Duncan Young takes a look at the rapidly evolving equity release market and asks what needs to be done to help it develop further
Innovation in the equity release market has been strong over the past year or two, especially with new players in both the lifetime mortgage and reversion arenas. But where do we go from here?
To create new products that will sell well obviously means the designers must look to meet specific consumer demand. However in the equity release market research with consumers is at best patchy, in actual fact it is almost non existent. Any research there is tends to concentrate on the end use for the money - new car, home improvements, holiday of a lifetime, rather than the structure of the liability incurred to meet that need for the cash.
So it is helpful to apply some broad brush market segmentation as a guide to the way the customer thinks with a view to seeing where product innovation is likely to go. I have roughly divided the market into four segments, which are:
- Flexible drawdown: This is, I think, the largest area of the market but the sums drawn down are low and so administration costs are relatively high. With these products customers meet an existing requirement for cash, but keep some capacity to borrow in reserve. These products can be both lifetime and reversion but the preponderance are the former.
- Small lump sum: Here the customer has a known requirement and that is it. These products are simple to administer with low risk for the product provider and so these tend to be very competitively priced.
- Large lump sum: Here the customer wants as close to the maximum as possible and with lifetime interest rates there will be a premium to be paid and a potential risk of negative equity, or a reversion can be chosen.
- Protected share: Some customers want to know that there is always a balance left either for inheritance reasons or to keep for a further advance.
In today's equity release market I cannot think of a product that meets more than two of these segments. The reasons for this? Usually ones of risk and cost. To give a customer a large lump sum, a lifetime mortgage provider runs the risk that their no negative equity guarantee will be called into play and so they need to be compensated by a higher interest rate. With drawdown products, apart from one, there is a cost associated with keeping the reserve portion available which has to be reflected in the pricing.
Taking on board my analysis it means that there is really only room for "me to" products to meet customer demand. Is this true?
The equity release market ought to look to the mainstream mortgage market and see if lessons can be learned. In the 1980s there were only prime mortgages with either variable rates or short term fixed rates. Advance criteria were the same across the industry with a few tweaks here and there. The standard of underwriting was very variable. The market became more competitive as the 80s turned into the 90s, and new ideas, which are now commonplace took hold. So discounts on interest rates came to be a marketing weapon. Underwriting went from self cert through non status to sub prime. Caps, collars and fixes stretched out for 10 or even 25 years - although no customers were really interested at the long end.
So what are the opportunities for the equity release product designers? There is scope for looking how interest is accrued. Stepped rates, teasers, greater use of caps and collars are all possible.
The second area is advance criteria. Within the lifetime sector it is broadly uniform, almost as if the first contract has been cloned by everyone else. But there is scope for loosening up. It is beginning with an investment property product. Further developments by lifetime product providers will reflect the fact that customers want flexibility when they sell their home. Going into a nursing home should not be a signal for sale. At the moment product providers rely heavily on the concept of morbidity - this is when a customer has to leave their home either to live with relatives or go into some form of assisted living accommodation. So amended criteria here could be very significant in terms of analysing the no negative equity guarantee.
There is possibly a further requirement on the immediate horizon as the government was to increase the amount of domiciliary care in the community by social services. In essence this will reduce morbidity considerably with all that that entails. It means that properties will be lived in for longer by older and frailer customers.
So either product providers will have to reduce their maintenance covenants (which emotionally are probably unenforceable anyway) or they are going to have to face up to the need for contemporary product design. This will mean providing assistance with a broader range of housing issues and being more realistic about house price inflation. There is already evidence that properties owned by people with equity release products under perform the main housing indices. This is an uncomfortable position for main lenders to accept.
To summarise, it is unlikely that the emphasis on product design will create new segments of the market but there will be more flexible pricing formulas and a general re-think of advance criteria - which will hopefully lead to increased sales through time.
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