded academic economics journal, Economics Letters.

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The Mysterious Mystery Shop

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?

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Just one in the Eye for Age UK?


A curious piece in the Eye yesterday claimed that a mystery shopper contacted Hub financial via the Age UK website, enquiring about an equity release mortgage.

Get a copy yourself and support good investigative journalism, but briefly, the shopper was quoted 5.35% from Just Group, a provider on the Hub ‘panel’ of lenders, as being the best value.

When the same shopper contacted L&G, also supposedly on the panel, he was quoted only 5%. He complained to Sir Brian Pomeroy (Age UK chairman of trustees) saying he might publish something about the problem, but instead got ‘a stiff letter from Julian Pike of expensive “reputation management” solicitors Farrer and Co’, suggesting firmly that he should not publish.

Just fancy that.

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The High Court judgment

The transcript is here. Some points to consider.

  • The independent expert, Nick Dumbreck (Milliman), calculated that ‘in the case of Rothesay, an SCR coverage ratio of 100% equates to a likelihood of its assets being sufficient to cover its Technical Provisions in one year’s time of 99.5%; an SCR coverage ratio of 130% would equate to a likelihood of its assets being sufficient to cover its Technical Provisions in one year’s time of 99.96%; and an SCR coverage ratio of 150% would equate to a likelihood of its assets being sufficient to cover its Technical Provisions in one year’s time of 99.994%’.
  • The probability of default is thus lower than the probability calculated by the HBOS advanced IRB model at the beginning of 2008. Policyholders can rest assured, then.
  • Matching Adjustment was not discussed at all, so presumably not deemed relevant to policyholder interests. Question: if MA were taken away, would that change the probabilities referred to above?
  • ‘As at 31 December 2018, for Solvency II purposes, Rothesay had total assets of about £36 billion, Technical Provisions of about £32 billion, Own Funds of £3.89 billion and a SCR of £2.16 billion. Its SCR coverage ratio was thus 180%.’
  • Dumbreck argued that while Prudential has a greater absolute capital surplus than Rothesay, ‘the levels of surplus relative to the amount of its technical provisions are of the same order of magnitude for both companies. He expressed the view that it is this relative cover for liabilities that is material, rather than the absolute surplus’.

More later.

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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.

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Just a NNEG Securitisation

In a recent (July 30) posting, Dean wrote that

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.

A related possibility is that the hedge, if there is one, is some kind of NNEG swap, which then raises the question: what is Just’s NNEG valuation?

Short answer: we don’t know and it would be naughty of us to speculate. We don’t have enough information about the firm’s ERM portfolio or enough information about the firm’s valuation approach.

But this got us thinking …

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The Bank’s ‘Stress’ Tests

My report on the Bank of England’s latest (November 2018) stress tests was published by the Adam Smith Institute on August 3rd.

The purpose of the stress tests is, in essence, to persuade us that the banking system is in good shape on the basis of a make-believe exercise which purports to show what might happen in the event of a supposed severe stress scenario as modelled by a central bank with a dodgy model and a vested interest in showing that the banking system is in great shape thanks to its own wise policies.

We are expected to believe that the central bank has managed to rebuild the banking system despite enormous pressure placed on it by the institutions it regulates, whose principal objective is to run down their capital ratios (or equivalently, maximise their leverage) in order to boost their returns on equity and resulting short-term profits, and never mind the systemic risks and associated costs imposed on everyone else or the damage their high leverage did in the Global Financial Crisis.

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