An undervaluation scandal is brewing in the equity release mortgage sector that is similar in nature to the Equitable Life fiasco of nearly two decades ago, a report from the Adam Smith Institute has warned.
The report, written by Durham professor of finance and economics Kevin Dowd, has said the ‘no-negative equity guarantees’ (NNEGs) issued by lenders in the market lie at the heart of the problem. NNEGs guarantee the maximum repayment on equity release loans be no greater than the property price at the time of repayment.
“This undervaluation problem is a ticking time bomb that could do serious damage to the financial health of the Equity Release sector,” Dowd warned.
He argued the Prudential Regulation Authority had made “half-hearted” efforts to address the issue and for years had failed to rein in “inadequate valuation methods”, raising questions about its supervision of the sector.
Dowd also criticised the Treasury Committee’s investigation into the UK life industry, saying it missed these issues and “unwisely set up the equity release sector as a poster child to be promoted”.
Dowd said the issues were similar to those Equitable Life experienced more than 20 years ago when the company struggled to fund its guaranteed annuity rate (GAR) policies as financial pressure mounted throughout the 1980s and 1990s.
This meant losses of between £2bn and £3bn for hundreds of thousands of its GAR investors, which eventually resulted in the government paying out £1.5bn in compensation.
Dowd pointed out the then-regulator, the Financial Services Authority, only released a report and “wised up” to the problem at the same time as everyone else, suggesting it was “asleep at the wheel”.
“The Equitable disaster was more than anything a failure of the regulatory system,” Dowd said. “Nearly two decades and one global financial crisis later, it seems like history is repeating itself again.”
As with GAR policies, he cautioned NNEGs also “have the potential to undermine the health of the firms that issue them”.