Equity Release Shopping for happiness at old age - Part 1

FEATURES About the Authors eqUItY reLeAse: sHOppING FOr HAppINess At OLD AGe - pArt I his article is about the general and economic environment for the Equity Release products available in the UK. This article is divided in two parts. Second Part of this article will be published in October Issue of Actuary India can be repaid out of income. It is a way one can beneit from the value of his or her home without having to move out – by borrowing against it or selling all or part of it for a regular income or a lump sum. [email protected] Saket Vasisth is involved in actuarial reporting for life insurance. He is student member of IAI and is working at WNS. In the first part we have covered the following: Nature of the product 2. Example of two situations leading customers to buy Equity Release 3. Jargon buster 4. Different types of Equity Release products available 5. Regulations – Equity Release council – its objectives and prescribed guarantees to be provided to the customers 6. Regulations – Financial conduct authority – (i) Customer outcomes, (ii) Information for the customer and (iii) FCA source book overview - Mortgages and home inance: Conduct of business source book Equity Release is an interesting insurance product which is sold in the UK by some life insurers and specialist pension irms. This product is intended for the elderly population facing pension shortfall, unexpected expenses or who want to holiday without substantially reducing their expenses. Equity Release allows customers to tap into the wealth accumulated in his or her house without moving out. Given increasing life expectancy and closure of many deined beneit schemes, Equity Release is a product which can rescue elderly people in case their deined contribution pension proceeds fall short of their needs. Equity Release means unlocking of some or all of the equity tied up in the house property, without the owner having to move house or being able to demonstrate that the inance generated [email protected] Mrs Smith is 70 and lives alone in a 3-bedroom bungalow in Southampton. Enjoying her retirement, she’d love to be able to see more of her three children and four grandchildren who all live in the north of the country. She would also like to make some improvements to her home to make it easier for her to maintain it on her own. Ideally, she would love to be able to afford modiied kitchen, a downstairs toilet and a new television. Mrs Smith cleared her mortgage several years ago, so she decides to revive her home, by unlocking a part of its value through Equity Release. This will give her the money she needs to regularly visit her family as well as improving her home. Keen to be able to leave an inheritance to her family, she decides to opt for Equity Release product. Given the valuation of her house, she can release a maximum of £75,000 but she’s worked out she only needs £50,000, 2/3rd of the potential release amount. By taking this smaller amount, she can now protect 1/3rd of her property’s value as a guaranteed inheritance for her family. This means that the amount to be repaid at the end of the loan will never exceed 2/3rd of her home’s value. Sarah Chapman is part of the Asset Production and Equity Release reporting team. She is a student member of the institute and faculty of actuaries and works for Aviva. Mr and Mrs Fisher, aged 65 and 61 respectively, live in a 2-bedroom detached property in York. Their property is worth £300,000, with a small outstanding mortgage. The couple have found themselves preoccupied with the inancial strain on their pensions. They are looking for a way to clear their mortgage and free up more of their monthly income. Mr and Mrs Fisher would also like to ind some additional funds to help their family, as they have a son who is struggling to acquire one property due to the lack of deposit funds. They decide to look into Equity Release. Mr and Mrs Fisher have been smokers for 10 years. The couple can actually release money from their home, since their health and lifestyle are taken into account in loan determination by the provider. The couple ind out that they could release a maximum of the Actuary India Sept. 2014 1. 17 £180,000. This is more than enough to settle their current mortgage and contribute to their son’s deposit for his new home. Jargon buster: Housing price index: It represents the relative change in the value of houses in a particular geography which make up the index. In the UK, Halifax and Nationwide are two main housing price indexes available. Other available housing price index are CLG/ONS, Land registry, Rightmove and Hometrack. Negative Equity: When the amount borrower owes to the lender is more than the value of home of the borrower. No Negative Equity Guarantee (NNEG): A ‘No Negative Equity Guarantee’ means that the amount repaid (including accrued interest, charges and all sale costs) will never be greater than the sale proceeds – no matter what happens to interest rates or house prices. So there’s no risk of passing on any debt to the family/heirs of the borrower. Should borrower’s home be sold for less than the outstanding mortgage balance after sale costs, NNEG will take care of this difference. This ‘No Negative Equity Guarantee’ is a very important safeguard for the borrower and his or her family and any future beneiciaries of his or her estate. It means that there is no risk of them being left with an outstanding mortgage debt after home is sold after sale costs are taken into account. This is known as non-recourse provision (NRP) in the US. the borrower decides to repay the loan early, the money has to be re-invested. If at the time of repayment interest rates are lower than at the time of the original loan, the return on investment can be signiicantly lower than expected. To recoup this anticipated loss, an ERC may be payable by the borrower. Normally, if the borrower wishes to repay the loan earlier than planned, the amount of an early repayment charge will depend on the difference