Using home equity release products to complement pension benefits

(1)

to complement pension benefits.

Marit Elias

Master’s Thesis to obtain the degree in Actuarial Science and Mathematical Finance University of Amsterdam

Faculty of Economics and Business Amsterdam School of Economics

Author: Marit Elias

Student nr: 10187898

Date: August 4, 2016

Supervisor: dr. Tim Boonen Second reader: dr. Servaas van Bilsen Supervisor: drs. Wichert Hoekert AAG

(2)

(3)

Pensions, housing, and health care are often analyzed separately. As a result, these three elements often do not match the preferences of individual households. Jointly adjusting these elements will enable households to optimize their financial needs, as well as to optimize individual savings and consumption. Nevertheless, the possibilities of doing so are still very limited in the Netherlands.

The main objective of this thesis is to analyze home equity release products cur-rently offered on the Dutch market. Moreover, it is examined to which extent these release products can contribute to a structural increase in consumption after the pen-sionable age and thereby complement pension benefits. This is done by considering different financial positions of Dutch pensioners and by determining which products, if any, best suit the various financial positions.

From the analysis, it can be concluded that the extent to which home equity re-lease products can complement pension benefits differs for each financial position. More explicitly, it shows that if the homeowners have saved too much over the course of their lifetime, then a reverse mortgage with annuity payments can be used to significantly increase consumption during retirement. In the case that homeowners experience insuf-ficient pension benefits, the yearly tenure payments received from releasing the home equity are not substantial, but the size of the deficit and the standard of living desired by the individual will ultimately determine whether or not the payments are sufficient to cover the shortage in pension benefits. For homeowners who are faced with large unexpected expenditures, the choice of the contract depends on the preferences of the individual, as well as the size of the lump sum needed to cover the expenditures. Indi-viduals may also release the home equity in the case of early retirement. The analysis shows that if the individual has accrued an average level of home equity, then the yearly payments will only be enough to cover the first pillar pension benefits. This implies that if the individual wishes to maintain the same standard of living, then the reverse mort-gage should be reinforced with early pension benefits from the second pillar. Finally, it should be noted that if the reverse mortgage contracts are obtained from Florius, then the received payments cannot adequately complement pension benefits in any of the financial situations described in this paper.

Keywords Home Equity, Equity release products, Reverse mortgage schemes, Home reversion schemes, Pension benefits, Early retirement, House Price Index, Healthy Life Expectancy.

(4)

Foremost, I would like to express my sincere gratitude to my thesis adviser dr. Tim Boonen of the Faculty of Economics and Business at the University of Amsterdam for providing guidance throughout the year. He consistently allowed this paper to be my own work, yet steered me in the right direction whenever needed. I would also like to acknowledge dr. Servaas Bilsen, as the second reader of this thesis, for taking the time to critically analyze my thesis and for providing me with valuable comments.

My sincere thanks also goes to drs. Wichert Hoekert AAG, my thesis adviser at Willis Towers Watson, for encouraging me to find a truly interesting topic and for sharing his immense knowledge with me along the way. Moreover, I would like to thank the Investment Consulting department of Willis Towers Watson for sharing their data and running the necessary simulations.

Finally, I must express my profound gratitude to my family for providing me with unfailing support and continuous encouragement throughout the years and through the process of writing this thesis. I could not have accomplishment this without their love and support. Thank you.

(8)

(9)

Introduction

Pensions, housing, and health care are often analyzed separately. As a result, these three elements often do not match the preferences of individual households. Jointly adjusting these elements will enable households to optimize their financial needs, as well as to optimize individual savings and consumption. Nevertheless, the possibilities of doing so are still very limited in the Netherlands (Bovenberg et al., 2016).

For this reason, in May 2013, several organizations, experts, and scientists combined forces and set up Taskforce Verzilveren. Its objective was to unveil the limitations of releasing home equity and to explore new possibilities of releasing the home equity, while still allowing individuals to remain in their homes. When Taskforce Verzilveren was established, the housing market was not doing very well. Average house prices had not been that low for the past twenty years and the interest rate for a 10 year mortgage was approximately 5.0 percent, almost double the rate it is today. Over the past three years, however, the housing market has been recovering. Consequently, home equity, which is the home’s value minus the mortgage, has increased substantially, while, according to Taskforce Verzilveren, the equity invested in homes already accounted for over e500 billion in 2010. Approximately 80.0 percent of this home equity belongs to individuals of ages 50 and older. This, together with the many other reasons discussed in this paper, has led to an increasing demand of releasing home equity as a tool for raising consumption.

Despite the increasing demand, few attention has been given to the extent to which releasing home equity may contribute to a structural increase in household income (Bovenberg et al., 2016). Half way through 2015, more than two years after Taskforce Verzilveren was established, Vereniging Eigen Huis announced that still no additional products had been introduced on the market so far, though progress had been made to develop more of these home equity release products. In this paper, current products will be analyzed from both the provider’s and the consumer’s perspective. In addition, it will be investigated whether or not these release products can contribute to a structural increase in consumption after the pensionable age and thereby complement (insufficient) pension benefits. This will be done by considering different financial positions of Dutch pensioners and by determining which products, if any, best suit the various financial positions. The main question that will be studied in this paper is thus:

To what extent can home equity release products, that are currently available on the Dutch market, contribute to a structural increase in consumption after the pensionable age and thereby complement pen-sion benefits?

(10)

2 Marit Elias — _{Home Equity and Pensions}

From the analysis, it can be concluded that the extent to which home equity release products can complement pension benefits differs for each financial position. More ex-plicitly, it shows that if the homeowners have saved too much over the course of their lifetime, then a reverse mortgage with annuity payments can be used to significantly increase consumption during retirement. In the case that homeowners experience insuf-ficient pension benefits, the yearly tenure payments received from releasing the home equity are not substantial, but the size of the deficit and the standard of living desired by the individual will ultimately determine whether or not the payments are sufficient to cover the shortage in pension benefits. For homeowners who are faced with large unexpected expenditures, the choice of the contract depends on the preferences of the individual, as well as the size of the lump sum needed to cover the expenditures. Indi-viduals may also release the home equity in the case of early retirement. The analysis shows that if the individual has accrued an average level of home equity, then the yearly payments will only be enough to cover the first pillar pension benefits. This implies that if the individual wishes to maintain the same standard of living, then the reverse mort-gage should be reinforced with early pension benefits from the second pillar. Finally, it should be noted that if the reverse mortgage contracts are obtained from Florius, then the received payments cannot adequately complement pension benefits in any of the financial situations described in this paper.

