Article | April 2007 | by Duncan Young
Home Reversion – How will regulation change the market?
6 April 2007 saw the Financial Services Authority (FSA) take responsibility for regulating the home reversion market, so now both arms of the equity release market are on a relatively level regulatory playing field. In the run up to regulation there were many predictions about how this extension of the FSA’s reach would affect both the equity release market as a whole and the home reversion segment that sits within it.
First off it is worth stating that new regulations have been welcomed by those operating in the equity release space and have been viewed positively as a means of increasing business. What regulation entails remains a bit of a mystery for many and some wild claims have been made. In essence the FSA has drawn a distinction between advising, investing and administering. For any broker firms which offer advice on equity release, the FSA has published a helpful leaflet which can be viewed on the website. In particular it highlights the grandfathering rules which how now come into force. To some extent these grandfathering rules have been superseded by SHIP, which states that its members will require reversion qualifications after April 2008. So, by that time brokers who wish to advise on home reversions will have had to take the necessary top up exams.
For product providers regulation has meant an investment in systems and control and a general imitation of the lifetime mortgage processes such as producing key facts illustrations automatically. None of these demonstrate much more than good practice and do not seem to have caused much public disquiet by product providers. So let’s initially look at two issues: how will regulation affect the overall equity release market? and what will be the impact on the market share between lifetime mortgages and home reversion plans?
In terms of the equity release market I believe that any change will be gradual, for the simple reason that the public are probably not aware that the change has even taken place. There has been very little consumer commentary about the new circumstances and I doubt whether it will have registered in the public mind that as the market is now regulated, now is the time to buy. For consumers the only real impact is that the SHIP compensation scheme has been replaced by access to the Financial Ombudsman Service and the Financial Services Compensation Scheme, which are in turn supported by product providers having FSA approved complaints procedures. The way that the public in general will hear about the changes will probably occur once they are in front of a broker who will fully explain it to them. This, however, means that the customer has already decided to investigate equity release to the level of seeking professional advice. I cannot be sure whether or not someone would seek out a broker purely because of the changes in regulation.
So, while it is unlikely that the overall market will be given a boost by regulation I do expect that home reversion products will increase market share slowly. This will come about because by passing their reversion modules, brokers will become more confident about the reversion process. All brokers understand a mortgage, whether it is prime, sub-prime or lifetime and know what a charge document is and how advance criteria work. With some reversion products there is a sale and leaseback on a lifetime tenancy or in a more modern context the transfer of the property into a trust with the customer having occupancy and other rights. Not a straightforward matter for a broker to explain. And while it may be argued that these are essentially legal points, the broker has to give comfort to their client at the time of sale. However familiarity will bring the necessary confidence – but this will not happen overnight.
The question remains, with this new found confidence will the principle advantages of reversion products shine through against lifetime mortgages?
If they do not, then reversions will continue to labour under the 7% market share they enjoyed in 2006 (according to SHIP statistics). I have read, not unsurprisingly, most reversion providers’ sale literature and it strikes me that reversion providers have two main selling points, which are:
- Amount: Reversions provide the largest amount of cash for customers. In addition reversion providers will often make this cash available on properties that lifetime mortgagees do not want as security.
- Protected share: Only part of a property has to be put at risk and so the customer can be sure that a percentage of their home will be available for their beneficiaries or for a subsequent further advance.
Obviously there is also a mix and match option where customers can enjoy a large advance together with a protected share.
Against these two selling points lifetime mortgages have a number of arguments. With lifetime mortgages, the customer benefits from house price inflation to the extent that it exceeds the interest accrual. There are well designed drawdown products – although there is one reversion drawdown scheme as well.
So, it will be an interesting debate now that the regulatory position has been equalised. However it is not the end of the story. In 2006 SHIP attracted three new members. Two were reversion providers and one was a lifetime mortgage company. The reversion providers introduced the Property Plan and an impaired lives product. Both were new features to the equity release market. The lifetime mortgage company brought a sophisticated drawdown product but despite all its bells and whistles, was essentially derivative. So, recent work in the product development space has come from reversion providers rather than lifetime ones.
It is open to debate about whether this is because of the building block of the reversion or whether it is to do with an attitude of mind. Reversion providers look at the property first as they are making an investment. If the property does not increase in value they will probably at best break even or could lose money. On the contrary, if the property fits then much else is just detail and so products can be fashioned around customer requirements.
But for a lifetime mortgage provider the property is in a different position. It is the security for the mortgage. Not only that, the mortgagee is giving a no negative equity guarantee which demands, for the mortgagee, that the property appreciates in value faster than the interest accrues. So it almost a quasi investment decision. However the mindset of the lifetime mortgage provider has been to protect value by covenants and strict morbidity rules, such as insisting on disposal of the property when the mortgagor goes into long term care. This inhibits product development to the structure of how the liability, that is the lifetime mortgage, is incurred hence the emphasis on drawdown products.
Now, we have reached Spring 2007 and I am aware of only two new entrants to the equity release market and both of these are reversion providers. Neither has made product announcements, but I cannot imagine that they will just arrive with “me to” offerings. I am not aware of new lifetime mortgage players - if anything the rumour mill suggests some of the smaller providers may be dropping out. This may have been exacerbated by the three main lenders all losing market share in 2006.
So I confidently expect that once brokers have taken the new regulations on board and passed their top up exams that they will be happier to recommend reversion products to their clients. This is, as I have argued a slow process which will not be supported by consumer demand for reversion products prior to meeting their adviser.
I do anticipate, however, the structure of the reversion product together with its product development opportunities will lead to an increased market share for reversions over the next few years.
Regulation was necessary and has to be embraced with open arms by the equity release industry, but it is not a panacea – if the customer did not want to enter into an equity release contract prior to regulation I cannot see how the simple fact of regulation will cause a sea change. I should add that I would love to be proved wrong and be seen to be unduly pessimistic. Time will tell.