Developing Equity Release Markets: Risk Analysis for Reverse Mortgages and Home Reversions

Equity release products are sorely needed in an aging 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 article 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: Value-at-Risk (VaR) and Conditional Value-at-Risk (CVaR).     

Securitization of Longevity Risk: Pricing Survivor Bonds With Wang Transform in the Lee-Carter Framework

Longevity risk is a major issue for insurers and pension funds, especially in the selling of annuity products. In that respect, securitization of this risk could offer great opportunities for hedging. This article proposes to design survivor bonds which could be issued directly by insurers. In order to guaranty some transparency in the product, the survivor bond is based on a public mortality index. The classical Lee‐Carter model for mortality forecasting is used to price a risky coupon survivor bond based on this index.     

Breakeven Determination of Loan Limits for Reverse Mortgages under Information Asymmetry

Since the loan limit of a reverse mortgage is a major concern for the borrower as well as the lender, this paper attempts to develop an option-based model to evaluate the loan limits of reverse mortgages. Our model can identify several crucial determinants for reverse mortgage loan limits, such as initial housing price, expected housing price growth, house price volatility, mortality distribution, and interest rates. We also pay special attention to the important implication of mortgage lenders’ informational advantage over reverse mortgage borrowers concerning housing market risk. In reverse mortgage markets, the elderly borrowers typically hold far less, relative to the lenders, or no information about the lenders’ underlying mortgage pools. Such information asymmetry leads these two categories of market participants to generate different perspectives on the risk of the collateralized properties, which can be identified to be important in determining the maximum loan amounts of reverse mortgages. We further find that the maximum loan amount of a reverse mortgage decreases in the correlation between the returns on the pooled underlying housing properties but increases with the number of the pooled mortgages.     

商业银行抵押贷款折扣率风险管理研究

折扣率是商业银行抵押贷款风险管理的核心要素。如何科学合理地确定折扣率,是有效发挥押品风险缓释作用的重要因素。本文在对折扣率现有计量方法进行归纳、总结的基础上,重点介绍了单一押品折扣率模型、基于内部评级法的折扣率模型、基于加权平均法的传统计算方法、VaR评估模型以及监管要求的其他方法,同时结合部分实际处置数据和评估案例,利用VaR方法中的参数法和非参数法进行了介绍性实证分析,并针对当前部分商业银行折扣率计量风险敏感性不足、计量依据和规范性有待强化等问题,提出了构建商业银行内部押品计量体系、强化折扣率计量验证管理、完善押品风险数据库建设和加强押品存续期管理等具体政策建议。     

Spatial Variation in Reverse Mortgages Usage: House Price Dynamics and Consumer Selection

Reverse mortgages have been obtained by nearly one million senior households. In the future, the number of eligible households will grow substantially, about 80 % are homeowners, and many of them have substantial equity in their home. We study state-level variations in rate of originations of HUD’s Home Equity Conversion Mortgage (HECM) product. Our focus is on the impact of house prices on the origination rate. We test the hypothesis that in states where real house prices are volatile and the current level is above the long term norm, seniors rationally anticipate future reductions in house prices and lock-in their housing equity gains by obtaining a reverse mortgage. We test alternative hypotheses, the first being that seniors living in states with high rates of house price appreciation increase their use of HECMs as a means to convert an illiquid wealth capital gain into a more liquid asset. A second alternative hypothesis is that the intertemporal changes in originations of HECMs were a result of changes in the supply of mortgage originators. Our empirical work supports the hypothesis that seniors used HECMs to insure against house price declines, but we find no evidence in support of the alternative hypotheses.     

Measuring Basis Risk in Longevity Hedges

Abstract

In examining basis risk in index longevity hedges, it is important not to ignore the dependence between the population underlying the hedging instrument and the population being hedged. We consider four extensions to the Lee-Carter model that incorporate such dependence: Both populations are jointly driven by the same single time-varying index, the two populations are cointegrated, the populations depend on a common age factor, and there is an augmented common factor model in which a population-specific time-varying index is added to the common factor model with the property that it will tend toward a certain constant level over time. Using data from the female populations of Canada and the United States, we show the augmented common factor model is preferred in terms of both goodness-of-fit and ex post forecasting performance. This model is then used to quantify the basis risk in a longevity hedge of 65-year old Canadian females structured using a portfolio of q-forward contracts predicated on U.S. female population mortality. The hedge effectiveness is estimated at 56% on the basis of longevity value-at-risk and 81.61% on the basis of longevity risk reduction.     

Determining an Optimal Principal Limit Factor for Reverse Mortgages under Economics-Based Models

The Journal of Real Estate Finance and Economics - Determining an optimal principal limit factor (PLF) is important for a reverse mortgage (RM) contract because it mainly influences the development...     

Anatomy of an ARM: The Interest-Rate Risk of Adjustable-Rate Mortgages

This article analyzes the dynamics of the commonly used indices for adjustable rate mortgages and systematically compares the effects of their time-series properties on the interest-rate sensitivity of adjustable-rate mortgages. Our ARM valuation methodology allows us simultaneously to capture the effects of index dynamics, discrete coupon adjustment, mortgage prepayment, and both lifetime and periodic caps and floors. We can, moreover, either calculate an optimal prepayment strategy for mortgage holders or use an empirical prepayment function. We find that the different dynamics of the major ARM indices lead to significant variation in the interest-rate sensitivities of loans based on different indices. We also find that changing assumptions about contract features, such as loan caps and coupon reset frequency, has a significant, and in some cases unexpected, impact on our results.     

