Regulatory scrutiny overhangs equity release

The Prudential Regulatory Authority’s (PRA’s) 29-page review, DP1/16: Equity Release Mortgages, highlighted areas of concern over the risks potentially posed by equity release.

The discussion paper asked for views on, among other topics:

■ equity release mortgage (ERM) valuations

■ capital treatment

■ risk management

■ how properties are maintained by the homeowner.

The document stated: “The PRA seeks a range of views on good practice for managing the risks introduced by investing in this asset class.”

Dean Mirfin, technical director for Key Retirement, says: “This is heavily driven by Solvency II [a European Directive which came into effect in 2016].”

The proactive approach from the PRA suggests far from making equity release mortgages less attractive, they realise the value it holds for many older people. Steve Lowe

Stephen Lowe, group communications director at Just Retirement, agrees: “The treatment of equity release assets under Solvency II has been a subject of much discussion for insurers.”

On 6 November 2015 the PRA published a Solvency II Directors’ update, stating that during 2016 it would undertake an industry-wide review of ERM valuations and capital treatment.

The letter referred to mark-to-model assets more generally but specifically mentioned ERMs, where the PRA considered there to be “particular challenges and a range of perspectives on the degree of risk embedded in ERMs and how they should be valued”.

The March 2016 paper was the first part of the PRA’s review.

Reception

Paul Carter, chief executive at Pure Retirement, says: “I doubt the PRA’s review will make equity release less attractive, as it is more likely to align the way in which the asset is treated and valued.”

Mr Lowe adds: “The proactive approach from the PRA suggests far from making equity release mortgages less attractive, they realise the value it holds for many older people and are working to ensure it continues to be an attractive asset for insurers.”

But not all industry commentators think the PRA’s review will necessarily lead to good consumer outcomes.

Mr Mirfin has expressed concern: “The PRA’s view on some of the risks may go too far and potentially make equity release more expensive and less flexible.

“However, only a few types of lenders [such as life assurers] may be affected by this, so it could provide opportunities for other competitive entrants to come into the market, if it does become constraining because of the PRA’s approach.”

Nigel Waterson, chairman of the Equity Release Council, says: “There is regulatory intervention that is appropriate for the market, particularly in terms of clarity and consistency or internal governance challenges at firms writing equity release business.

“But it is a case of balancing this so new entrants are not deterred from joining the market, which would limit competition.

“Crucially there are also inherent differences in equity release compared to traditional assets that fall within the PRA’s current review. It would be an odd outcome if regulatory intervention resulted in fewer products and less protection for consumers.”

John Mahon, head of equity release securitisation for Aviva, comments: “Firms should work closely with the PRA to come to a resolution that works for all, and which ensures good customer outcomes.”

Whether the PRA’s review makes equity release less attractive or not remains to be seen, but Mitch Hopkinson, head of advice at deVere UK, says: “Equity release’s attractiveness also depends on future interest rates and whether lenders continue to be prepared to potentially ‘take a hit’ should longevity remain on an upward trend.”

Affordability requirements

In April, the Financial Conduct Authority (FCA) softened the affordability requirements under its Mortgate Conduct of Business rules (MCOB 9.4) to allow equity release lenders to apply for a rule waiver to allow them to “switch off” affordability assessment for borrowers offering interest-charging lifetime mortgages that can convert to roll-up mortgages.

This followed the 2014 Mortgage Market Review, which demanded strict affordability criteria on lenders relating to the client’s income and repayment options.

However, this meant some equity release customers who would have taken out a lifetime mortgage so they could repay interest for as long as they wished may have not passed the affordability assessments.

Following calls from the industry as part of its 2015 FCA Call for Inputs on the mortgage sector, the FCA relaxed the affordability rules.

In a statement on its website, the City watchdog explained the modification had been made because it did not consider “an affordability assessment is required where there is no risk of arrears and repossession in the event of missed payments”.

Key Retirement’s Mr Mirfin comments: “The FCA is reacting positively to the need to ensure older borrowers get access to competitive markets, and this is no different for the mortgage sector, including lifetime mortgages.”

Our primary concern is to ensure more people have access to the advice they need to make adequate provisions for their retirement and later life. Nigel Waterson

He says relaxing the affordability requirements for mortgages where an interest-only loan can convert to roll up with any default/repossession risk is “is an important step as it opens a way for more innovation to follow which allows serviceable lending”.

Innovation

In a speech in 2015, Christopher Woolard, director of strategy and competition at the FCA, told the FCA’s mortgage conference: “While we have seen a combination of regulation and industry-led initiatives to help clean up the market, some will argue the costs of equity release, both upfront and compounded, are relatively high for the individual, and the previous image has stuck.”

However, he said there was a debate to be had about what products could exist to help the ageing population, adding: “Does regulation need to adjust to foster more of a market in areas such as equity release, while still protecting consumers?”

Pure Retirement’s Paul Carter believes in innovation and lighter-touch regulation: “We need the regulators to get up to speed with the market dynamics and understand the complexities.

“The need for equity release is growing and the regulator must work with us to allow us to create products which meet consumer needs, giving funders the freedom to deliver such innovation.”

Mr Waterson adds: “Both conduct and prudential regulations have an impact on the potential to innovate and help more consumers.

“We therefore urge the PRA to work alongside the FCA, which shares our view that equity release can play a bigger role in meeting the challenge of supporting the UK’s ageing population, to consider how equity release is currently funded; the extent to which current prudential requirements create barriers for firms; and whether a broader approach could be taken which would enable alternative sources of funding to be accessed.”

Financial Advice Market Review

In March 2016, when the Financial Advice Market Review was published, the FCA made it clear there was an advice gap, particularly around retirement, and a lack of innovation.

At the time, Mr Waterson of the ERC, called on the regulator to do more to encourage signposting to specialised advice.

He said: “FAMR can create a positive legacy if its recommendations succeed in helping consumers engage more effectively with financial decisions, both before and during retirement.”

He said at the time Pension Wise was “missing a trick” in terms of “flagging housing wealth as a potentially valuable source of retirement funding”.