“Integrating Residential Property with Private Pensions in the EU”

Project report by the Institut für finanzdienstleistungen e.V. (iff) in cooperation with Rostock University (UROS), Andrássy University (AUB), Waterford Institute of Technology (WIT), Technical University of Delft (TUD), The Libera Università Maria Ss. Assunta (LUMSA) and Queens University Belfast (QUB) Acknowledgements: This report and its Annex present the results of the research project “Promoting the contribution of private savings to pension adequacy: Integrating residential property with private pensions in the EU” led by iff, institute for financial services, Hamburg. Financial support by the European Commission, DG Employment, Social Affairs and Inclusion is gratefully acknowledged. We also thank the many participants and stakeholders involved in our work over the course of 2016 and 2017. This project has received funding from the European Union’s EaSi Grant Programme under grant agreement No VS/2015/0218. This publication reflects only the authors’ views and the Commission is not responsible for any use that may be made of the information it contains. Authors in alphabetical order: Kerim Al-Umaray, Richard Burke, WIT, Sean Byrne, WIT, Sebastien Clerc-Renaud, iff, Kess Dol, TU Delft, Jörg Dötsch, AUB, Martina Eckardt, AUB, Marja Elsinga, TUD, Michael Feigl, iff, Giovanni Ferri, LUMSA, Declan French, QUB, Marietta Haffner, TU Delft, Peter Hennecke, UROS, Joris Hoekstra, TU Delft, Yogesh Jaiyawala, WIT, Francesca Lipari, LUMSA, John Maher, WIT, Donal McKillop, QUB, Elena F. Pérez Carrillo, Universidad de León, Pierluigi Murro, LUMSA, Doris Neuberger, UROS, Stefan Okruch, AUB, Flaviana Palmisano, LUMSA, Felix Piazolo, AUB, Udo Reifner, iff, Tripti Sharma, QUB, Dirk Ulbricht, iff. Download the entire Report or the Annex to the report please.

Executive summary

Purpose and methodology

This report addresses the topic of integrating residential with private pensions in the European Union. It is looking at asset conversion linked to household residential property, such as Equity Release Schemes (ERS), in a context of ageing Europe and housing wealth divergences across it. Currently consumers have mortgages and they have pensions. Both are long term products, requiring advice, involving income and capital, with independent set up costs and competing priorities in terms of their commencement. The potential for integration of these now independent offerings is what was considered in this project. While examining this issue in detail in six Member States – Germany, Hungary, Ireland, Italy, Netherlands, and UK – it has regard also to the profile of other Member States and of countries outside the European Union. The project was undertaken over a two year period covering 2015 to 2017 and involved detailed compilation, analysis and interpretation of secondary data relating to individual countries. It also required the generation of original qualitative and quantitative evidence consisting of focus groups, interviews and surveys, drawing on the opinions, experiences and perspectives of consumers, suppliers, regulators, non governmental organisations representing the elderly and government departments. The research has allowed for empirical experience, theoretical analysis, frameworks, models and international policy reports. The project was commissioned and undertaken because of the impact of an ageing population in Europe, the sustainability of existing retirement income frameworks, the materiality and illiquidity of housing assets in portfolios held by segments of the population, and a hypothesis that such housing wealth could play a role in retirement income augmentation. The perspective adopted by the consortium has regard to economic, fiscal, behavioural and legal dimensions in the first instance.

