In this blog we explore how the FCA’s frequently-articulated policy priorities on the ageing population and vulnerable consumers, product complexity, and retirement advice may shape future FCA work on equity release. We also consider how advisors and product manufacturers and lenders can best respond to this increased scrutiny.
Overview: a potentially beneficial but complex product
Equity release mortgages (ERMs) have been growing in popularity in the UK over recent years, driven by a growing elderly population that often has considerable housing wealth but little in the way of retirement savings. The average amount people have saved in a pension is £30,000 1, whereas over 65s have the highest rate of home ownership of any age group with 77% owning their own home 2. With the average UK home worth £227,000 3, many pensioners could have considerably more wealth in their property than in their pension.
While there have been significant historic conduct concerns around equity release, both policymakers 4 and regulators have pointed to equity release as a way of addressing some of the public policy issues related to the UK’s shortfall in retirement savings through enabling the elderly to access housing wealth as a retirement resource. The FCA’s most recent public statements on equity release have, broadly, been cautious but positive 5.
However, the FCA has also articulated wider policy priorities which, in our view, suggest that equity release could come under yet further close scrutiny from the FCA.
The equity release mortgage market
The market for ERMs has almost trebled in size over the past 5 years, with the value of new sales recovering from a post-recession lull of £788m in 2011, to £2.15bn in 2016 6. The number of equity release plans available in the UK market has also increased, from 24 in August 2007 to 78 as of August 2017 7. Importantly, interest rates on equity release products have fallen by 90bp in recent years as a result of increased competition 8. Nevertheless, compared to conventional mortgages, equity release still represents a more expensive method of borrowing against residential property.
While many of the firms active in the equity release market are specialist equity release providers, large insurers like L&G (the largest provider by market share) have also started to offer ERMs. In November 2017, Nationwide also entered the equity release market, illustrating established financial services firms’ growing interest in the market and the increasing momentum it has generated.
Although equity release products have a troubled conduct history, the move to bring ERMs into the scope of the FSA’s regulation in 2004, and a concerted effort by the industry itself, has helped to improve their reputation. Most ERMs sold today are either lifetime mortgages 9 or home reversion plans 10, and, with the benefit of no negative equity guarantees (see below) bear little resemblance to the home income plans 11 and shared appreciation mortgages 12 that had previously caused significant conduct concerns.
Innovation in the ERM market means that products now offer a wider variety of features which help address many of the previous concerns of consumers and regulators. The majority of plans available today offer early repayment facilities and the option to draw down income over time rather than taking a lump sum 13. Importantly, they also feature a ‘no negative equity guarantee’ (NNEG), meaning the amount owed by the borrower can never exceed the value of the property. Other features available include inheritance guarantees which ring-fence a fixed proportion of a property’s value to be passed onto future generations; and downsizing protections which allow the customer to avoid early repayment charges if they choose to move to a smaller property within a given timeframe.
Equity release and the FCA’s policy priorities
The ageing population and vulnerable consumers
The FCA first articulated its focus on vulnerable consumers in its Occasional Paper on Vulnerability, and put vulnerability at the heart of its approach to regulation with the publication of its Future Approach to Consumers document in November 2017 (our previous blog provides more details). The regulator has also given particular attention to ageing-related aspects of vulnerability, publishing its Ageing Population Occasional Paper, in September 2017. The paper notes that consumers are more likely to experience transient or permanent vulnerabilities as they grow older and says that firms should “proactively recognise the potential vulnerabilities associated with older consumers and act with appropriate levels of care.”
ERMs are exclusively sold to older consumers, with the age of a new ERM customer averaging between 67 and 72 14. Given the FCA’s focus on ageing and vulnerability, these should consequently be important considerations for advisers and firms in the equity release market.
