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Risk Analysis for Reverse Mortgages with Different Payout Designs

Risk Analysis for Reverse Mortgages with Different Payout Designs APJRI 2015; 9(1): 77–105 Daniel Cho, Katja Hanewald* and Michael Sherris Risk Analysis for Reverse Mortgages with Different Payout Designs Abstract: We analyze the risk and profitability of reverse mortgages with lump- sumorincomestreampayments fromthe lender’s perspective. Reverse mortgage cash flows and loan balances are modeled in a multi-period stochastic framework that allows for house price risk, interest rate risk and risk of delayed loan termina- tion. A vector autoregressive (VAR) model is used to simulate economic scenarios and to derive stochastic discount factors for pricing the no negative equity guar- antee embedded in reverse mortgage contracts. Our results show that lump-sum reversemortgages aremore profitableand requirelessrisk-basedcapital than income stream reverse mortgages, which explains why this product design dom- inates in most markets. The loan-to-value ratio, the borrower’sage,mortality improvements and the lender’s financing structure are shown to be important drivers of the profitability and riskiness of reverse mortgages, but changes in these parameters do not change the main conclusions. Keywords: reverse mortgage, income stream, equity release, vector autoregres- sive model, stochastic discount factor, risk-based capital JEL Classification: G12, G21, G32 DOI 10.1515/apjri-2014-0012 1 Introduction Population ageing is a global phenomenon and the question of how to finance the retirement and health http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Asia-Pacific Journal of Risk and Insurance de Gruyter

Risk Analysis for Reverse Mortgages with Different Payout Designs

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Publisher
de Gruyter
Copyright
Copyright © 2011–2019 by Walter de Gruyter GmbH
ISSN
2153-3792
DOI
10.1515/apjri-2014-0012
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Abstract

APJRI 2015; 9(1): 77–105 Daniel Cho, Katja Hanewald* and Michael Sherris Risk Analysis for Reverse Mortgages with Different Payout Designs Abstract: We analyze the risk and profitability of reverse mortgages with lump- sumorincomestreampayments fromthe lender’s perspective. Reverse mortgage cash flows and loan balances are modeled in a multi-period stochastic framework that allows for house price risk, interest rate risk and risk of delayed loan termina- tion. A vector autoregressive (VAR) model is used to simulate economic scenarios and to derive stochastic discount factors for pricing the no negative equity guar- antee embedded in reverse mortgage contracts. Our results show that lump-sum reversemortgages aremore profitableand requirelessrisk-basedcapital than income stream reverse mortgages, which explains why this product design dom- inates in most markets. The loan-to-value ratio, the borrower’sage,mortality improvements and the lender’s financing structure are shown to be important drivers of the profitability and riskiness of reverse mortgages, but changes in these parameters do not change the main conclusions. Keywords: reverse mortgage, income stream, equity release, vector autoregres- sive model, stochastic discount factor, risk-based capital JEL Classification: G12, G21, G32 DOI 10.1515/apjri-2014-0012 1 Introduction Population ageing is a global phenomenon and the question of how to finance the retirement and health

Journal

Asia-Pacific Journal of Risk and Insurance – de Gruyter

Published: Jan 1, 2015

Keywords: reverse mortgage

References

  • Loss Given Default of High Loan-to-Value Residential Mortgages
    Qi
  • Aging and the Income Value of Housing Wealth
    Venti