This thesis will be structured as follows. Chapter 2 will provide some background in-formation on this topic. This includes inin-formation on relevant literature, the financial position of Dutch pensioners, the desire to release home equity, the existing products on the market today, the risks that are associated with equity release products, and last but not least, different ways in which release products may complement pension benefits. In Chapter 3, the data will be discussed. In Chapter 4, a description of the model will be provided and the mathematical formulas that are essential to value the release products will be defined. Which of the release products best suit the financial positions experienced by Dutch pensioners will be discussed in Chapter 5. In addition, sensitivity analyses will be performed in order to determine the effect of changes in age, loan-to-value ratio, and the size of the accumulated home equity on the value of the products. Finally, concluding remarks and ideas for further research will be presented in Chapters 6 and 7, respectively.

The calculations in this report have been performed using R and the R-code for an individual who is 60 years old has been provided in Appendix B. The analyses for the ages 65 and 70 are done analogously.

(11)

Background information

2.1 Relevant Literature

Although there exists an increasing amount of literature on equity release products on the market today, this paper has been primarily inspired by the master thesis written by Joosten (2015). For her master thesis, the author has analyzed the equity release products currently existing on the Dutch market. She follows the methods described by Alai et al. (2014) and Shao et al. (2015), while adjusting market variables to fit the Dutch market. In order to capture the dynamics of the economic variables, the author forecasts the variables using a vector autoregressive model. She then uses the model, in particular the market price of risk, to find the associated stochastic discount factors. The products are then valued by simulating numerous future scenarios. Finally, a sensitivity analysis is performed to determine the effect on the value of the products due to changes in the market variables.

Despite the fact that this paper was written over a year ago, no additional products have yet entered the market. This means that analyzing the Dutch market today, entails analyzing the same products discussed in Joosten (2015). However, while Joosten (2015) provides a general description of the products, this research paper will contribute to the current literature by focusing on the extent to which release products can provide structural increases in consumption as a means of complementing pension benefits. In order to do this, different financial positions of Dutch pensioners will be considered and the main objective will be to determine which products, if any, best suit the various financial positions. Rather than using a vector autoregressive model, the products will be valued using simulations provided by the Investment Consulting department of Willis Towers Watson. Furthermore, different payment methods will be analyzed in order to cover the financial positions experienced by Dutch pensioners. More specifically, term payments and annuity payments will be discussed.

2.2 The Desire to Release Home Equity

This section is intended to show why and when it may be desirable for homeowners to release their accumulated home equity. This will be done by discussing some of the advantages of releasing home equity, by examining the individuals’ ambitions to save and their intentions to leave an inheritance, and by addressing the financial incentives offered to them by the Dutch government. Furthermore, a rough sketch of the financial position of Dutch pensioners and a brief description of the Dutch pension system will be provided.

(12)

2.2.1 Advantages of Releasing Home Equity

According to Bart et al. (2016), there are several reasons why people may want to release home equity. First of all, it may help to optimize consumption over the life cycle and thereby increase welfare. This is further explained in Modigliani and Brumberg (1954). In this paper it is shown that individuals do not only consider how much they can spend in the consecutive period, but also take into account the consequences of their current behavior on future consumption. This suggests that, as individuals age, they will start consuming their accrued equity in the case that they do not wish to leave an inheritance or, for instance, use their equity to cover long term health care costs. In this case, consumers will maximize utility by consuming all of their equity before they pass away. This can be a problem if part or even all of their equity is invested in the home. In this analysis, long term health care costs will not be taken into account. This is because regular health care costs can be easily insured against a reasonable price and the chance of long term health issues is so small, that precautionary savings will almost always lead to a loss in welfare. This idea also leads to the second advantage of releasing home equity found in Bart et al. (2016). If people are able to release their home equity when necessary, then the need for precautionary savings goes down, which will in turn increase consumption.

2.2.2 Ambition to Save

Households may save too much or too little over the course of their lifetime. The problem is that many households are not fully capable of adjusting their saving ambitions to their specific needs. In this way, it may be difficult to smooth consumption over time. Especially for younger individuals, required savings may be higher than desired, due to children related costs or the fact that their income level may still be relatively low. Also, homeowners who pay off their mortgage and at the same time participate in a collective pension scheme may save more money than needed to maintain their lifestyle at the time of retirement. This is currently a major issue in the Netherlands, since homeowners are encouraged to pay off their mortgage within thirty years. Paying off a mortgage reduces living expenses and thus the homeowner may need a lower pension ambition to maintain the same standard of living. Many households that own a home obtain a pension ambition of over a 100.0 percent when taking into account the decrease in living expenses (Knoef et al., 2015). This does not hold for homeowners that have an interest-only loan, for which the borrower pays only the interest on the principal balance, with the principal balance unchanged. Morduch (2015) shows that households who save too much or too little may experience significant welfare losses of three to five percent over their entire lifetime.

2.2.3 Intentions to Leave an Inheritance

If homeowners are unable to release the equity in their home, then all of the accumulated home equity will be passed on to their heirs once they have departed. The question arises whether or not this is desirable.

Evidence suggests that the home equity is not solely viewed as a bequest, since the intended size of the bequest is often not as large as the amount of capital invested in the home (Kopczuk and Lupton, 2007). For instance, in the Netherlands, many homeowners who are reaching the retirement age have purchased a home before the eighties. A large part of the equity that is ‘stored’ in the home has thus been obtained by the continuous increase in house prices. According to Parlevliet and Kooiman (2015), the balance of

(13)

the assets and liabilities of the Dutch households has increased from twice the Gross Domestic Product (GDP) in 1982 to nearly four times the GDP in 2012. Although this increase has been primarily due to increases in pension capital, the increase in home equity has also been an important driver. It seems unlikely that these households intend to use these ’windfall profits’ for one and only one purpose only; that is to increase the size of their heritage. It seems much more reasonable that these homeowners would rather use part of the profits to raise their own consumption (Conijn et al., 2014). Lockwood (2013) shows that the desire to leave an inheritance is stronger for those who have accrued a significant amount of capital. It is thus considered to be a luxury good. If individuals have to cope with large medical expenses in later stages of life, then they will have less equity left over and the desire to leave a bequest will decline. The same would apply if the home equity is needed to possibly cover a shortage in pension benefits.

On the contrary, Haffner (2005) shows that the Dutch elderly in general do not con-sider their accrued home equity as a means of financing living expenses. In fact, in the Netherlands, home equity has always been considered as a nest egg that can be used in case of emergencies. Warnaar and Gaalen (2008) show that even before the crisis, households preferred to keep a reserve in order to absorb financial shocks. Ultimately, if no such shocks occur then this nest-egg will automatically be left as a bequest. Notice that even if homeowners would like to leave an inheritance, then releasing home equity may still be optimal. For instance, assume that an individual lives approximately eighty years. By the time that the homeowner has deceased, the children may already be close to retirement themselves and may no longer need the extra capital. In this case, it may be more desirable to release the equity earlier in time, so that it can be granted to the children when they need it most. On the other hand, when taking out a contract, homeowners may also choose to release only part of their equity and specify exactly what portion of the home equity they would like to leave as a bequest.

