First supplementary memorandum submitted
by Which?
FOLLOW UP
TO EVIDENCE
SESSION ON
24 JANUARY 2006 [348]
REGULATION OF
THE EQUITY
RELEASE MARKET
(Q 76)[349]
1. The potential growth of the equity release
market in the UK has been exaggerated in some quarters[350]
but it is clear there will be a significant growth over the coming
decades because of a combination of:
a. changing demographics,
b. under-provision for retirement and general
household savings,
c. rising costs of health care,
d. rising consumer expectations,
e. a huge growth in property values; and
f. the behaviour of the retail financial
services industry—we expect more activity in this sector
on the part of firms as margins are squeezed in other product
areas.
TRANSITIONAL PROBLEMS
FACING THE
UK
2. The Government has recognised the need
for reform to ensure the long-term sustainability and affordability
of the UK pensions system. We are now awaiting the pensions White
Paper following the reports of the Pensions Commission. If the
reforms are successful, then this should bring significant benefits
to future generations of pensioners and taxpayers. However, due
to the long-term nature of retirement planning it will be some
time before the benefits of pension reform work through the system
3. Which? is concerned that there will be
significant transitional challenges for the cohorts of consumers
in their late forties and fifties who will face an uncertain retirement
over the next decade. They will retire too soon to benefit to
the same degree as younger generations from the current reforms,
nor will they be in a position to make sufficient additional pension
provision due to the closeness of retirement. To be sure, the
Government could protect these cohorts of consumers through targeted
PAYG state pension provision. However, we believe there is real
scope for the Government to investigate radical funded solutions
to supplement retirement incomes in cases where the market cannot
deliver.
THE NEED
FOR ALTERNATIVE
SOLUTIONS TO
BRIDGE THE
GAP
4. It is our firmly held view that there
is a real need for alternative `quasi-market' solutions in a number
of key areas to bridge the gap between state and retail market
provision. This can be seen in the provision of financial advice
(which is why we have been campaigning for a National Financial
Advice Network); the provision of decent and affordable pensions
(which is why we have supported the idea of a National Pensions
Savings Scheme); and access to banking (as our support for the
concept of shared branch banking shows). The same principle applies
to providing access to affordable means of supplementing retirement
income.
5. Because of the limitations of the retail
private sector model we are of the view that an alternative form
of equity release product/provider is needed to provide access
to those consumers the market cannot serve fairly and effectively.
We have been undertaking some preliminary work in defining what
the key features would be of such a product.
6. We should stress that Which? needs to
undertake much more work on the costings, distribution and regulation
of such a scheme but we are confident that such a product could
be constructed and access provided through the not-for-profit
sector and other channels such as local authorities.
LIMITATIONS OF
CURRENT MARKET
MODEL
7. Equity release could play an important
role in helping consumers manage the demands of retirement. However,
as the Committee will be aware, Which? has a number of concerns
about the way the market has developed including: some of the
selling practices in the market, the design and transparency of
the products, the high cost of products, and restricted access.
8. This last point is a crucial one for
Which?. We envisage that the market will develop in such a way
as to focus on consumers with significant housing and other assets.
The products are expensive as mentioned and the minimum sums that
can be borrowed can be quite high. We believe that the retail
private sector financial services industry will find it hard to
provide fair and decent products for consumers on lower-average
incomes or those who live in regions with lower levels of housing
wealth. This is unfortunate as it is these groups of consumers
who are likely to need a boost to income in retirement or who
may be in desperate need for additional sources of income to fund
expenditure such as home repairs.
9. As with much of retail financial markets
and financial inclusion (eg. stakeholder pensions), the issue
is all about the economics of access. The margins are not there
which would allow retail firms to serve this part of the market—or
to be more precise on terms which would represent value for lower-medium
income consumers. The retail industry could design equity release
products for this market (ie with smaller borrowing requirements)
but we think the cost of doing this would be prohibitive for the
consumer.
PROPOSED KEY
FEATURES OF
ALTERNATIVE EQUITY
RELEASE SCHEME
10. If a new equity release scheme is to
deliver benefits to consumers who are in greatest need of access
to additional income then we believe the following key features
would be important:
a. It should provide small amounts of equity.
