While rising interest rates in the UK have strained parts of the economy, they have also had the benefit of increasing the net asset value of the £2.1tn defined benefit pension ecosystem.
This increase in value has triggered a wave of risk transfer deals from pension trustees to specialist pension and insurance managers, a wave that shows no sign of slowing in the medium term.
In the UK, these pension and insurance managers are tightly regulated by the Prudential Regulation Authority, which dictates how each manager invests with a view to ensuring that policyholders are protected, and that systemic risk is mitigated.
The capital and investment policy of each manager is carefully monitored with those twin objectives in mind. As a result, these managers need to invest in assets with specific properties.
These characteristics include, but are not limited to, long duration (often greater than 15 years); high-quality, predictable (in the case of insurance managers, contractually fixed) cash flows; bankruptcy remote structures that offer liquidity; and well-defined third-party verification of said cash flows.
Traditional asset classes, like stocks, corporate bonds and even standard structured credit, often cannot provide managers with all of these required qualities. As a result, managers must be more thoughtful about asset allocation, and seek tailored solutions in more esoteric markets – typically infrastructure, real estate and some commodities.
British companies should take advantage of the European equity release market.One niche asset that has real potential to fill this growing gap is equity release.
The product offers homeowners, typically migrating to or in retirement, a way to refinance the mortgage on their main property, or release equity built up in that property, in a manner that maximises free cash flow.
For the lender, the product is long dated, secured, bankruptcy remote and backed by high-quality collateral. All qualities vital to meet the criteria of the PRA.
Equity release assets are structured specifically for insurers and pension funds in exact use cases, with these assets not only offering attractive risk-adjusted yields but crucially, creating much coveted 17-year-plus duration cash flows that align with clients' liabilities and (often narrow) regulatory requirements.
In addition, the notes are listed and rated, creating a standardisation that encourages liquidity.
The healthy demand picture described above coincides with rising supply. Britain’s aging population is seeking out new mortgage products that match their needs, as they look to remain in their home while also maximising spending capacity in the near term.
With 16mn people over the age of 60, the addressable market for equity release is set to double in volume terms over the next 20 years.
The right equity release mortgage product, particularly one that offers borrowers the flexibility to refinance over time, can be the better option versus a more traditional mortgage.
It allows homeowners to access the equity built up in their property, providing a tax-free lump sum to supplement regular income, while still retaining ownership and the right to live in their home for life or until they move into long-term care.
This can be particularly advantageous for those who are retired or have limited income, as it offers financial flexibility and stability without the burden of servicing higher mortgage repayments.
By unlocking this capital, equity release not only gives retirees the means to enhance their own lives, but also direct the flow of capital towards activities that will ultimately fuel economic growth, unlocking the capital built up in the British economy to be diverted to more productive avenues.
With both demand and supply set to increase, the importance of creating a mechanism to match supply and demand, and therefore an efficient clearing price for the product, is vital to the health of the wider UK economy.
Implementing this innovation is crucial to keep up with the market’s growth.By taking the underlying loans and creating a liquid, listed and standardised product for pension and insurance managers, equity release can both meet the precise needs of customers, as well as deepen the supply of capital for those borrowers looking to utilise equity release to navigate their retirement.
Over time this will encourage better pricing, more competition and more innovation, all of which will benefit the UK economy.
Implementing this innovation is crucial to keep up with the market’s growth. There is a lack of available products across Europe, primarily due to the lack of funding structures that are able to support long-dated fixed-rate products such as the UK’s annuity liabilities.
The UK is well positioned to be at the vanguard of this industry, driving the export of financial services to the European market, another benefit to the UK.
British companies should take advantage of the European equity release market, which is expected to take off in the coming years due to the critical need for financial solutions that cater to a similarly ageing demographic on the continent.
John Jeffrey is managing partner of Senior Capital
