The ‘no negative equity guarantee’ is an important feature of modern equity release plans, giving borrowers confidence when they use equity release to generate some cash from their property in retirement.
It’s a feature included at no extra cost to the borrower, ensuring that the debt never exceeds the current value of the property.
This is important because it means, when the borrower dies, their beneficiaries don’t inherit any debt.
But according to a new report, the equity release sector could be in deep trouble after undervaluing their no negative equity guarantees.
The report, called “Asleep at the Wheel: The Prudential Regulation Authority and the Equity Release Sector” comes from the free-market Adam Smith Institute.
It suggests the regulator has missed opportunities to effectively manage the risks faced by the equity release sector.
According to the Adam Smith Institute, the Prudential Regulation Authority has known about these risks for years. It is now argued that the regulator has knowingly allowed firms to use valuation methods that are unfit for the task.
According to report author Kevin Dowd, “Nearly two decades and one Global Financial Crisis later it seems like history is repeating itself.”
Professor Dowd goes on to say that this equity release issue is another case of incompetent management, undervalued long-term guarantees and regulators who are not up to their jobs.
He’s certainly pulling no punches in his criticism of how the sector is being regulated.
It’s an important issue because the equity release market is large and fast growing.
It has nearly tripled in size between 2012 and 2017, with forecasts it will grow by a further 40% by 2020.
The ageing population and rising property prices are encouraging more people to consider equity release as an option to supplement their retirement income in later life.
Last year, the Prudential Regulation Authority carried out stress tests, considering a 30% fall in property prices and concluding this could lead to losses in the sector of between £2bn and £3bn.
According to the regulator at the time, the risks were skewed towards equity release providers with large house price exposure.
According to the report, the Prudential Regulation Authority is confused about the capital requirements it imposes upon the industry.
The Adam Smith Institute claims when the PRA was asked at a parliamentary Committee in 2017 about the size of these capital requirements, Deputy Bank Governor Sam Woods suggested the requirement was £126bn. But just moments later, his colleague David Belsham suggested it was just £80bn.
The Treasury Committee is accused by Professor Dowd of botching its scrutiny of the impact of Solvency II on insurance companies, and having been captured by corporate lobbyists.
According to the hard hitting report, questions must now arise about the Prudential Regulation Authority’s capacity to regulate the industry competently.
Report author Kevin Dowd, professor of finance and economics at Durham University, said:
“We never seem to learn. Equitable Life hit the rocks two decades ago because it under-valued its long-term guarantees. Now the Equity Release sector is in deep trouble for the same reason. In both cases, the firms involved got into difficulties because they were using voodoo valuation methods that had no scientific validation. Same causes, same results.
“In the aftermath of the Equitable Life fiasco we were assured that lessons had been learned and the vastly expensive Solvency II regulatory regime was installed to ensure there would never be a similar disaster in the future.
“The PRA and Solvency II have failed spectacularly.
“The most astonishing thing about this scandal is that the PRA knew about these poor valuation practices but permitted them anyway. It would be interesting to know why.”
With the Dowd report featuring in a BBC Radio 4 programme and making various headlines in the press, it’s unlikely this issue of equity release sector risks will go away quietly.