A delay to controversial new rules on U.K. life insurers' equity release mortgage investments has brought the prospect that the changes could be softened, but while there is scope for change, and possibly further delay, few expect the rules to be scrapped altogether, and price changes already made in response to the proposals are likely to hold for now.
The U.K. Prudential Regulation Authority, or PRA, in July launched a consultation on proposals that would likely raise capital requirements for equity release mortgages, or ERMs, potentially hitting a number of life insurers that rely heavily on such investments to back long-term liabilities assumed through bulk annuity pension transfers. But following an industry backlash, the PRA said Oct. 25 that it would delay the rules at least until the end of 2019.
ERMs allow homeowners, who must typically be at least 55, to borrow money against the value of their house, with the loan and usually rolled-up interest repaid with the proceeds from selling the house after the owner dies or moves into long-term care. Insurers invest in them, along with other illiquid assets, to back the defined benefit pension liabilities they take on in bulk annuity deals.
Equity release mortgages offer a bigger benefit than other assets under Solvency II's matching adjustment, which enables insurers to avoid capital charges on illiquid assets if they are held to maturity and closely match liabilities. David Ellis, a partner at consulting firm Mercer, said in an interview that when it comes to setting up a bulk annuity transfer, ERMs "can be the [part of the portfolio] that has given a kicker to pricing and got an insurer over the line because they have had a better return."
Pricing 'kicker'
But the PRA is concerned that insurers are giving themselves too much credit under the matching adjustment for ERMs, in particular because of no negative equity guarantees, or NNEGs. Such a guarantee ensures that the repayment will not exceed the house proceeds, exposing insurers to the risk that the proceeds do not cover the borrowings plus interest.
The PRA's consultation was on the introduction of a calibration for NNEGs, with a view to implementing it at the end of 2018. The effects were quick: Listed life insurer Just Group PLC, where equity release mortgages made up around 37% of total 2017 assets according to S&P Global Ratings, saw its shares fall to a low of 71 pence on Sept. 18 from the 135 pence they were trading at the day before the announcement.
Just warned in its first-half earnings announcement Sept. 6 that implementing the proposals "could result in a material reduction in our capital position," and prices rose in the bulk annuity transfer market as insurers started to cut back on ERMs in response to the proposals.
Speaking to S&P Global Market Intelligence before the PRA announced the delay, Martin Bird, head of risk settlement at Aon PLC, said that when pricing new business, "We know insurers are making use of other assets to support that or dialing down the exposure to equity release while they figure out what their strategy is going forward for that particular asset class."
The delay therefore prompted relief in the industry, with the Association of British Insurers welcoming it and Just's share price rising 12.2% to 83.40 pence on Oct. 25 and a further 7.9% to 90 pence on Oct. 26.
Prospects for change
The open-ended nature of the PRA's statement on the delay, which said the rule's implementation date "will not be before Dec. 31, 2019," has prompted optimism about a softening.
In an Oct. 26 research note, Numis analyst Marcus Barnard said: "We hope that the PRA now seek to 'enhance its engagement with the industry' on some of the other concerns raised on the [consultation paper], such as the reasonableness of the proposals, the method and assumptions, and the pro-cyclical aspects of the proposals."
Barnard was quoting a section from a July 3 letter to PRA CEO Sam Woods from Nicky Morgan, chair of the influential House of Commons Treasury select committee, in which we welcomed the PRA's commitment to engage more with insurers on Solvency II.
Asked whether the delay left room for a softening of the proposals, Berenberg analyst Trevor Moss said: "For sure. I don't think there were many people, certainly in the insurance industry, who agreed with what [the PRA] were proposing."
But those hoping for a complete abolition of the equity release rule may be disappointed. Moss said that although he felt the PRA "went too far in this case," there is "an element of truth" in the PRA's concern and that "some additional strengthening of the capital requirements is probably on the cards at some point."
Insurers seem to think the same. Some appear unperturbed by the prospect of a new rule — prominent bulk annuities writer Rothesay Life bought an £860 million portfolio of equity release loans from UK Asset Resolution Ltd. on Sept. 27, before the delay was announced. But there is an expectation that bulk annuity price changes made before the delay announcement will stick.
"The PRA, in my mind, been very clear with its views in this area, so I think most insurers would price on the basis that this is going to come in anyway," said Hymans Robertson partner James Mullins.
S&P Global Ratings and S&P Global Market Intelligence are owned by S&P Global Inc.