2.2.4 Financial Incentives

In the Netherlands, the market for rental homes is divided into two sectors and these sectors are commonly referred to as ‘sociale huur’ and ‘vrije sector’. To be eligible to rent a home belonging to the first sector, both the rental home and the individual need to meet certain requirements. As of January 1st, 2016, the rent may not exceed e711 (after taxes) and the total income of the household may not exceed e35,739 (before taxes). Those who are eligible will be granted a subsidy from the government, as their income is not considered high enough to cover the rent. Individuals who have an income that exceeds this amount, but do want a rental home, are forced to rent a home from the second sector. In this sector, the rental homes are not regulated and so they tend to be more expensive. On top of that, the government does not grant any subsidies for these homes. Together with the currently low interest rates, individuals with higher incomes are thus encouraged to buy a home instead.

For those who have decided to purchase a home, the government has introduced a new policy in 2013 that only allows home mortgage interest deduction if the mortgage is paid off within thirty years. A home mortgage interest deduction enables taxpayers who own a home to reduce their taxable income by the amount of interest paid on the loan. This implies that individuals with higher incomes are not only stimulated to purchase a home, but are also forced (or highly encouraged) to pay off their mortgage in a relatively short period of time, most likely well before they reach the pensionable age. Assuming that individuals do not solely save to leave a bequest, this increases the need for reliable release products that will allow homeowners to consume their savings.

(14)

Moreover, financially encouraging Dutch households to invest money in illiquid assets, such as home equity and pension benefits, constrains households to adjust their con-sumption over time to meet their financial needs. This is certainly not optimal for the homeowner, as spreading consumption efficiently over a lifetime increases welfare (Mor-duch, 1995). Moreover, a lack of liquidity implies that homeowners cannot easily reach out to their equity in the case that idiosyncratic risks present themselves. For example, if house prices drop below the market price for which the house was initially bought, then homeowners may not be able to respond to a reduction in income due to unemployment, as they face large potential losses when moving to a smaller home.

2.2.5 Financial Position Dutch Pensioners

Owning a home means more than solely having a place to stay; it can be a valuable source of income in later stages of life. The problem is that the money invested in the home is still very illiquid and often cannot be released without having to give up the home in return. Lately, this has become an even bigger issue as more elderly own their own home and repayment mortgages have become the default (opposed to interest-only mortgages). Moreover, the purchasing power of pension benefits have been under a great deal of pressure, as their adequacy is being questioned.

For this reason, in May 2013, several organizations, experts, and scientists, combined forces and set up Taskforce Verzilveren. Its objective was to unveil the limitations of releasing home equity and to explore new possibilities of releasing the home equity, while still allowing individuals to remain in their homes. They found that the total equity invested in homes accounted for over e500 billion. Furthermore, they observed that the amount of home equity increases with age. Approximately 80.0 percent of the total home equity belongs to individuals of ages 50 and older, while the retired population accounts for approximately 38.0 percent of the total home equity, resulting in an average home equity ofe257,000 per home (Taskforce Verzilveren, 2015).

2.2.6 The Dutch Pension System

For those who are not familiar with the Dutch pension system, the Dutch pension system consists of three pillars, namely public pension (or AOW), occupational or employer’s pension, and individual pension. Following the research of Bart et al. (2016), this paper will focus on pensions from the second pillar, which objective is to maintain a standard of living. This is because under the current legislation there is still room, within certain bounds, for adjustments or exchanges between housing and health care in the second pillar. For the first pillar this is less expedient because it concerns an unconditional basic income that falls just above the poverty threshold. In the third pillar, households already have the opportunity to customize their pension schemes and regulate their premium payments at any point in time. For workers, the added value of customization and flexibility therefore lies within the second pillar. This does not hold for the self-employed who do not have any personnel, in Dutch they are also known as ‘zzp’ers’. In general, these workers are restricted to the third pillar and may only in some cases temporarily take part in the second pillar. In this paper, the complexities regarding zzp’ers will not be discussed, as this is a very heterogeneous group. Nonetheless, more flexibility in the second pillar will make supplementary pensions more attractive for them.

(15)

2.3 Solidarity Versus Differentiation

While individuals may desire to release their accrued home equity, one could argue the extent to which individuals should be given the power to control their own financial situation. Traditionally, solidarity has been seen as one of the major strengths of the Dutch collective pension system. Individuals are obligated to join a uniform pension scheme through mandatory participation, so that costs and risks can be pooled. How-ever, Bovenberg et al. (2016) has reported that recently individuals seek to acquire more differentiation, due to the fact that the trust in financial institutions has decreased sig-nificantly over the past few years, resulting in an increasing desire to individually alter career paths and living circumstances to meet their individual needs. At the same time, digitization has allowed for better customization, enhanced transparency and more free-dom of choice for individuals against a more affordable price.

Bart et al. (2016) suggests that this type of differentiation can be achieved in two ways, namely by means of customization offered by the provider and by means of freedom of choice granted to the individual. Unfortunately, imperfections in both the financial market and individual behavior lead to an imperfect market. In this section, the major financial and behavioral risks will be discussed. Moreover, a short overview will be provided of the trade-offs resulting from these imperfections.

2.3.1 Imperfections in the Financial Market

There are several imperfections in the financial market that lead to market failures, as discussed in Bart et al. (2016). One of the imperfections discussed, is the existence of agency- and governance- issues in financial markets. More explicitly, it concerns trust issues between households and the agents who are authorized to make important de-cisions for them. How can households find intermediaries who possess the professional expertise and yet act in the interest of these households?

Furthermore, the insurance market may suffer from adverse selection due to asymmetric information between insurers and policyholders. This leads to increasing costs, which in turn increases risk premiums, making it even less attractive for the ‘good’ risks to participate. Segmenting these risks into homogeneous pools solve the problem of adverse selection, but at the same time may lower the value of the insurance due to the lack of heterogeneity. A different way to fight adverse selection is through mandatory participation schemes. An example of this is the primary health care offered in the Netherlands, which is in Dutch also known as the ‘basisverzekering’.

Another issue is that the market does not always lead to a distribution of income that is favored by society. The government therefore faces a trade-off between reducing income inequality and boosting economic growth. The government may use their fiscal policy to, for example, influence household expenditures. More specifically, the financial incentives discussed in Section 2.2.4 can be used to influence decisions such as buying a home and the type of mortgage obtained.

