A wide scale underestimation of longevity risk could create a real problem for the equity release market in the years to come. The issues lie in several areas: firstly, as an industry we are using marginally out-of-date data as prescribed by the Financial Services Authority (FSA). Secondly, we are failing to use differential pricing based on a more detailed analysis of a person’s health and previous family history. Finally, we are not factoring in improvements in medical science on a condition by condition basis.
A simple problem
The problem is fairly simple – we are living longer than we are illustrating. In 1901, males born in the UK could expect to live to around 45, females to around 49. By 1981 a man aged 65 could expect to live a further 14 years and women a further 18 years. By 2051, is estimated to have increased by 22 and 24 years respectively.
The rapid increase in life expectancy means that using out-of-date data can cause pricing errors. This is a concern of the Institute of Actuaries’ working party on equity release, on which Partnership Assurance’s chief actuary, Steve Groves, is a leading participant. This group has raised the concern that the prescribed mortality figures are out-of-date and do not take sufficient account of possible future mortality improvements. The current basis uses tables projected to calendar year 2010. While this makes some allowance for future improvements, it understates improvements beyond 2010 and the Institute of Acutaries’ working party has concerns that the problems may be even more pronounced for younger cases and as the date of calculation gets closer to 2010.
Using our mortality data we can demonstrate the issue very clearly. A healthy male, aged 65, has a life of 19 years as prescribed by the FSA tables, whereas our data sets down an expectancy of 21 years.
The implications of this discrepancy are potentially huge. Assuming our 65 year-old has a £250k property and a loan amount of £70k with an APR of 7.3 per cent (based on one of the UK’s leading providers). His property growth is 3 per cent annually. After 19 years (FSA life expectancy) the property would be worth £438k, the loan outstanding would be £267k, and the estate can expect to be left £171k.
After 21 years, (Partnership Assurance’s life expectancy), the property would be worth £465k, and the loan outstanding would be £307k, so on this basis the estate can expect to be left £158k. Thus the estate’s expectation is £13k less if calculated using latest mortality data.
Also, again assuming 3 per cent property growth, the negative equity guarantee is reached 31 years after the start of the policy, i.e. when the outstanding loan exceeds the value of the property. According to the FSA prescribed mortality data, there’s a seven per cent chance of living for 31 more years for a healthy male aged 65, whereas according to our data, there is a 12 per cent chance.
We are also concerned by the wording in MCOB referring to ‘the estimated term of the regulated lifetime mortgage’ and the reference that seems to imply that illustrations are only required up to the client’s life expectancy. This is potentially misleading as there is a 50 per cent chance that they will live longer than this date. We feel that advisers should consider illustrating on a simple basis of 20 or 30 years, or to a much higher certainty of death 80-90 per cent.
Impaired lives
Impaired rates for equity release plans will further exacerbate the problem as it will necessitate a scaling back in the benefits paid on standard rates to reflect the fact that over 40 per cent of people could benefit from impaired rates.
Our advice to brokers, especially in light of ‘Treating Customers Fairly’ (TCF) is to project expected mortality on longevity at 80-90 per cent probability, otherwise they may find that they are inadvertently creating a future problem for themselves. Also, whenever the product is being used to support a supposedly finite timescale event such as inheritance tax (IHT) planning or long-term care planning, then consider a wider spread of longevity data.
