The BBC has learned that UK pension companies may be harbouring billions of pounds of losses from equity release loans.
A report by Professor Kevin Down of Durham University – seen by BBC Radio 4 for ‘The Equity Release Trap’ – shows that firms have been undervaluing the guarantee costs on the loans, which are secured against lenders’ homes.
In the three months to the end of June, homeowners aged 55 and above borrowed a record £971m through equity release, the Equity Release Council says.
Some companies could require help from the industry’s Financial Services Compensation Scheme (FSCS) to cover negative equity costs.
Insurers invest in these loans to fund pensions, and the pensions themselves are also covered by the FSCS.
The loans are paid off when borrowers die or move into care. Interest is added each year or month, and because of compound interest, the loans can grow in size very quickly.
But the loans come with a guarantee that borrowers won’t have to pay back more than the value of the house. Any difference is absorbed by the lender.
The value of the debt can exceed the value of the house it is secured against, especially if borrowers live longer than expected or the value of the house drops.
This means that a property price crash or a period of consistent negative growth would see equity release loans become a loss-maker for their providers.
In one case study Anna and Chris Lee borrowed £112,000 (30% of the value of their home) at a rate of 6.78%. It will take just over 10 years for that amount to double.
The Prudential Regulation Authority (PRA), which oversees the companies using these loans, says it is considering whether to tighten the rules, but critics say it has been too slow.
Kevin Down, professor of finance and economics at Durham University and author of the report, says: “It evokes the global financial crisis, but this is an insurance crisis. It’s not on the scale of the financial crisis, but it’s bad enough.”
A spokesperson for the Equity Release Council, the industry body for the equity release sector, said: “While the detail of pricing decisions are commercially sensitive, common factors in offering a No Negative Equity Guarantee include three fundamental lines of security: a prudent view of house price trends with allowances for future uncertainty; stress tests for very adverse scenarios; and significant extra risk capital to ensure that, in an extreme adverse event in the residential property market, providers remain able to meet future obligations to policyholders. We understand the general approach to NNEG pricing reflects current accepted rules and will continue to consult on this matter with the PRA as indicated.”