What is Reverse Mortgage?

A simple definition of reverse mortgage can be

“A reverse mortgage is a loan available to seniors and is used to
release the home equity in the property as one lump sum or multiple
payments. The homeowner's obligation to repay the loan is deferred
until the owner dies, the home is sold, or the owner leaves (e.g., into
aged care)”
The analysis of definition provides some basic features of reverse mortgage
products. These are
 The loan is available only to senior citizens owning a home
 The loan can be in the form of Lump-sum or multiple payments like
annuity etc
 Homeowner does not have obligation to repay the loan till the house is his
prime residence
Some lenders have come out with plans different from the above to suit the
requirements of the borrowers. Some of such plans are

1. Home Reversion / Sale and Lease Back- The homeowner sells the
house but keeps the right to live in the house till the time it is his prime
residence. The amount could be used for home improvement, any other
health need etc.

2. Interest-only Mortgage- The borrower takes lump sum and pays only
interest during his lifetime. The principal is recovered through the sale of the
home

3. Mortgage Annuity/ Home Income- The loan is used to purchase an

annuity for the homeowner. The advantage is that even if the homeowner
moves out of the home, the annuity will continue till his death

4. Shared Appreciation Mortgage- This provides loans at a below market

interest rate.. In return, the lender gets a pre-agreed share in any
appreciation in the property value over the accumulated value of the loan.

The various considerations which needs to be taken while pricing a product of

this nature are
 Age of the borrower-If it is a joint borrowing then the age of the
younger borrower is considered.
 Value of the property- Then value of the property plays a major role in
determining the price for an RM product
 Expected Interest Rate- As the product resembles the normal annuity
product in some sense, the current and expected interest also plays a
major role in pricing the product

Significance of Reverse Mortgage Market for India

The society in India has under-gone huge changes in last 4-5 decades.
Nuclear family has replaced the joint family system. The system of family
supporting the older people has gone. As mentioned earlier the public
pension system has not been able to provide an alternate support to old
people. This condition leaves the older people in jeopardy. They face
following issues
1 1.Outliving their retirement income,
2 2.Depending on their children to help pay expenses,
3 3.Getting sick and having no way to pay the expenses,
4 4.Not being able to guarantee an income for their spouse after they
are gone ,
5 5.Being able to live as long as they like in their own home.

Looking at the current situation, the needs for a product which can help these
people to solve some of these problems is always a welcome step. Reverse
mortgage or equity release products tries to answer all these problems. Every
Indian, irrespective of its income level tries to build a home for himself during
his working life. Reverse mortgage will give him/her an opportunity to
generate income from that very home. As the ownership remains with the
borrower, he can transfer the home to his successors also if the later agrees
to pay the loan amount. Such a product relieves the pressure on government
also to provide old age security and thus government also needs to support
such initiative.
Many economies have been benefited from this arrangement and the market
for such products has increase quite a lot in these markets. Two such
examples are the UK and the USA market.

Reverse Mortgage in Developed Markets

UK
The market for reverse mortgage or Equity Release as it is known in the UK
has been growing very fast. The following tables provides an overview of the
market and its 10 fold growth within a span of 5 years
Value of new business in year (£m)
1998 1999 2000 2001 2002 2003
Mortgage Sales 6 85 297 359 651 1032
Reversion Sales 121 155 227 213 201 129
Total 127 240 524 572 852 1161

Risk inherent in the Reverse Mortgage Product

Any financial product involves some risk and reverse mortgage is no
exception. The lender faces many type of risk for this product. Some of these
risks are
I. Longevity Risk- The lender has to provide the payment upfront either
lump sum or instalments as the case may be but gets his money back
only when the borrowers dies or move into another residence. As we
are aware that the life expectancy of people is increasing, the risk of
late recovery of loans is a big risk for the lenders.
The risk is aggravated by the fact that with the payments from reverse
mortgage, the lifestyle of the borrower gets better which may become one of
the contributors in the improvement of longevity.
The longevity risk is higher for reverse mortgage where the payment is
continued till the death of the borrower since not only the recovery gets
delayed but also the lender has to make payments for a longer time,
II. Interest Rate Risk- The payments to the borrower in case of a
reverse mortgage is fixed, either for a term or lifetime but the
cashflows for the lender may not be fixed and are dependant on the
interest rate market. Thus the lender runs the risk that the interest
rates in the market may move in the opposite direction of that the
lender anticipated.
III. Market Risk (Property Value Risk)- The lender in a reverse
mortgage can claim back his loan only from the property on which the
loan has been granted. He does not have recourse to any other asset
of the borrower. If the sales proceeds of the home are not sufficient,
the lender cannot clam the balance from the heirs of the borrower.
This gives rise to the risk of adverse movement in property market
which affects the profitability of the product. Though this risk can be
diversified with increasing the geographical reach of the operations of
the lender but the risk still remains
IV. Early Redemption Risk- Some of the reverse mortgages loans may
give the borrower an option of repay the loan at any point of time. This
leads to another risk for the lender of early redemption as the borrower
will pay back the loan when it is most beneficial to him which in most
cases does not coincide with the interests of the lender. In case the
lender has securitised the loan, which in most of the cases it is, the risk
becomes higher as the lender cannot closer its position in this case.
V. Adverse selection and moral hazard risk- As with insurance
products, reverse mortgage products also have the scope of adverse
selection i.e. only people with expected higher longevity may go for
such products.

Role of life insurers in Reverse mortgage market

Life insurance market is growing in India and there are many international
players who are entering the market. Without going into details of regulatory
framework, we foresee that life insurers can play a very active role in this
segment of business and thus have a good growth in their portfolio. The
reasons behind this thinking are
1 Better understanding of mortality/longevity trends- Life insurers
have better research about mortality trends and so they have better ability to
measure longevity risks which is one of the major risk in the product. This
also helps in development in the market as the life insurers can provide
option of life annuity to borrowers rather than payment for fixed term. A life
annuity will help the borrower to have income even at the time when he is
very old.
2 Long Term Player- Reverse Mortgage is a long term product. Life
insurers being long term players in the financial market, they have ability to
estimate and manage long term interest rate movements and thus manage
the interest rate and other risk in better manner
3 Natural Hedge- Life insurers are on a better footing to hedge reverse
mortgage product risk with their portfolio of life insurance benefits.
Conclusion
As at present, India is poised for a strong economic growth, we should not
miss any avenue to accelerate or support the growth momentum. Home
equity/ Reverse Mortgage products are such products that have the potential
of not only increasing the liquidity in the economy but also diversifying many
risks. Besides insurance and pension products, actuaries with their long term
horizon are in the position to play a leading role in designing products like
reverse mortgage needing inputs both from actuarial and finance/investment
domains.