Overall principal findings

Scope for ERS: There is scope for deployment of property to augment retirement income though such scope is unevenly spread across EU Member States. This scenario is principally a function of the age profile of the population, the extant housing patterns, the cultural approach to savings and housing, and the degree of state involvement in housing and pensions both in direct provision and also by way of incentives. ERS can only be part of the solution as they are only of interest to a rather small part of the population, i.e. the cash poor but house rich with no bequest motive. Unfortunately, for those in most need of additional income, i.e. low income households with subsequently even lower pensions, ERS is usually not applicable as these households generally do not possess high real estate equity that could be released. Lenders see a future market in housing equity release products since the population is ageing, pensions are under pressure and housing equity is an underestimated resource. However, finding a good balance between risks and returns is not easy, both for households and for providers. In only a few European countries, such as the UK, a market for housing equity release products has really emerged. In most other countries, such a market is still in an embryonic state or non-existent. Providers of housing equity release products often suffer from a bad image. Indeed, households in serious need can be an easy victim for unscrupulous providers that want to sell untrustworthy (too expensive, bad conditions) products. Main stakeholders: Generally the form of property deployment involves variations in ownership, the exchange of cash in different time periods, the degree of risk with respect to property values, mortality, morbidity and interest rates, the availability of capital, and the legal form of contract. Six key stakeholders are involved: households, the State as the default supplier of retirement income and the maker of fiscal rules, the regulatory authorities who supervise financial markets, financial institutions and their financial intermediaries, and lastly legal actors who devise, advise on, interpret and enforce contracts. ERS serving different consumption preferences: The use of ERS differs considerably across EU member states. As an example of the most developed ERS market across the EU, the equity release market in UK is dominated by the loan model (lifetime mortgages). Homeowners demand such products primarily to finance home or garden improvements (63%), followed by to pay debts (31%) and go on holidays (29%). Only 13% of customers need the funds to help with regular bills. This suggests that ERS may serve different purposes from one country to the next. In the UK, the industry has organized itself through a trade association and today, the products are sold with a mandatory ‘No Negative Equity Guarantee’ that reduces the loan-to-value ratio or the liquidity released. Consumer awareness: Even in the most developed market, not many people in the UK understand equity release completely or are aware of this financial product. Equity release schemes can become a regular source of income for people in retirement if there is more transparency about the mechanisms and tax implications of taking out ERS. Fair propositions, quality standards and multiple providers: If designed appropriately, priced fairly and sold responsibly, ERS products are able to provide substantial social and economic benefits to individuals in retirement that seek financial solutions adapted to their needs. ERS can support consumers at the peak of their life experience in releasing capital from their homes to meet their daily needs as well as to greatly improve their quality of life. The market will only be considered consumer friendly however, when there are more providers competing to offer competitively priced products offering greater choice and flexibility to the over 65 year olds. The US experience, where a sizeable number of providers have been present on the market, also emphasises the need for real competition by ensuring there is a buyer’s market where shopping around is possible. Possible solutions: The process for ERS deployment could involve a range of solutions for different age cohorts. Younger cohorts may have possibilities not available to their older counterparts already committed to wealth accumulation in housing and other tradional pension fund assets. The project has sought to develop a hybrid system of old age pensions offering a permanent choice between the conversion of homes into liquid pensions and the conversion of pension savings into homes. This product should be adapted to different legal orders and implemented in a fairly standardised way so that retail markets can offer it at reasonable cost. Among the solutions that have been put forward to remove barriers to development of market solutions, are a list of minimum quality features, consumer information leaflets to raise awareness of advantages and risks, and a suggestion on how risk sharing mechanisms and product construction could encourage the providers to enter the market. There could be merit in piloting an urban initiative in a number of Member States, which would examine the effectiveness of one or more product proposals. A joint approach beween European and national funding sources could provide the necessary impetus, social cover, commercial cachet, financial oversight and political support that would make this possible. Sharing good practice, robust stakeholder governance, and community participation would be counted among the prerequisites. One way of doing this would be to invite applications from collaborating stakeholders for a specified number of pilot schemes which met defined criteria. Government role: There is a need for better coordination across governments with regards to policies on equity release. To ensure that those implementing policy changes have considered the impact on equity release, government and consumers, it is important for a department of the government to take a leading role in this area. Policymakers will have better insight on the use of equity release in fulfilling policy aims such as increasing retirement income or paying for social care if more efforts are spent on understanding the sector. Instigating the future development of solutions: The Action has identified a number of technical requirements that such ERS solutions should best meet if they are to provide a meaningful and sustainable solution to the pension shortfalls they are supposed to address. Through features such as the no-negative equity guarantee, mandatory independent advice and other such features, these will assist providers and policy makers as well as representative groups to appreciate these requirements. In the findings of the work, proposed solution pathways also encourage the testing of avenues by stakeholders. The Action will hopefully have shown the possibilities that exist in this area but also the limitations that currently exist and that could be overcome by innovative solutions. Discussions and survey responses with and from key providers have informed the work and proposed solutions. The Action has contributed to a better understanding and awareness of ERS which is still only led by niche players in a very small market in only very few EU member states. We believe that the Action will help to stimulate further consideration and attract the interest of larger banks and insurance companies for development and distribution of an acceptable product with the minimum acceptable features to make them attractive and with limited risk for consumers. Alongside commercial providers, the Action will hopefully also provide ideas for policy makers on how they can lever the development of solutions including how to enhance the willingness and ability for non-profit and government agencies to develop equity release products. As the research underpinning this report was conducted using a workstream task framework, it is appropriate that the central messages arising from each work stream are set out separately.

Summary of Workstream findings Need and feasibility for ERS EU wide (Workstream 1)

We find enormous differences regarding the market conditions for ERS in the EU. Regarding overall need and feasibility, measured by demographic pressure, risk of poverty, pension adequacy, homeownership and mortgage market characteristics, the Netherlands and the UK exhibit favourable conditions, the opposite applies to Germany and Ireland, while Hungary and Italy lie in between. Regarding the potential of ERS to reduce old-age poverty, Ireland and the UK have only medium conditions, while the conditions are unfavourable in the Netherlands. Policy recommendations Against the background of the varying legal, social and economic preconditions it is not possible to transfer “best practices” from one country to another. As a first consequence, we consider some more general aspects of the transnational potential for ERS. The demographic development will definitely weaken the current pension systems in the long term. This will be a driving force to find alternatives for old-age provision in each of the countries and may generate a development from currently “familial markets” towards a higher degree of commodification of residential property. It is nevertheless difficult to determine the critical point, when wider parts of the population will fully perceive the problem of old-age security and turn towards different solutions.