between the borrower’s benchmark rate and the Index Rate (normally FTSE UK gilt 15 year yield index). If the Index is lower than the benchmark rate then an early repayment charge will be payable. Normally, if the index is higher than the benchmark rate then no such charge is payable by the borrower. Loan to value (LTV): At the time of contract inception, LTV is the ratio of loan provided to value of property. At later stages, accumulated interest is also added to the numerator of this ratio. And denominator will be the value of property at that later time. the Actuary India Sept. 2014 18 3. Shared appreciation mortgage: The lender loans the borrower a capital sum in return for a share of the future increases or in the growth of the property value. The borrowers retain the right to live in the property until death. The older the client the smaller the share required by the lender. For example, on a property valued at £100,000 an immediate interest free mortgage of £25,000 could be granted. If the property value rises to £180,000 before the client’s death, then the total repayment to the lender would be £25,000 capital plus 3/4 of the £80,000 gain in value = £25,000 + £60,000 = £85,000 of the total £180,000 proceeds. 4. Enhanced lifetime mortgages: Some providers offer more money to those with lower-than-average life expectancies. Aviva, More2Life and Partnership offer these mortgages. Type of products: There are broadly two types of Equity Release plan available: • • Mortgage Property sales: Property sales 1. Home income plan: A lifetime mortgage where the capital is used to provide an income by purchasing an annuity often provided by the lender, which is often an insurance company. 2. Home reversion: Policyholder sells a share in his or her house at lower than their market value and retains the right to stay in their home for rest of his or her life. When the policyholder dies or moves into long-term care and the property is sold, the provider gets the same share of whatever the policyholder’s home sells for as repayment. For example, if the contract is for 50% of the property to the provider, they would get 50% of the sale price. Mortgage: 1. Early redemption charge (ERC): Borrower has an option to repay. Borrower can re pay the loan and interest early (i.e. before death or moving into long term care) but there could be an early repayment charge, as set out in provider’s Key Facts Illustration and the offer of loan. A lifetime mortgage is designed to last for a borrower’s lifetime, hence the name early redemption charge. Normally, loan is provided at an interest rate which is ixed for the borrower’s lifetime. Lenders do not expect to receive that money back for a period of time, which is calculated using mortality rates. If on death. Interest payments are paid whilst the borrowers remain in the property. Stonehaven and More2Life offer this option. 2. Lifetime mortgage: A loan secured on the borrower’s home (a mortgage loan) is made. Compounded interest is added to the capital throughout the term of the loan, which is then repaid by selling the property when the borrower (or borrowing couple) dies or moves out (perhaps into a care home). The borrower retains legal title to the home whilst living in it, and also retains the responsibilities and costs of ownership. In the UK, more than 85% of Equity Release market is dominated by this product. For most lump-sum deals, interest rates are ixed at the outset. This product is comparatively expensive than other options because larger initial amount is given to the policyholder. Interest only loan: A mortgage is made, on which the capital is repaid One can take out lifetime mortgages from the age of 55 (provided the house value is at least £70,000), but home reversions are available only to people aged 65 or older. As per Equity the product together with any obligations on the part of the customer are clearly set out in their literature. Equity Release providers to use actuarial expertise to compute no negative equity guarantee. After 2008-2009 economic slowdown, because of home mortgages, it makes even more sense for the regulator to make it compulsory for Equity Release providers to give no negative equity guarantee to the customer. 3. The right to move their plan to another suitable property without any inancial penalty. 4. The right for the customer to choose an independent solicitor of their own choice to conduct their legal work. 5. The ERC certiicate signed by the solicitor is there to ensure clients are aware of the terms and implications of the plan including the impact of Equity Release on their estate. 6. No negative equity guarantee: All ERC plans carry a no negative equity guarantee. This means customers will never owe more than the value of their home and no debt will ever be left to his or her next of kin, immediate family or any other person having an interest in the property. This guarantee (as enforced by the ERC) has caused Financial Conduct authority (FCA): The Financial Services Authority (FSA) is now divided in two bodies (i) Financial Conduct Authority (FCA) and (ii) Prudential Regulatory Authority (PRA). Firms advising or selling Equity Release schemes are regulated by the Financial Conduct Authority (FCA). Regulated irms and their agents are placed on the FCA Register and have to comply with certain regulatory standards. The regulator has outlined six core customer outcomes which every Equity Release provider must aim to achieve. These are: Release council’s report more than 85% of the Equity Release market share is dominated by lifetime mortgages and 13% is with home reversion plans. Regulations: Equity Release product regulations are predominantly prescribed by: • Equity Release Council (ERC) Financial Conduct authority (FCA) Equity Release council, ERC (formerly known as safe home income plan SHIP), a trade body set up in December 1991 to help protect customers of Equity Release. Founding members of ERC were Allchurches Life, Hodge Equity Release (as Carlyle Life), Home & Capital Trust and GE Life (as Stalwart Assurance). Equity Release Council represents the providers, qualiied inancial advisors, lawyers, intermediaries and surveyors who work in the Equity Release sector. A major focus of the Equity Release Council’s work is to ensure that products are safe and accessible for consumers. Each member of the ERC that provides Equity Release products has to sign the ERC’s code of conduct. This code provides a number of safeguards and guarantees for consumers. This means that people who use Equity Release products offered by Equity Release Council members can have conidence in the products they use and the information they receive. Guarantees to be provided to the customer: The following guarantees have to be provided to customers: 1. To allow customers to remain in their property for life provided the property remains their main residence. 