Finally, Bart et al. (2016) mentions that incomplete financial markets limit the trading of systematic risks, such as inflation risk or longevity risk. This implies that these risks cannot be hedged. Longevity risk plays an important role when dealing with reverse mortgages. If homeowners live longer than expected then the loan may eventually exceed the market value of the home, due to annual interest payments. Who actually bears this risk depends on the contract and whether or not the provider offers a so called no negative equity guarantee (NNEG). The no negative equity guarantee is designed to protect the individuals, as well as their heirs, against large potential losses if the individuals live longer than expected in exchange for a slightly higher interest rate.

(16)

2.3.2 Imperfections of Individual Behavior

Life-cycle theory assumes that households are able to estimate their needs for retirement by taking into account factors such as expected future lifetime earnings, tax rates, health status, and longevity. Evidently, households do not always know what is best for them and even if they do, they may not be capable to quantify their wishes or adequately asses the risks involved. Additionally, if households do manage to determine their optimal decisions strategies, then they may lack the willpower to implement them. Two other imperfections of individual behavior are discussed in more detail below.

Default options have a very large impact on participation rates (Mitchell et al., 2016). This also applies to home equity release products. In the Netherlands, homeowners are free to decide what to do with their home equity: they can either leave it as inheritance or they can release it for consumption. The default option is inheritance and home equity can only be used for consumption if individuals step in. However, there are only a limited number of products available and only few people are aware of their existence. As a consequence, home equity is often left as inheritance, despite the real intentions of the homeowner. Changing the default setting to release products by means of automatic enrollment will almost certainly have a major impact on consumption.

Another behavioral issue associated with decision making is referred to as hyperbolic discounting. If individuals are hyperbolic discounters, then they apply high discount rates to the near term and lower discount rates to the future. In other words, individuals who are hyperbolic discounters place a lower value on future benefits and overvalue the present. They thus have the tendency to over consume today (Mitchell et al., 2016). This means that if individuals were to determine how much equity they would like to release, then they would prefer lump sum payments, but tend to not spend it well, increasing the risk of longevity. In this way, people run the risk of exhausting their assets well before the end of their lifetime.

2.3.3 Trade-Offs

The extent to which people can control their financial situation varies from manda-tory participation schemes to absolute freedom of choice. Many regulations regarding pensions, housing, and health care seek to find a balance between the two in order to allow individuals to make their own choices, yet protect them from making incorrect and possibly even harmful decisions. Bart et al. (2016) identify the following generic trade-offs:

1. The trade-off between the intrinsic value that people attach to making their own decisions and the need to be unburdened.

2. The trade-off between granting individuals the freedom of choice to anticipate their individual needs while at the same time protecting them against the imperfections of individual behavior.

3. The trade-off between granting individuals the freedom of choice and treasuring the solidarity of a pool of individuals to prevent external effects from happening. 4. The trade-off between differentiation and keeping costs low.

5. The trade-off between the need for individuals to be unburdened and their limited trust in financial institutions.

(17)

The first trade-off is one that is faced by the individuals and it is the trade-off between the intrinsic value that people attach to making their own decisions and the need to be unburdened. Put differently, there is a social trade-off between paternalism and liberal-ism. In general, individuals like to control their own life, but prefer to be unburdened when it comes to situations that they cannot entirely foresee.

The second trade-off involves granting individuals the freedom of choice to anticipate their individual needs while at the same time protecting them against the imperfections of individual behavior. Households often have the most accurate information regarding their current financial situation, as well as a clear vision of their wants and needs. Mak-ing their own decisions allows them to anticipate their continuously changMak-ing desires. However, imperfections of individual behavior show that individuals may deviate from optimal choices, especially if it concerns risky decisions with long-term implications. One specific example is the trade-off between liquidity (flexibility) and commitment. More liquidity will allow individuals to anticipate unexpected financial shocks, yet in the mean time may tempt them to consume more capital and thus save less for the future. In this way, there may be no capital available if financial shocks indeed occur.

The third trade-off involves a trade-off between granting individuals the freedom of choice and treasuring the solidarity of a pool of individuals to prevent external effects from happening. For instance, self-selection can negatively affect the solidarity in a pool if individuals possess more knowledge about their individual life expectancy and are able to use it to their advantage.

The fourth trade-off is a trade-off between differentiation and keeping costs low. Unfortu-nately, customization and freedom of choice go hand in hand with increasing production costs. The reason for this is that it requires more specific information on the financial po-sitions of individual households, which needs to be collected as well as processed. The last trade-off concerns the need for individuals to be unburdened and their limited trust in financial institutions. If households have little trust in the institutions, they will prefer the freedom of choice. No one would like to commit to an agent who they do not trust. Conversely, if people are convinced that the institution will act in their best interest, then they will likely appreciate the agent taking over their complex decision making.

Besides the high potential for home equity release products, one should thus seek to find the right balance in order to allow individuals to make their own choices, yet protect them from the imperfections of individual behavior and the imperfections in the financial market.

2.4 Existing Products on the Market Today

If individuals wish to release their home equity, then they may do so in two different ways: by means of a loan and by means of selling the home. The first method is commonly referred to as a reverse mortgage scheme, in which case the homeowners release their equity by means of taking a loan and using their home as collateral. The latter is referred to as a home reversion scheme, in which case the homeowners release their home equity by either moving to a different home or by selling the home and then renting it back. Even though both methods manage to release the home equity, they thus differ substantially in the way that the equity is being released. In this section, a general description of the two methods will be provided. Moreover, the products that are currently offered on the Dutch market will be introduced.

(18)

2.4.1 Reverse Mortgage Schemes

In terms of equity release products, a loan may refer to obtaining either an extra mort-gage or a reverse mortmort-gage. Obtaining a second mortmort-gage can be attractive for home-owners if the released equity is used to pay for adjustments to the home, since the homeowners may then benefit from home mortgage interest deduction. However, home mortgage interest deduction is not allowed if the homeowners have other intentions to release the equity. Moreover, by obtaining an extra mortgage, living expenses will rise and the homeowner thus faces the risk of not being able to afford the increased living expenses. This has resulted in stricter income requirements that have to be fulfilled by homeowners who are willing to get this type of mortgage. This implies that only those households who meet all the requirements can make use of this product and this is in contrast with the goal of targeting the second pillar of the Dutch pension scheme. Higher income households may already benefit from the options provided within the third pillar and so it will be more interesting to focus on products that are available to everyone. For this reason, extra mortgages will not be analyzed in this paper.