One area in which vulnerability may be of particular concern is with regards to the ‘dilapidations’ clauses in many ERM policies. These clauses require the borrower to maintain the property and provide suitable insurance. In order to meet the FCA’s expectations, advisers will need to make clear the state of repair that borrowers will be required to maintain, and, as ERM loan books mature, lenders will want to consider the potential for financial strain on the borrower should the need arise to enforce the policy’s contractual terms. In extremis, efforts to enforce these terms through pressurising the borrower or by taking legal action could be highly sensitive and run up against the FCA’s stance on vulnerability.
The FCA’s ageing population paper discusses the issues older and vulnerable consumers can have with complex financial decisions and products, indicating that the regulator continues to be interested in this topic and its interplay with consumer vulnerability. Andrew Bailey noted in his September 2016 speech on pensions and long-term retirement that the complexity of ERMs can create both prudential and conduct concerns 15.
The complexity of ERMs means that the regulator will be looking for firms and advisors to ensure that features of the product are clearly explained and documented for consumers. In particular:
- Regulators have already drawn attention to the potential costs of ERMs for consumers, and will expect advisers to provide clear explanations of costs, including the compound nature of the interest charges and the effect this can have over long periods of time (for example, someone borrowing at a rate of 6.5% may be surprised to learn that the amount they owe will almost double in the space of 11 years). The FOS indicates that it commonly receives complaints from family members, who are often surprised to learn how much is owed from the policyholder’s estate.
- Early repayment charges add complexity to the product and are another area of complaint highlighted by the FOS. Those moving homes or choosing to downsize are likely to incur these charges, and the FCA requires 16 financial advisers to consider whether the borrower has plans to move or might do anything else that would put them at risk of early repayment charges, e.g. health considerations.
Retirement outcomes and pensions advice
A wide variety of the FCA’s recent work has focused on pensions and the advice consumers receive around retirement. The regulator recently looked at pensions transfer advice and is in the process of finalising its Retirement Outcomes Review (ROR), which is expected to be published later in 2018. The organisation is also working with The Pensions Regulator to develop a cross-organisational pensions strategy.
Equity release is not in the scope of the ROR, and the FCA previously looked at ERM-related advice, dropping proposals to introduce a specialist equity release qualification for advisers in 2017. However, the ROR’s interim report notes that “Consumers may use other products to save for retirement and draw on those savings, such as Individual Savings Accounts (ISAs) and equity release products” 17, showing the FCA continues to be mindful of the wider retirement income market.
Given the growing size of the equity release market, the advised nature of the product, and its substitutability and complementarity to traditional pensions savings, the FCA’s current focus on pensions could logically lead it to look further at ERMs in order to establish a more holistic picture of the retirement market.
The FCA’s existing ERM advice rules (MCOB 8) place a strong emphasis on the suitability of advice anyone wishing to take out an ERM must receive. The detailed nature of these requirements provides firms with a clear guide to the FCA’s expectations, but also highlights the many areas in which the FCA sees potential for conduct risks. These requirements also add to the product’s aforementioned complexity.
Many of the complaints about ERMs relate to the advice the borrower received when taking out the product, and while the overall number of FCA complaints is currently quite low 18, future regulatory intervention may focus on areas of consumer detriment highlighted by complaints.
Considerations for equity release product providers and advisors
In sum, we expect the FCA to refocus its attention on the ERM industry in the context, and as a direct consequence, of its broader policy focus on the elderly and vulnerable, product complexity, and retirement and pensions advice. ERM manufacturers and advisers should be mindful of how the FCA’s broad policy approach will translate to its supervision of ERM operations. In particular:
- The FCA will be looking for product manufacturers to undertake careful scrutiny of their distribution networks and the suitability of the information they provide that can be passed on to end-consumers. In addition, they will need to demonstrate to the FCA that they have effective systems and controls to exercise suitable levels of oversight over their distributors. Firms will also need to consider how they design products to better suit the needs of vulnerable consumers, given the regulator’s prioritisation of this issue.
