On 31 March 2016, the PRA issued a discussion paper (DP1/16) on equity release mortgages (ERMs). While the discussion paper is mostly relevant to life insurance and reinsurance companies with ERM exposure, it will also be of interest to industry stakeholders (including banks, building societies, other lenders, trade bodies, brokers, credit rating agencies, consultants, actuaries and auditors) and academics.
Items of particular interest in the discussion paper are:
- ERM valuation - use of relevant market inputs: the PRA is primarily concerned with ‘fair’ value to the extent it impacts prudential requirements for valuation. There are different techniques used to measure ‘fair’ value. The PRA has asked for feedback on how valuation inputs (e.g. prices quoted in active markets) should be classified and which market inputs are most significant.
- ERM valuation - framework and calibration: In the UK, there is often a guarantee that, on certain forms of repayment, any excess of the accrued loan amount above the (sale) value of the property will be written off or waived by the lender. This is the ‘no negative equity guarantee’ (NNEG). There are several techniques that could be used to value the NNEG. The PRA has asked for feedback on the framework and calibration of such techniques.
- Risk management of ERMs: Good risk management of ERMs is central to demonstrating an overall system of control over investments. Amongst other things, the PRA has asked for feedback on which techniques should be used to identify and monitor emerging risks to ERMs (e.g. changes in flood risk and other environmental issues etc.).