Reverse mortgages on the other hand, allow homeowners to borrow money against the home’s value by means of a lump sum payment, periodic payments, or in some countries even an annuity. In contrast with classical mortgages, no interest payments are made, but instead are added to the loan. The homeowner can keep receiving payments until the maximum amount, usually a fixed percentage of the total equity, is reached. As soon as the homeowner leaves the home, the loan will be paid off by releasing the home. The primary reasons for leaving include: moving to a different home, moving into a nursery home, and death. Observe that a reverse mortgage allows homeowners to stay in their own home, yet consume part of the accumulated home equity. In addition, it allows homeowners to decide on exactly which part of the home equity they would like to use for consumption and which part they would like to leave as inheritance.

2.4.2 Home Reversion Schemes

In addition to loans, homeowners may also choose to sell their home in order to release the equity. The most common approaches are: moving to a less expensive home, moving to a rental home, or selling the home to a creditor and then renting it back. All three approaches pay out a lump sum, however, the first approach releases only some of the equity, while the second and the third approach release all of the equity.

The first two approaches share some major concerns. Both approaches result in home-owners having to leave their home. As long as the homeowner does not attach any value to the property, then moving should not be a problem. However, if the homeowner does attach a certain value to the property, such as emotional value, then moving becomes a lot harder and may even result in a welfare loss. This welfare loss must then be compen-sated for by the additional consumption generated from selling the home and releasing the equity. The degree of attachment seems to be positively correlated with the amount of years spent in the home. The longer people live in a particular home, the more they get attached to it, and the harder it becomes to move. This implies that the increase in consumption needs to be larger in order to offset the increasing welfare loss. In ad-dition, empirical evidence suggests that most of the elderly do not want to move, and even if they do, they do not necessarily want to reduce the amount of equity invested in their home. This is also shown by Venti and Wise (1990), who study the behavior of elderly with regard to moving. Besides, in 2016 the Dutch government introduced the ‘Blijversleningen’, which are loans offered by the government to encourage the elderly to make adjustments to their home, so that they can live independently in their own home for a longer period of time, reducing the desire to move.

(19)

The third approach has a so called ‘sell and rent back’ construction. As the name suggests, it allows the elderly to sell their home, release the equity and rent the home at a reasonable price for unlimited time. It therefore provides a good alternative for those who do not feel the need to move. However, it does come at a cost. For this approach to be profitable the welfare increase due to increasing consumption needs to outweigh the loss in welfare due to increasing living expenses. Notice that this is also the case for homeowners who are moving to a rental home. The former homeowner will no longer have to pay for home related costs, such as maintenance and home specific taxes, but will now have to start paying rent. Since it is assumed that most of the mortgage has been paid off, the amount of rent that needs to be paid will by far exceed the initial living expenses. In general, homeowners who make use of this construction are not protected against longevity risk or investment risk, but there are cases in which these risks are partly or even fully covered by the creditor.

2.4.3 Terminology

If homeowners opt for a reverse mortgage, then they must determine what kind of payments they would like to receive. Following the terminology used in Joosten (2015), it is possible to differentiate between three types of payment methods. A ‘lump sum’ payment pays out all of the released home equity at one point in time, usually at the start of the contract. A ‘tenure’ payment refers to monthly payments which are paid out as long as the individual is alive and occupies the home. Finally, a ‘term’ payment provides monthly payments for a fixed amount of time.

A reverse mortgage with tenure or term payments may also be referred to as a reverse annuity mortgage. This is because it periodically pays out a constant amount to the individual. However, when taking into account the increasing interest payments that are added to the loan, the payments are no longer constant. For this reason, ‘annuity’ payments will also be discussed. With annuity payments the payments are chosen in such a way that the sum of the interest payment and the payment to the individual is constant for each term over a fixed period of time. After this time period, no more payments will be made by the provider. However, if the individual wishes to remain in the home then the interest payments will continue and the loan value will continue to grow. Notice that a reverse mortgage with annuity payments is not directly offered on the Dutch market, but may be obtained if individuals are capable of doing the calculations on their own and have the willpower to only liquidate the predetermined amounts.

2.4.4 Current Dutch Market

Currently the Dutch market publicly offers five home equity release products. The first product is the Rabo KeuzePlus Hypotheek, which is a credit mortgage. The second release product is called the Florius Verzilver Hypotheek, which is offered by Florius, a daughter company of ABN AMRO. It is the only reverse mortgage currently offered on the Dutch market. The other three release products have a sale and rent back construc-tion and they are offered by Zilver Wonen Fonds, Verzilvermijvast, and Lommerhuizen. Due to limited information available, Rabo KeuzePlus hypotheek and Lommerhuizen will not be discussed in this paper. Notice that some of the Dutch elderly may still be making use of previously offered products that are no longer available on the market today. These products will not be discussed in this paper.

(20)

Florius Verzilver Hypotheek

Florius Verzilver Hypotheek is a reverse mortgage that allows homeowners to release their equity in any way they want at a fixed interest rate. This means that a homeowner can opt for a lump sum payment, for periodic payments or any combination of the two. Homeowners may also decide to only receive payments in case they need the extra cash. The size of the payments are up to the homeowner. However, in order to obtain such a contract, certain requirements need to be met. For instance, the homeowner needs to be at least 60 years old, not more than 55.0 percent of the equity can be released, and the loan needs to be paid off no later than 12 months after the death of the last survivor. The homeowner is obligated to get additional home insurance and carry out the necessary maintenance for as long as the contract lasts. Moreover, the property needs to valuated once every five years and the associated costs are for the homeowner. Florius states that if the market price turns out to be lower than expected, due to a decrease in house prices for example, then Florius has the right to lower the maximum amount of home equity that can be released. As a consequence, future periodic payments may be reduced or they may even be canceled altogether. An advantage of this reverse mortgage scheme is that homeowners can tailor payments to their individual needs. Another advantage is that Florius offers a no negative equity guarantee. With the NNEG in place, the amount by which the value of the loan exceeds the market value of the home will be covered by the provider.

Zilver Wonen Fonds and Verzilvermijvast

Zilver Wonen Fonds and Verzilvermijvast are very similar, however, they do differ in terms and conditions. Zilver Wonen Fonds requires that the home needs to be a single-family home or apartment, the market value needs to be at least e150,000, and the home needs to be located in one of the provinces in which they operate. Zilver Wonen Fonds offers 80.0 percent of the market price to the homeowner and it is directly paid to the homeowner by means of a lump sum payment. In return, the (former) homeowner will start to pay rent which will be approximately 5.5 percent of the market price. Yearly changes in rent will be based on the Dutch Consumer Price Index (CPI). An advantage is that maintenance will now be carried out by Zilver Wonen Fonds, which may be beneficial for the older generation.

