Developing Equity Release Markets: Risk Analysis for Reverse Mortgages and Home Reversions
North American Actuarial Journal, Forthcoming
49 Pages Posted: 17 Jan 2013 Last revised: 1 Apr 2014
Date Written: October 1, 2013
Equity release products are sorely needed in an ageing population with high levels of home ownership. There has been a growing literature analyzing risk components and capital adequacy of reverse mortgages in recent years. However, little research has been done on the risk analysis of other equity release products, such as home reversion contracts. This is partly due to the dominance of reverse mortgage products in equity release markets worldwide. In this paper, we compare cash flows and risk profiles from the provider’s perspective for reverse mortgage and home reversion contracts. An at-home/in long-term care split termination model is employed to calculate termination rates, and a vector autoregressive (VAR) model is used to depict the joint dynamics of economic variables including interest rates, house prices and rental yields. We derive stochastic discount factors from the no arbitrage condition and price the no negative equity guarantee in reverse mortgages and the lease for life agreement in the home reversion plan accordingly. We compare expected payoffs and assess riskiness of these two equity release products via commonly used risk measures, i.e., Value-at-Risk (VaR) and Conditional Value-at-Risk (CVaR).
Keywords: Reverse Mortgage, Home Reversion, Vector Autoregressive Models, Stochastic Discount Factors, Risk-Based Capital
JEL Classification: G12, G21, G32
Suggested Citation: Suggested Citation