- The FCA will expect advisers to pay close attention to its rulebook and to ensure that the customer understands both the complex nature of product and the charges involved. The regulator will also be looking for advisers to identify client vulnerabilities, consider these as part of their suitably assessment and ensure that any vulnerabilities are continually reassessed over the lifecycle of the ERM.
1Christopher Woolard, Speech on the future of the UK mortgage market, July 2015
2House of Commons Library, Home ownership and renting demographics, June 2017, p11
3ONS, House Price Index, December 2017
4For example, Baroness Wheatcroft and Lord German both contributed to the Smith Institute’s publication, 'making the most of equity release', published in March 2012.
5In a speech on the future of the UK mortgage market in 2015, Christopher Woolard, the FCA’s Director of Strategy and Competition, said that the elderly population is often asset-rich but cash-poor, noting that “The ability to access some of that [housing] asset, as a restricted lump sum or as a gradual income could make a significant difference to people’s lives.” This recognition was caveated, with Woolard saying “in the not too distant past, equity release became a dirty word” and that “some will argue that the costs of equity release, both up front and compounded over time, are relatively high for the individual, and that the previous image has stuck.”
The FCA’s CEO, Andrew Bailey, reflected Woolard’s remarks in a September 2016 speech, noting that “Some argue that the costs of equity release, both up front and compounded over time, are relatively high for the individual which signals a note for caution. Others, however, can point to potential benefits, especially for those who want to remain in homes they’ve worked and paid for over their lifetime.” Bailey offered a “note of caution” on the complexity of the products and the aforementioned NNEG, which he said can raise both prudential and conduct concerns.
The FCA’s September 2017 ageing population occasional paper notes that “Older consumers may want – or need – to use their housing equity to support their financial needs while remaining in their home” and that “In light of pension shortfalls, housing equity will continue to play a key role in later life and retirement planning.” The paper notes that lifetime mortgages “remain a useful tool and meet a number of consumer needs”.
6Equity Release Council, Market Report, Autumn 2017, p15
7Equity Release Council, Market Report, Autumn 2017, p4
8The Equity Release Council says that average ERM interest rates have fallen from 6.20% in January 2016 to 5.30% in July 2017. Equity Release Council, Market Report, Autumn 2017, p5 and p6
9Lifetime mortgages allow consumers to release cash (typically as a lump sum) by taking out a fixed rate mortgage on their home, which is repaid either when they die, move into care, or sell the home
10Home reversion plans allow consumers to sell all or part of their property to the plan provider while retaining the right to live in and make use of the property until they die.
11In the 1980s thousands of elderly people were sold ‘equity linked home income plans’, which offered the potential for a higher income and a cash lump sum by releasing money from their homes. These plans were dependent upon the performance of the stock market, with the idea that a rising market would mean a better income for those who had bought such plans. The complex nature of such products meant many consumers did not understand the risks they were taking and many of those who had bought the plans were left in severe financial difficulty; these sort of plans were ultimately banned in 1991.
12In the 1990s some 15,000 consumers were sold ‘shared appreciation mortgages’, which provided the borrower with a lump sum in exchange for the lender gaining a share of any future appreciation in the property’s value. Rapidly rising house prices meant that such schemes often turned out to be extremely poor value, leaving many borrowers to repay sums far greater than they had expected.
13The Equity release council provides an overview of the most common product features in its Equity Release Council, Market Report, Autumn 2017, p5.
14Equity Release Council, Market Report, Autumn 2017, p10; average age of 68 for lump sum plans, and 72 for drawdown plans
15Our previous blog explored some of the PRA’s prudential concerns around ERMs.
16FCA MCOBs, Chapter 8, 8.5A.6
17FCA, Retirement Outcomes Review Interim Report, July 2017, p19
18Complaints saw a small uptick in the last two bi-annual periods reported by the FCA, reaching 1,215 complaints in 2016 H2 before dropping slightly to 1,123 in 2017 H1. It is important to be mindful of growth in the ERM market over this time.