The rules and regulations of Verzilvermijvast differ slightly from those of Zilver Wonen Fonds. While the administrative expenses are 1.5 percent for Zilver Wonen Fonds, they are a e1000 for Verzilvermijvast. In addition, Verzilvermijvast pays out 90.0 percent of the market value at the start of the contract, and pays out the remaining 10.0 percent once the contract ends. This means that if the individual moves, then 10.0 percent of the market value will be offered to the individual. On the other hand, if the contract terminates because the individual has passed away, then the remaining part will be paid to the heirs. Moreover, if the value of the home has increased, then 50.0 percent of this increase will be added to the second payment. On the contrary, if the value of the home has decreased, then 50.0 percent of the loss will be subtracted from the second payment. Some other requirements are that the homeowner needs to be 55 years or older, the existing mortgage cannot account for more than 50.0 percent of the market value, and the market value can not exceed e300,000. In the case of an apartment, Verzilvermijvast will only pay up to e150 of the mandatory maintenance costs (VvE bijdrage). Last but not least, the former homeowner owes Verzilvermijvast three months of rent as a security deposit, first year’s rent needs to be paid up front, and the rent will be approximately 6.0 percent of the market price.

(21)

2.5 Equity Release Products and Pension Benefits

So far, the desire of releasing home equity has been discussed as well as the available options on the Dutch market today. The question that now arises is how these equity release products can be used to complement pension benefits. This question will be analyzed by distinguishing between the four different financial positions experienced by Dutch pensioners presented below.

2.5.1 Excessive Pension Benefits

Consider the situation in which pensioners receive just the right amount of pension benefits without taking into account the home. If it is possible to release the home equity during retirement, then the home can be included in the calculation of the pension ambition. Taking into account the home equity and the decrease in living expenses will lead to a pension ambition of over a 100.0 percent (Knoef et al., 2015). This issue may be addressed in two ways.

Recall that households who save too much may experience significant welfare losses over their lifetime. It may thus be optimal to reduce pension savings in earlier stages of life. The reduction in pension savings may be used to pay off mortgages, pay off student loans, or simply to increase consumption when the homeowners need it most. However, since this does not revolve around finding the right release product, but is more concerned with the redistribution of wealth, this option will not be discussed in this paper.

A second approach is to release the home equity and adjust the consumption pattern by increasing the level of consumption during retirement. If the homeowners retire, they will have more leisure time and may wish to use the extra money to travel around the world or to fulfill any other life-long wishes. At the same time, the level of consumption tends to gradually decrease with age, possibly due to declining health and mobility. Warnaar et al. (2016) confirm this idea by stating that an individual who is 70 years old spends around 13.0 percent less than an individual who is 65 years old. This consumer behavior can be captured by means of a reverse mortgage with annuity payments. While tenure or term payments provide a constant stream of payments, a reverse mortgage with annuity payments will provide larger payments at the start of the contract, which then decrease as the interest payments continue to grow. Having assumed that the individual already has sufficient pension benefits without taking into account the additional income, the individual will likely wish to only receive payments as long as they are still healthy and still able to spend the extra money. The time period over which the payments are offered should therefore be equal to the number of years that the individuals is expected to be alive and healthy. This will be approximated using the healthy life expectancy, which will be further explained in Section 3.7.

Observe that releasing the home equity may optimize consumption, in the sense that individuals will be better off by releasing the equity opposed to leaving the entire home equity as a bequest. However, enabling individuals to release their home equity also increases the desire to reduce pension savings in order to prevent individuals from saving too much in the first place. In this way, consumption can be optimized over their entire lifetime, rather than after the pensionable age.

(22)

2.5.2 Insufficient Pension Benefits

Recently Nibud has shown their concerns about future retirees. They expect that med-ical expenditures and living expenses will increase, while the pensionable income is expected to decline. More precisely, around 25.0 percent of the working population is expected to have insufficient pension benefits (Warnaar et al., 2016). These individuals will thus need a steady increase in income until they pass away. For homeowners, this problem can be solved by obtaining a reverse mortgage with tenure payments, which will provide the homeowners with constant periodic payments. Releasing the home equity may thus be used to compensate for the shortage in pensionable income.

2.5.3 Large Unexpected Expenditures

In the case that homeowners are faced with large unexpected expenditures, such as large medical bills, a lump sum payment may be more convenient. The lump sum can be used to cover the unforeseen expenditures and the remainder of the home equity will then be used to pay the rent (in case of a home reversion scheme) or pay the interest (in case of a reverse mortgage scheme). Which of the two lump sum schemes is preferred under the current economic conditions will be determined from the analysis.

At the Netspar-congress in June, 2016, Niels Kortleve, manager of innovation at PGGM, stated that in terms of pensions a lump sum payment may be very valuable, especially for lower level income households. Having no other resources available to them, they may use the lump sum payment to pay off any debts or to make adjustment to their home. This shows that lump sum payments may also be valuable for covering expected costs such as outstanding loans.

2.5.4 Early Retirement

In the Netherlands, individuals may not receive any pension benefits of the first pillar pension before they reach the pensionable age. This implies that if they decide to retire early, then they will somehow have to cover this gap.

One way of accomplishing this, is by opting for a variable pension, or more specifically, a high/low construction. This allows individuals to alter their pensionable income in such a way that they will receive larger payments for a fixed period of time. The number of years that an individual is allowed to receive higher payments has been restricted to five to ten years. After this period, the payments will decrease. Moreover, the ratio between the higher and lower payments is required to be at least 100:75, meaning that the lowest payment needs to be at least 75.0 percent of the largest payment.

According to Kortleve (2016), the demand for this type of construction has increased significantly over the past few years, as is shown in Table 2.1. The table displays the year in which the old age pension benefits started, the total usage of the high/low con-struction, the fraction of users who used a high/low construction after the pensionable age, and the fraction of users who used a high/low construction in combination with early retirement. As an example, of those pensioners who started receiving old age pen-sion in 2009, 10.4 percent used a high/low construction, while 9.7 percent used it after the pensionable age, and only 1.7 percent used it in combination with early retirement. From the table, it can be observed that the total usage of a high/low construction by Dutch pensioners has increased from 10.4 percent in 2009 to 35.1 percent in 2015. The main reason for this is the increase in pensionable age. More explicitly, the increase in pensionable age has caused more participants to opt for early retirement in combination with a high/low construction.

