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Risk Management and Payout Design of Reverse Mortgages

34 Pages Posted: 15 Mar 2013  

Daniel Wanhee Cho

University of New South Wales (UNSW) - ARC Centre of Excellence in Population Ageing Research (CEPAR)

Katja Hanewald

University of New South Wales - ARC Centre of Excellence in Population Ageing Research (CEPAR)

Michael Sherris

University of New South Wales - ARC Centre of Excellence in Population Ageing Research and School of Risk and Actuarial Studies; UNSW Australia Business School

Date Written: March 14, 2013

Abstract

We analyze the risk and profitability of reverse mortgages with lump-sum or income stream payments from the lender's perspective. Reverse mortgage cash flows and loan balances are modeled in a multi-period stochastic framework that allows for house price risk, interest rate risk and risk of delayed loan termination. A VAR model is used to simulate economic scenarios and to derive stochastic discount factors for pricing the no negative equity guarantee embedded in reverse mortgage contracts. Our results show that lump-sum reverse mortgages are more profitable and require less risk-based capital than income stream reverse mortgages, which explains why this product design dominates in most markets. The loan-to-value ratio, the borrower's age, mortality improvements and the lender's financing structure are shown to be important drivers of the profitability and riskiness of reverse mortgages, but changes in these parameters do not change the main conclusions.

Keywords: Reverse mortgage, Income stream, Equity release, Vector autoregressive model, Stochastic discount factor, Risk-based capital

JEL Classification: G12, G21, G32

Suggested Citation

Cho, Daniel Wanhee and Hanewald, Katja and Sherris, Michael, Risk Management and Payout Design of Reverse Mortgages (March 14, 2013). UNSW Australian School of Business Research Paper No. 2013ACTL07. Available at SSRN: https://ssrn.com/abstract=2233688 or http://dx.doi.org/10.2139/ssrn.2233688

Daniel Wanhee Cho (Contact Author)

University of New South Wales (UNSW) - ARC Centre of Excellence in Population Ageing Research (CEPAR) ( email )

Level 6, Central Lobby (enter via East Lobby)
Australian School of Business Building
Sydney, New South Wales NSW 2052
Australia

Katja Hanewald

University of New South Wales - ARC Centre of Excellence in Population Ageing Research (CEPAR) ( email )

ARC Centre of Excellence in Population Ageing Rese
The University of New South Wales
Sydney, New South Wales NSW 2052
Australia

Michael Sherris

University of New South Wales - ARC Centre of Excellence in Population Ageing Research and School of Risk and Actuarial Studies ( email )

Australian School of Business
Quadrangle Building
Sydney, NSW 2052
Australia
+61 2 9385 2333 (Phone)
+61 2 9385 1883 (Fax)

HOME PAGE: http://www.asb.unsw.edu.au/schools/Pages/MichaelSherris.aspx

UNSW Australia Business School ( email )

Sydney, NSW 2052
Australia

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