Policy measures, tools and implications (Workstream 2)

Workstream 2 provides an in-depth analysis of the policy measures relevant for private pensions and residential property in Germany, Hungary, Ireland, Italy, the Netherlands and the UK. These detailed country case studies are complemented by two additional studies analysing for the EU-28 life cycle patterns of pensions and housing and old-age poverty and housing. We cover a large variety of complex issues like pension systems, taxation, incentive and subsidy programs touching family and social policy, housing and mortgage market structures and development as well as social and cultural aspects. We study and compare ERS markets and their development, estimate the respective market potential, compare and discuss best practices. Our research reveals that both the complex conditions and the policy measures regarding private pensions and residential property differ widely among the six states covered. With regard to the integration of residential property into private pensions there is obviously no lowest common denominator which would allow to compile some of the analysed countries into groups. Nevertheless, to complement the current old age provision system by liquidating residential property seems to make sense in each country. Policy recommendations Since taxation and subsidies for private pensions and housing are not adapted to one another, not even within countries, the resulting incentives for investing in these assets are mixed and potentially contradictory. Therefore old-age provision would benefit from increased awareness by national legislator to better attune fiscal and other public policy measures. In addition to better targeted tax incentives, consumers would benefit from better transparency regarding costs and benefits of different saving vehicles for old-age, including ERS products. To this end, a transparent and stable financial system is a necessary prerequisite. Due to the large variation between countries, general product standardization seems not viable at the moment. Follow-up efforts would be worthwhile to identify which products and which product features are most promising to allow for the development of future cross-border markets. Experiences with the PEPP initiative might perhaps draw lessons for implementing such fiscal incentives that are conducive to the evolution of cross-border ERS markets. This would enable in particular member states with only a small potential for ERS markets to gain from economies of scale and scope.

Perspectives on ERS from the consumer focus groups (Workstream 3)

The focus group discussions have shown that there is considerable interest in releasing housing among consumers. A less generous pension and health care system is an important driver for this. Releasing housing equity does not necessarily involve a financial product. A majority of the focus group participants suggests that in case of financial need, especially if one lives in a large house, a house sale combined with a move to a smaller owner-occupied dwelling (downsizing) is the first option. In that case, people are not dependant on financial institutions and they can live rent-free which, for many participants, is one of the main benefits of owner occupation in the later life course. At the same time, various focus participants stated that they have an emotional attachment to their dwelling. For this people, releasing housing equity while staying in the house (ERS, sale-and-leaseback) would be an interesting option. Indeed, for the consumers in the first two focus groups, using an ERS was often the second option after downsizing. Apart from the desire to become old in the family dwelling, the interest in ERS seems to be connected to the wish to offer children a helping hand. Many consumers indicate that they prefer to financially help their children when they are still alive rather than leaving a bequest after they have passed away. At the same time, various focus group participants were wary to release too much equity because they might need it for care purposes when they became ‘really’ old. Financial autonomy turns out to be very important for older home owners. Many focus group participants indicate that they lack the knowledge of ERS and they would like to have access to objective ERS information from independent sources. Probably as result of the global financial crisis, the trust in financial institutions is low across the board. Introducing uniform product standards, such as the ones developed by the Equity Release Council in the UK, might enhance the trust in the providers of ERS. An awareness campaign of the government could also play a positive role. Preferably, such a campaign should focus on the potential societal benefits of ERS. In the last focus group, some alternative ERS solutions were discussed. This discussion clearly showed that particular groups (young people, self-employed people, tenants) need some support in their pension provision. Therefore, it seems wise not to limit the discussion of, and product development within, ERS to older home owners alone. Policy recommendations

  • More objective information on ERS should be provided.
  • Uniform product standards for ERS should be developed.
  • The central government should develop a clear vision on ERS (pros, cons, connection with other policy areas).
  • Product development in ERS should not only focus on older home owners but also on young people, self-employed people and tenants.