(23)

Year Total Pensionable Age Early Retirement 2009 10.4 9.7 1.7 2010 11.2 8.2 3.0 2011 9.9 7.1 2.6 2012 12.9 6.8 6.1 2013 16.9 6.1 10.8 2014 35.7 8.5 27.2 2015 35.1 9.4 25.7

Table 2.1: The table displays the total usage of high/low constructions for individuals who

started receiving old age pension benefits in the years 2009 to 2015, as well as the usage after the pensionable age and the usage in combination with early retirement. The usage is expressed in percentages.

An alternative to the high/low construction is to release the home equity by means of a reverse mortgage with term payments. For instance, if an individual wishes to retire at the age of 60, then the term payments may provide a structural increase in income for the next five years. After those five years, the individual will have reached the pensionable age and will start receiving the first pillar pension benefits.

(24)

Chapter 3

Data

Initially, it is assumed that the individual is 65 years old. Although the pensionable age has already increased slightly and will likely increase even more in the near future, it is assumed here that 65 is still the pensionable age. Hence, the individual has just retired and now faces the decision of releasing some or even all of the accumulated home equity to generate additional income. The average home equity owned by individuals of ages 65 and older amounts to e257,000 and therefore this will be the starting point of the analysis. The maximum age that the individual can attain is 100 years. When dealing with early retirement and when performing sensitivity analyses, individuals of the ages 60 and 70 will also be considered.

As will be further described in the next chapter, the products will be valued based on the cash flows that they generate. These cash flows depend on mortality rates, the House Price Index, the Consumer Price Index, the mortgage rates, the discount rates, the loan-to value-ratio, and last but not least, the healthy life expectancy. In this chapter, each of these topics will be discussed in more detail.

3.1 Mortality

Recall that the contract of an equity release product ends when the homeowner moves to a different home, moves into a nursing home, or passes away. By using the arguments discussed in Section 2.4.2, it is fair to assume that homeowners, especially those that have attained the pensionable age, do not have any intentions to move unless they really have to and so people only leave their home in case they either pass away or move into long-term care.

Let D denote the event that the individual passes away and let N H denote the event that the individual transfers to a nursing home. The probability of the first event can be captured by the AG2014 mortality model. With the publication of the Projection Table AG2014, the Royal Dutch Actuarial Association (AG) has presented the most recent estimate of future mortality for the Dutch population. Remark that an updated table will be published in September, 2016, and may slightly alter the results of this study when implemented. The projection table gives the best estimate for the one-year probabilities of death qx(t), for the ages x ∈ X := {0, 1, 2, ..., 120} and years

t ∈ T := 2014, 2015, ..., 2064. Suppose that an individual was born on the first of January of year t − x. Then q_x(t) is the probability that someone who is alive on the first of January of year t will be dead on the first of January of year t+1. These probabilities are not modeled directly, but instead are obtained by using mortality rates. The estimate of future mortality is based on both mortality data of the Netherlands and mortality data of European countries with similar wealth to the Netherlands. The mortality rates

(25)

are estimated using a Li-Lee model and a detailed description of the application of this model is provided by Koninklijk Actuarieel Genootschap (2014). Assuming that µx+s(t + s) = µx(t) for all 0 ≤ s < 1, yields:

qx(t) = 1 − exp(−µx(t)),

where µ_x(t) denotes the mortality rate at time t for an individual who is x years old.

The second event can be accounted for by adjusting the one year probabilities of death as follows. Notice that if the individual transfers to a nursing home due to medical con-ditions, then the chance of passing away increases. On the other hand, if the individual has deceased before entering a nursing home, then the probability of entering a nursing home automatically becomes zero. This implies that the two events are indeed depen-dent after one of the events has occurred. However, there are many other causes of death despite declining health and so they are not necessarily dependent before either one of the events has occurred. Since this analysis only focuses on what happens before the individual either moves to a nursing home or passes away, these two events are taken to be independent for simplicity. Probability theory then implies that the probability that either one of the events has occurred is equal to:

P (D ∪b N H) = P (d D) + P (b N H) − P (d D ∩b N H).d (3.1) Now consider the last term of Equation (3.1) and notice that the individual can only experience both events in the case that they first move into a nursing home and then pass away. The probability of the event that they both occur, while the time of death is smaller than the time of entering a nursing home, is assumed to be zero. Equation (3.1) can therefore be written as:

P (D ∪ N H) = P (D) + P (N H) − P (D ∩ N H|N H < D).

The probabilities of entering a nursing home for each age are provided by Centraal Bureau voor Statistiek (CBS) and are shown in Table 3.1.

Male Female Total 60-64 years 0.0095 0.0090 0.0093 65-69 years 0.0085 0.0093 0.0089 70-74 years 0.0106 0.0201 0.0154 75-79 years 0.0282 0.0480 0.0381 80-84 years 0.0696 0.1246 0.0971 85-89 years 0.1540 0.2314 0.1927 90-94 years 0.2541 0.3233 0.2887 95-100 years 0.3228 0.4098 0.3663

Table 3.1: The table gives the probabilities that an individual will enter a nursing home. The

probabilities are provided for each age group and each gender. The last column gives the gender neutral probabilities, which are obtained by taking the averages of the second and third column.

Having obtained the probability that the individual has moved into a nursing home or passed away, the probability that the individual is still alive and occupies the home is then simply computed as:

(26)

In the analysis, the mortality rates will be used to calculate the expected value of the cash flows. If the cash flows are received while the individual is still alive and still occupies the home, then the cash flows will be multiplied by the conditional probability that none of the events has occurred at time t + 1, given that none of the events has occurred at time t. Similarly, if the cash flows are received when the individual either transfers to a nursing home or passes away, then the cash flows will be multiplied by the conditional probability that either one of the events has occurred at time t + 1, given that none of the events has occurred at time t.

A notable difference with the methodology of Joosten (2015) is that in this paper the mortality rates of individuals are used rather than those of couples. In other words, Joosten (2015) assumes that the house is owned by two individuals rather than just one. Taking into account that both individuals have retired and that there is an average age difference of three years, she performs the analysis for a couple consisting of a women aged 65 and a man aged 68. For the analysis she adopts a joint life last survivor policy and so she assumes that if one of the individuals has deceased, then the other one will continue to live in the home. This is plausible if the last survivor indeed wants to continue to live in the home without being forced to move elsewhere. On the other hand, there are several reasons to believe that a joint life first survivor policy may be more favorable. For example, the home may be too spacious for a single individual, so that the last survivor prefers to move to a smaller home. If the house is not too spacious, painful memories of their loved one may be enough reason to move to a different home. In addition, the last survivor may not be capable to live independently and must therefore be transferred to a nursing home. For simplicity, it will therefore be assumed that the home is owned by a single individual and so individual (gender neutral) mortality rates will be used. Comparing this to the joint life last survivor policy, means that on average the amount of time spent in the home is smaller and this will slightly affect the results of the analysis. For instance, the value of the no negative equity guarantee will be reduced.

