Equity release companies are significantly undervaluing the ‘no negative equity guarantees’ they offer borrowers, a new report claims.
Think tank the Adam Smith Institute (ASI) suggests that there is a ‘scandal brewing’ in the UK’s equity release sector, arguing that the Prudential Regulation Authority (PRA), the industry regulator, has known for years that companies’ valuation methods are inadequate but ‘only made half-hearted efforts’ to address the under-valuation problem.
Equity release allows homeowners to take out a loan against money tied up in their home, with the debt being paid back after their death or when they move into long-term care. A no negative equity guarantee ensures that a borrower will never owe more than the value of their home. This gives borrowers peace of mind in the event of a house price crash if the value of their property were to fall below the amount they owed.
The report’s author Kevin Dowd, professor of finance and economics at Durham University, says: ‘We never seem to learn. Equitable Life hit the rocks two decades ago because it under-valued its long-term guarantees. Now the equity release sector is in deep trouble for the same reason. In both cases, the firms involved got into difficulties because they were using voodoo valuation methods that had no scientific validation.’
The institute reports that the equity release market had nearly trebled in size between 2012 and 2017 and has been forecast to grow a further 40 per cent by 2020.
However, Dean Mirfin, chief product officer at equity release provider Key, points out that it is lenders rather than homeowners that will feel the brunt if house prices were to crash.
He says: ‘Today’s report highlights that not only is the equity release market highly regulated but that it is the lenders rather than the customers which bear the risk of house price fluctuations.
‘The no negative equity guarantee is an important safeguard that ensures customers will never owe more than the value of their home, which provides peace of mind and the security of knowing they will not leave this debt to their families.’
The PRA, which declined to comment on the report, has published a consultation paper Solvency II: Equity release mortgages, which asks for feedback by 30 September on proposals to provide firms with greater clarity on how they should address no negative equity guarantee risks.
Mirfin adds: ‘The equity release market is growing significantly as more and more people use the equity in their homes to improve their standard of living in retirement. Product innovation and the important safeguards allow us to help these customers and we are hopeful that the PRA will bear this in mind as it continues with its consultation process.’
A spokesperson for trade body the Equity Release Council adds: ‘This is a prudent and highly regulated area of financial services to ensure market stability and good customer outcomes. The PRA is currently consulting on equity release regulations and the council and its members will continue to engage constructively on this matter.
‘While the detail of pricing decisions are commercially sensitive, common factors in offering a no negative equity guarantee include three fundamental lines of security: a prudent view of house price trends with allowances for future uncertainty; stress tests for very adverse scenarios; and significant extra risk capital to ensure that, in an extreme adverse event in the residential property market, providers remain able to meet future obligations to policyholders.’