Equity release

Hello

I understand writing term assurance diversify longevity risk for immediate annuity.

but could you pls help me to undrstand how writing equity release product diversify investment or longevity risk for annuity?
Refer sec 6.3 of ch14...

Thanks in advance

 

Yogesh,

I note that you ask a lot of questions. Have you genuinely thought about the features of equity release and annuity products?

This is an application subject. To pass this exam you will need to demonstrate an understanding of the underlying principles and the ability to ‘apply’ it to the scenario in question.

Why don’t you first tell us what you think ? We can then focus on which bit, if any, needs correcting.

 

The section you are referring to is talking about securitisation of equity release products under a matching adjustment portfolio (MAP). In order to be eligible for matching adjustment, the assets backing the annuities need to be fixed. In order to generate fixed cashflows out of equity release, you can securitise these. This will take the form of a senior and junior note. The senior note being the fixed cashflows which could then be transferred into the MAP to back annuity liabilities.

I think you could easily argue that this diversifies your annuity investments as the security will perform in relation to the repayments on the underlying equity release products. This is likely to be very different to the other, perhaps more 'standard' assets which may be held within the MAP i.e. gilts, corporate bonds.

For your second question about diversifying longevity risk:

Writing equity release products carries longevity risk. Therefore, I would say the opposite - this increases longevity risk to the lender.

Think about what the product means to the lender - an upfront payment of a percentage of the borrower's home. The loan carries interest which is only repayable upon death (along with the principal borrowed). Generally, the only way a lender has access to reclaim the principal and interest is through sale of the property.

The risk to the lender is a negative equity scenario - i.e. the proceeds from the sale of the property upon death are less than the principal + interest. This could happen for two main reasons in my view - the borrower lives longer than expected or property prices have fallen.