3.2 House Price Index

Simulations of the return on European real estate will be used to estimate the Dutch House Price Index (HPI) for the next 40 years. The return on European real estate will be simulated using the Asset Model provided by Willis Towers Watson. The Asset Model is typically used to produce valuations and cash flows from a range of securities that the user might like to consider in a portfolio. The model takes the returns from the property index coming from the Economic Scenario Generator (ESG) and then uses the Capital Asset Pricing Model (CAPM) to obtain the capital returns. A short description of the model is provided below. Subsequently, the forecasts will be compared to historical Dutch house prices.

The Model

Let the capital return from the original index at time t be denoted by CRIt. Moreover,

let the total return index at time t from the original property index be denoted by T RIt

and let DY denote the dividend yield at time t. The capital return from the original index is then derived from the total return and the dividend yield as follows:

CRIt= CRIt−1×

T RIt

T RIt−1× (1 + DYt)

(27)

The capital return implied by the above capital return index is then adjusted to give the final capital return of the portfolio, which is determined by applying a random shock. For a fixed valuation date, the final capital return for security i is thus calculated by:

Ri= RM + i,

where RM is the capital return of the original index and i is a normally distributed

random variable with a mean of zero.

From the model, 1000 simulations of the return on European real estate are obtained. The averages for the next 40 years are plotted in Figure 3.1. From this plot it can be observed that the return on European real estate grows rapidly during the next 10 to 15 years and converges approximately to a return of 6.0 percent a year.

Figure 3.1: The graph plots the averages of return on European real estate over 1000

simula-tions for the next 40 years. It shows that the return on real estate is expected to grow during the next 10 to 15 years and converges to a return of approximately 6% a year.

Comparison

Whether European real estate is a good enough indicator for the behavior of Dutch house prices will be determined using a rough comparison between the simulations and the historical data. House prices of the last 20 years are obtained from CBS. Since these are indices, with 2010 being equal to 100.0 percent, the growth rates can be obtained by taking the differences of the logarithmic of the indices. This yields the Dutch House Price Index over the past 20 years, as displayed in Figure 3.2. The graph shows that the Dutch HPI has reached its maximum just before the European Union introduced its new currency, namely the euro. Moreover, it can be observed that HPI dropped significantly after the financial crisis of 2008, and reached its lowest point shortly after, due to the European sovereign debt crisis that has been taking place in the European Union since the end of 2009.

(28)

The summary statistics of both the Dutch House Price Index and the simulations of the return on European real estate are displayed in Table 3.2. Comparing the mean and the upper and lower quantiles of both data sets, it can be concluded that the return on real estate roughly follows the underlying distribution of the Dutch HPI. The simulations of the return on real estate do exhibit a larger minimum and maximum in absolute value, suggesting that the simulations contain more outliers.

Figure 3.2: The plot shows the Dutch House Price Index for the years 1995 to 2015.

Return on House Price Real Estate Index Minimum -0.2940 -0.1040

1st Quantile -0.0139 0.0095

Mean 0.0556 0.0433

3rd Quantile 0.1203 0.0866

Maximum 0.5919 0.1796

Table 3.2: The table provides summary statistics of the return on European real estate and the

Dutch House Price Index. For the return on real estate the values are based on 1000 simulations. The summary statistics of the HPI are obtained from historical data of the past 20 years. The slight difference between the return on European real estate and historical Dutch house prices may be justified by the following explanations. First of all, this is a com-parison between past observations of the last 20 years and future forecasts of the next 40 years. If the market is expected to be less stable in the future or over a longer horizon then this may explain the larger fluctuations. Secondly, this is a comparison between Europe and the Netherlands. Including countries that experience larger fluctuations in house prices will increase the confidence interval. Moreover, unlike the Dutch House Price Index, the return on European real estate is based on a property index that com-bines different types of real estate and so it does not solely consist of residential real estate, which includes properties such as houses and apartment buildings. However, de-spite the limitations, the return on European real estate will be a good starting point of this analysis.

(29)

3.3 Consumer Price Index

Verzilvermijvast and Zilver Wonen Fonds both use the Dutch Consumer Price Index (CPI), provided by CBS, to determine the yearly increase in rental yields. The CPI captures the changes in the price level of a market basket of consumer goods and services purchased by Dutch households. Summary statistics of the yearly percentage changes in CPI for the years 1996 to 2015 are given in Table 3.3. On average, the CPI increases 2.0 percent a year and so it will be assumed that the rental yield experiences a growth rate of 2.0 percent a year.

CPI Minimum 0.6000 1st Quantile 1.2500 Mean 1.9950 3rd Quantile 2.4000 Maximum 4.2000

Table 3.3: The table provides summary statistics of the Dutch Consumer Price Index.

3.4 Mortgage Rates

In this section the variable interest rate, fixed interest rate, and reverse mortgage rates are determined.

3.4.1 Floating Mortgage Rate

In many European countries the variable interest rate (also known as a floating rate or adjustable rate) that has to be paid for a mortgage follows the Euribor rate (Euribor-rates.eu, 2016). More explicitly, an individual who takes out a mortgage based upon a variable interest rate will often pay the Euribor rate, usually the 1-month or 3-month Euribor rate, plus a fixed commission. Following the research of Joosten (2015), this commission is taken to be equal to 2.0 percent. Mathematically, this can be written as:

Mortgage rate = (3-month Euribor rate) + 2.0%. (3.2) The 3-month Euribor rate can be estimated using the spot rate with a duration of three months. However, the spot rates that are simulated by Willis Towers Watson for the next 35 years have a duration of one year. This is in line with the other calculations, as all other variables are also computed on a yearly basis. In order to use the simulations of the 1-year spot rate, a fixed rate (the mean difference) of 0.3 percent will be added to the nominal rate. The 3-month Euribor rate and the 1-year spot rates are depicted in Figure 3.3. The figure shows that adding a fixed rate indeed gives a good approximation of the 3-month Euribor-rates. Equation (3.2) thus becomes:

Mortgage rate = (3-month Euribor rate) + 2.0% = (1-year spot rate + 0.3%) + 2.0% = 1-year spot rate + 2.3%.

Using home equity release products to complement pension benefits

to complement pension benefits.

Marit Elias

Contents

Introduction

Background information

2.1

Relevant Literature

2.2

The Desire to Release Home Equity

2.3

Solidarity Versus Differentiation

2.4

Existing Products on the Market Today

2.5

Equity Release Products and Pension Benefits

Chapter 3

Data

3.1

Mortality

3.2

House Price Index

3.3

Consumer Price Index

3.4

Mortgage Rates