2. To provide customers with fair, simple and complete presentations of their plans. This means that the beneits and limitations of Outcome 1 - Customers can be conident that they are dealing with irms where the fair treatment of customers is central to the corporate culture. Outcome 2 - Products and services marketed and sold in the retail market are designed to meet the needs of identiied customer groups and are targeted accordingly. the Actuary India Sept. 2014 • 19 Outcome 3 - Customers are provided with clear information and kept appropriately informed before, during and after the point of sale. arranging lifetime mortgage, the actual or typical fee must be quoted Financial Conduct Authority (FCA) handbook has following 10 blocks: Firms are supposed to provide two documents marked with the ‘KeyFacts’ logo that set out important information. The information should be in prescribed standard format so that it can be used to compare products and services from different irms. 1 . Glossary – which contains terms used in the handbook Document 1: The ‘KeyFacts’ about Equity Release services: 4 . Business Standards - detailed requirements relating to irms’ dayto-day business 5. Outcome 4 - Where customers receive advice, the advice is suitable and takes account of their circumstances. Outcome 5 - Customers are provided with products that perform as irms have led them to expect, and the associated service is of an acceptable standard and as they have been led to expect. Outcome 6 - Customers do not face unreasonable post-sale barriers imposed by irms to change product, switch provider, submit a claim or make a complaint. i. Information about the service the irm can offer ii. Whether it offers lifetime mortgages, home reversion plans, or both iii. Whether it offers advice or just information, and iv. How much customer will have to pay for the service Document 2: The ‘KeyFacts’ about this lifetime mortgage or home reversion plan’ document will be tailored for speciic to the prospective policyholder’s requirements: i. How much customer want to release the Actuary India Sept. 2014 Equity Release firms - What the FCA expects them to do? Firms selling Equity Release schemes must make sure that advertisements, product brochures and other promotions are (i) clear, (ii) fair and (iii) not misleading. This includes: 20 1. The advantages and disadvantages of particular features of the Equity Release schemes have to be equally stated 2. With lifetime mortgages, the irm must provide the annual percentage rate (APR) whenever it provides any price information 3. The adviser must check whether using the scheme will affect customer’s tax position and any entitlement to beneits 4. If there’s a fee for advising on or ii. The overall cost, including any upfront fees and charges iii. What customer will pay each month, if there are monthly repayments, and iv. What happens if customer wants to make early repayment of loan 2 . High Level Standards - standards applying to all irms and approved persons 3 . Prudential Standards - sets out the prudential requirements for irms 5 . Regulatory Processes - manuals describing the functioning of the FCA’s and PRA’s 6 . Redress - the processes for handling complaints and compensation 7 . Specialist sourcebooks requirements applying to individual business sectors 8 . Listing, Prospectus and Disclosure - United Kingdom Listing Authority rules 9 . Handbook Guides - Aimed at giving a basic overview of certain topics and point irms in the direction of material in the Handbook applicable to them. 1 0 . Regulatory Guides - These are guides to regulatory topics Fourth block is Business Standards (for the detailed requirements relating to irms’ day-to-day business conduct) in which regulations for mortgages and home inance are provided. Business sourcebook for mortgages and home inance (MCOB) came into force on 31 October 2004. It contains 13 chapters and 6 schedules as follows: MCOB 1: Application and purpose MCOB 7: Disclosure at start of contract and after sale MCOB 2: Conduct of business standards: general MCOB 8: Equity Release: advising and selling standard MCOB 3: Financial Promotion of qualifying credit, home rever- MCOB 9: Equity Release: product disclosure sion plans and regulated sale and rent back agreements MCOB 4: Advising and selling standards MCOB 10: Annual Percentage Rate MCOB 5: Pre-application disclosure MCOB 11: Responsible lending, and responsible inancing of home purchase plans MCOB 6: Disclosure at the offer stage MCOB 12: Charges MCOB 13: Arrears and repossessions: regulated mortgage contracts and home purchase plans Schedule 1: Record keeping requirements Schedule 4: Powers exercised Schedule 2: Notiication Requirements Schedule 5: Rights of action for damages Schedule 3: Fees and other required payments Schedule 6: Rules that can be waived MCOB can be found here: http://fshandbook.info/FS/html/handbook/MCOB MANY HAPPY RETURNS OF THE DAY the Actuary India wishes many more years of healthy life to the fellow members whose Birthday fall in September 2014 AsHA J JOsHI N C DAs V K VYDIANAtHAN (Birthday greetings to fellow members who have attained 60 years of age) the Actuary India Sept. 2014 G N AGArWAL 21