Longevity Risk Management in Singapore's National Pension System

Although annuities are a theoretically appealing way to manage longevity risk, in the real world relatively few consumers purchase them at retirement. To counteract the possibility of retirees outliving their assets, Singapore's Central Provident Fund, a national defined contribution pension scheme, has recently mandated annuitization of workers’ retirement assets. More significantly, the government has entered the insurance market as a public‐sector provider for such annuities. This article evaluates the money's worth of life annuities and discusses the impact of the government mandate and its role as an annuity provider on the insurance market.     

银行信贷资产证券化的潜在流动性风险与监管研究

本文通过构建理论模型研究了银行信贷资产证券化面临的潜在风险,主要是银行"发起—分销"模式下潜在的流动性风险。研究表明,对于单个银行而言,"发起—分销"模式并未起到控制和降低风险的作用,只是通过增加扣减比例的方式来对冲风险,而抵押贷款证券则面临未来价格可能更大幅度的下跌,风险仍潜藏在银行间市场;对于银行间市场而言,部分银行的流动性不足会抑制整个市场所提供的流动性,尤其是当抵押贷款证券的市场价格低于银行最初预期的平均收益水平时,那些经营稳健的银行也会受到金融传染的影响。     

资产证券化对系统性风险的影响机制

次贷危机表明,资产证券化等金融创新可以和商业银行体系一样促使系统性风险的形成、积累和传导。但国内外学术界并没有对资产证券化在系统性风险积累和传导中的作用机制形成完整的结论。通过分析发现,资产证券化的复杂运作机制、基本功能以及基础资产均可以促使系统性风险的形成和积累,并通过基础资产和证券化产品两个渠道引起系统性风险的传导。因此,中国在设计资产证券化时,必须灵活确定具体产品的长短期模式,严格规定基础资产的构成标准,并基于监管特许权理论来构建评级机构,同时遵循宏观审慎原则来创建资产证券化的监管体系。     

住房抵押贷款证券化的法律风险研究

住房抵押贷款证券化是一项结构复杂的金融创新,涉及诸多法律问题。本文结合我国住房抵押贷款证券化的金融生态环境,探讨了投资者面临的假按揭风险、抵押物处置风险和房贷险等法律问题,提出了完善相关法律金融制度的建议。     

Downside Risk Management of a Defined Benefit Plan Considering Longevity Basis Risk

To control downside risk of a defined benefit pension plan arising from unexpected mortality improvements and severe market turbulence, this article proposes an optimization model by imposing two conditional value at risk constraints to control tail risks of pension funding status and total pension costs. With this setup, we further examine two longevity risk hedging strategies subject to basis risk. While the existing literature suggests that the excess-risk hedging strategy is more attractive than the ground-up hedging strategy as the latter is more capital intensive and expensive, our numerical examples show that the excess-risk hedging strategy is much more vulnerable to longevity basis risk, which limits its applications for pension longevity risk management. Hence, our findings provide important insight on the effect of basis risk on longevity hedging strategies.     

Hedging Longevity Risk When Interest Rates are Uncertain

Abstract

This paper proposes an asset liability management strategy to hedge the aggregate risk of annuity providers under the assumption that both the interest rate and mortality rate are stochastic. We assume that annuity providers can invest in longevity bonds, long-term coupon bonds, and shortterm zero-coupon bonds to immunize themselves from the risks of the annuity for the equity holders subject to a required profit. We demonstrate that the optimal allocation strategy can lead to the lowest risk under different yield curves and mortality rate assumptions. The longevity bond can also be regarded as an effective hedging vehicle that significantly reduces the aggregate risk of the annuity providers.     

Mortality-Indexed Annuities Managing Longevity Risk Via Product Design

Abstract

Longevity risk has become a major challenge for governments, individuals, and annuity providers in most countries. In its aggregate form, the systematic risk of changes to general mortality patterns, it has the potential for causing large cumulative losses for insurers. Since obvious risk management tools, such as (re)insurance or hedging, are less suited for managing an annuity provider’s exposure to this risk, we propose a type of life annuity with benefits contingent on actual mortality experience.

Similar adaptations to conventional product design exist with investment-linked annuities, and a role model for long-term contracts contingent on actual cost experience can be found in German private health insurance. By effectively sharing systematic longevity risk with policyholders, insurers may avoid cumulative losses.

Policyholders also gain in comparison with a comparable conventional annuity product: Using a Monte Carlo simulation, we identify a significant upside potential for policyholders while downside risk is limited.     

Effects of Health and Longevity on Financial Risk Tolerance

We investigate the effects of health and life expectancy on tolerance of financial risk. Using a standard life-cycle model, we find that the effects of health and life expectancy on preferences over lifetime-income risk are theoretically ambiguous. However, risk tolerance is independent of health and life expectancy when utility takes one of the standard (harmonic absolute risk aversion) functional forms or when optimal consumption is constant over time. Our empirical results, using data from a stated-preference survey (n=2,795), suggest that financial risk tolerance is positively associated with both health and life expectancy; hence utility is not consistent with standard functional forms.     

A Cautionary Note on Natural Hedging of Longevity Risk

In this article, we examine the so-called natural hedging approach for life insurers to internally manage their longevity risk exposure by adjusting their insurance portfolio. In particular, unlike the existing literature, we also consider a nonparametric mortality forecasting model that avoids the assumption that all mortality rates are driven by the same factor(s).

Our primary finding is that higher order variations in mortality rates may considerably affect the performance of natural hedging. More precisely, although results based on a parametric single factor model—in line with the existing literature—imply that almost all longevity risk can be hedged, results are far less encouraging for the nonparametric mortality model. Our finding is supported by robustness tests based on alternative mortality models.