Equity release providers caught ‘in the nip'
THE last two columns explained equity release and its risks, and I finished last week explaining that costs of future equity release could increase.
I've had a few questions, so thought I would explain why. It may trigger you to consider earlier equity release, or not at all, and also whether you would wish your investments to be exposed to the shares of those companies who offer equity release programmes.
The Financial Conduct Authority's predecessors (they just had a different name) have been caught snoozing on numerous occasions and we would hope their renamed FCA are wise to this. BCCI, Barings, Johnson Matthey are all well documented but what about the potential risk that comes with Equity Release schemes?
Whether it was endowment policies, pension transfers, zero dividend preference shares, structured at risk investments et al, some financial advisers have been caught swimming with no trunks when those tides went out.
Worse still, the designers of the products, and many advisers, didn't understand tides. ‘Who would have thought that would have happened?' becomes a bit repetitive after a while.
In our third coverage of Equity release, let's consider another risk, and the potential of that impact on you as a shareholder, and the person who is taking out an equity release plan.
Naturally, you would only enter into an equity release plan if it has a no negative equity guarantee (NNEG). This simply means that if your debt rolls up and becomes more than the current value of the property, you won't be held accountable for the excess.
Like any deal, there's a trade-off - i.e. winner v loser. The risk of negative equity is no longer yours, but the potential for your return is equally reduced as the debt rolls up.
For the equity release provider, the risk lies flat with them. If they have their calculations wrong, their shareholders (you, inside a pension fund, ISA etc) may pay dearly.
After the Equitable life debacle, the regulator was supposed to move toward a more dynamic, risk-based regulation, rather than rules based. It would appear lobbying may have got in the way – as always.
Professor Dowd has calculated how insurers are protecting themselves and The Adam Smith institute has concluded:
“I am not aware of a single firm that has demonstrated that it is valuing its NNEGs using a defensible valuation methodology“
Simply put, they have mixed up the ‘forward price' of property and a ‘future price' – schoolboy error. One is based upon house price growth assumptions based on the past, and the other is based upon a financial instrument called an option. They are as related as Trump and Corbyn.
The Prudential Risk Authority also refers to it as ‘conflated'.
I checked the risk/impact to the person taking out an equity release plan with the Equity release council, as it stated you ‘should' be ok if an insurer/provider is unable to meet its liabilities. They confirmed that: “There can be no change to a regulated contract's guaranteed terms as a result, including the interest rate customers signed up to. For Equity Release Council members, this includes safeguards such as the No Negative Equity Guarantee, a fixed or capped interest rate for life and the right to remain in the property for life or until they need to move into long-term care”.
The only obvious issue, which therefore affects the ‘equity releaser', is that, after the current review, insurers realised they are exposed via their assumptions and the insurance options they are using to protect them. Such options are expensive and one might assume will have to change, and as such, the cost will make its way to you, equity releaser.
Whilst future interest rates are now very uncertain – i.e. will there ever be a Brexit? (One way or another inflation and interest rates will swing wildly) – But all things being equal, the review should have an upward impact on equity release rates.
As a shareholder however, these products put a huge strain on insurers' liquidity and in the case of falling house prices, the option prices can be crippling as they are not linear in their correlation i.e. balance each other out, and are often leveraged, so the downside can be a multiple.
Beware your shareholdings.
:: Peter McGahan is chief executive of independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority. If you would like to discuss equity release mortgages, please call Darren McKeever on 028 6863 2692, email firstname.lastname@example.org or visit www.wwfp.net.