We are undertaking more research on consumer needs and have not
arrived at a final figure yet but we think that a minimum figure
somewhere in the region of £3,000 would be appropriate.
b. There should be a no-negative equity guarantee.
c. It should be low cost in terms of interest
rate charged and other fees. This does not necessarily mean that
the interest rate should be lower than interest rate charged on
retail private sector products. The key issue is one of access
ie. providing access to small amounts of equity on reasonable
terms. We do not think retail providers would be able to provide
access to small amounts of equity—to be precise they would
only be able to do this on terms which were prohibitive for consumers.
d. early redemption and repayments should
be possible.
e. clear, fair and simple. Any terms and
conditions such as redemption fees and switching costs should
be clear, fair, reasonable and transparent eg. they should not
be linked to fluctuating financial instruments which are hard
to predict and understand such as gilts.
f. it should be transferable to other properties.
g. an `income drawdown' facility should be
available to allow equity to be withdrawn in instalments as well
as a lump sum.
h. we are evaluating whether the scheme should
be operated on `roll-up' basis where the interest is rolled up
and added to the loan or a fixed rate basis where the amount owed
by the consumer is fixed at the outset.
FUNDING
11. Due to the nature of the potential market
and the economics of access problems for the private sector, the
Government would need to facilitate the core funding for this
scheme. We stress that this should not be seen as a direct `grant'.
The aim should be for this to be cost-neutral for the taxpayer.
12. This is a crucial point for the success
of such as scheme. If the economics of access are to be viable
then two conditions must be met:
a. some form of central funding (or facilitated
access to funding) needs to be made available to provide the economies
of scale to minimise costs and
b. the scheme needs to be funded on a cost-neutral
basis (or possibly cross-subsidised) to allow costs to be minimised
further.
13. In our view, the Government is best
placed to facilitate the operation of such a scheme.
FUNDING MECHANISMS
14. We are exploring two possible funding
mechanisms—both involving the establishment of a `Central
Equity Release Fund (CERF)'[351].
15. The first involves government providing
loans from the CERF at wholesale market/government bond rates
to approved equity release scheme providers who would then provide
equity to consumers at an interest rate/price which incorporated
the additional costs such as administration and necessary regulation.
16. The alternative model involves approved
providers applying for tranches of interest free funding from
the CERF with the Government taking an agreed share of the proceeds
when the home is sold.
17. Both funding mechanisms imply different
levels of risk for the different parties involved in the scheme
depending on the appropriate interest charging rate applied to
the scheme and the nature of the product ie. whether it works
similar to a private sector `roll-up mortgage' or fixed-repayment
mortgage.
18. A variation on the CERF would be to
create a `quasi-market' vehicle to manage the funding of equity
release schemes. This would be similar to the Fannie Mae and Freddie
Mac institutions in the USA which fulfils a similar role for mortgages.
However, concerns have been raised about the governance arrangements
relating to these institutions in the USA and m-ore thought needs
to be given as to the appropriate regulatory regime—although
this in our view does not undermine the fundamental value of the
concept.
PROVIDERS, COST
AND REGULATION
19. As mentioned above, we are undertaking
further detailed work on: who would be the appropriate providers
for the scheme; how much the scheme would cost; pricing arrangements
(eg. should the interest rate be capped?); and appropriate form
of regulation.
20. With regards to providers, our initial
view is that the providers should be local authorities and a restricted
list of other `approved providers' such as charities operating
on a not-for-profit basis.
21. The scheme and providers would undoubtedly
attract a degree of regulation both in terms of `prudential' and
conduct of business regulation.
22. Although providers would not be putting
their own (or depositors) capital at risk, they would in effect
be acting as gateway providers of taxpayers money and as such
would be expected to act prudently and responsibly. We are examining
whether the credit union regime could be used as a model for prudential
regulation.
23. We are confident that the degree of
conduct of business regulation need not be as rigorous as that
required for private sector equity release schemes. The reason
for this is that providers would be operating on a not-for-profit
basis and we do not envisage the same conflicts of interest between
providers and consumers being present in the distribution chain
as is the case with retail financial services.
OTHER ISSUES
TO CONSIDER
24. There are a number of other issues we
are in the process of investigating to finalise our proposals.
The two key areas are: state aid rules and the impact of other
state benefits and health care funding.
25. We need to be certain that government
involvement in facilitating the scheme funding would not be classified
as `state aid'. Our preliminary view is that this is not the case
as providers of this new scheme would not be in direct competition
with existing retail private sector equity release providers.
26. Finally, we are considering how this
new scheme would interact with rules relating to existing state
benefits such as minimum income guarantee and pensions credit
and local authority funding for residential care. The existence
of such rules are outside our remit as a consumer organisation
but clearly we need to understand what the effects would be on
the success or failure of the scheme.
May 2006
348 Ev 1-25 Back
349
Ev 13 Back
350
The report from the Institute of Actuaries, "Equity Release
Report 2005" (13 January 2005) demonstrated there are
natural limiting factors. Back
351
working title. Back
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