Providers and ERS markets (Workstream 4)

The number and type of ERS suppliers, market volumes, product types offered, as well as their legal treatment vary widely across EU member states. The market is dominated by the loan model type, even if this is not offered in some countries (e.g. Germany, Hungary). Only the Irish and British ERS markets are well-developed and mature. The products are only eligible for elderly homeowners, whose residence values exceed a minimum threshold. The most common form of payment is as a one-off cash lump sum. ERS markets usually operate only inside the country. According to various stakeholders, the interest in such products is increasing related to the greying population and the increasing demand for care. However, the comparability of the different products remains difficult, and the consumer has to pay various fees. Equity release products are complex and they expose their providers to a large range of risks. The current risk management mechanism adopted by providers/insurers in combination with stricter Solvency II regulations imply that ERS will never be utilised fully by interested customers due to the low loan-to-value (LTV) in loan model products. Moreover, a low LTV combined with a high interest rate makes the product appear expensive to the customer. One of the difficulties for the introduction of a European wide ERS product, adequate for sale in the Internal EU Market is the legal definition of the concept. Equity Release has not yet been defined precisely in legislation, even less so in a way that is applicable for the different types of products being marketed at present, or potentially. As the 2014 Mortgage Credit Directive excluded ERS, perhaps a future new instrument may fill the gap. Policy recommendations To overcome the main difficulties of ERS a number of elements could be incorporated into the design of ERS products, its marketing and sale. As subsidies and taxation have been used in some countries but do not seem to be effective we reach the conclusion that, whatever the model, type or subtype a possible approach to design a future product could be based on the division of risks that exist in ERS products. Providers, be placed under supervision and in a position to manage at least two main risks through financial markets. They are, risks associated with the assessment of the situation of the person that is contracting (and of the beneficiaries), as well as the risks linked to the value of the property. Our research suggests that the development of equity release markets across the European Union is contingent upon two main factors. The first relates to an active involvement of European governments in promoting equity release schemes as mainstream retirement planning options, overcoming consumer perception-related barriers and reducing regulatory barriers for suppliers. The second element requires introducing products suiting consumers’ needs that would provide them with substantial amount of housing capital at lower costs. This further calls for increased market competition and adoption of better techniques to manage the risks inherent in an equity release offering by suppliers.

Product development – enhacements and new solutions (Workstream 5)

This workstream sought to develop proposals which would provide access to residential property while augmenting retirement income through private pension based solutions. This was undertaken by examining the constituent elements of pension and equity release products, the existing market patterns regarding equity release and the attitudes of individuals to different approaches to providing housing and additional retirement income. Discussions also took place with stakeholders. Existing equity release products are provided primarily in the loan model, are used to generate lump sums for the householder, offer a no negative equity guarantee and involve fixed costs in terms of financial and legal advice, valuation etc. They are often used where other means of generating cash from a property are not considered attractive by householders or are unavailable. They seem to fit household and supplier needs in stable or rising house price markets. They remain a niche product, albeit one that is showing a steady growth rate in the UK. Market practice has developed therein a manner whereby almost the entire supply side are members of a trade group with a code of practice designed to offer a high level of protection to consumers who avail of the product. In consumers’ minds, the product is perceived as commanding a premium price. This price reflects the level of fixed costs, the no negative equity guarantee, the provision of income in cash on the product only after the householder has vacated the property, often 15-20 years later. The proposals now developed seek to provide additional policy choices with respect to improving affordability. The solutions involve some combination of a redistribution of risk, a redistribution of ownership, a reframing of occupancy, a bundling of pension and housing benefits, individual and collective product models, and product terms involving periods commencing with household formation to those which commence with equity release from freehold property held in retirement. The solutions are aligned with different age cohorts: those who now own a property, those who are already committed to home ownership using a mortgage, and those setting out in household formation. The solutions offer choices that seek to overcome cost or income constraints. Policy recommendations The solutions thus could involve the State taking on a risk bearing role. It could offer tax relief on mortgages in the form of as private pension contributions. Others could involve individuals using the savings capacity arising after the repayment of mortgages to contribute to private pensions. These could then be drawn down to service an equity release loan in retirement. Depending on the country-specific policy framework, subsidies or tax reliefs should be used only in so far as to create a level playing field of ERS with other private pension products (e.g. state-subsidized Riester pensions in Germany). Individuals could also substitute a tenancy for outright ownership of a residential property, or have a form of shared ownership through a collective legal structure. Individuals could also commit to releasing equity from a residence at the same time as they obtain mortgage finance for that property. The solutions recognise a spectrum of occupancy scenarios: as a tenant, as a shared owner and as an absolute individual private owner.

Summary of achievements: A conference and stakeholder meetings at national level as well as expert interviews were held throughout 2016 and 2017. These events concentrated on exchanging and collecting views from suppliers, regulators and intermediary organisations like home associations and consumer protection associations in each of the six countries. In addition, also in each of the six countries, 3 separate focus group interviews were held with ordinary homeowners and pensioners to gain information about their preferences, needs and attitudes as to ERS products and their alternatives. Finally, for each country a stakeholder dissemination event and in some such as Germany an information event was organised to raise awareness in regard to ERS products. Leaflets in the respective national language have also been published comprising the main results of the project tailored to the respective national target audience. Download the entire Report or the Annex to the report please.