Reverse mortgage pricing and risk analysis allowing for idiosyncratic house price risk and longevity risk |
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| Affiliation: | 1. School of Risk Management, Insurance, and Actuarial Science, St. John’s University, United States;2. Insurance/Risk Management & Business Economics/Policy, University of Pennsylvania - The Wharton School, United States;1. Department of Actuarial Mathematics and Statistics, Heriot-Watt University, Edinburgh EH14 4AS, United Kingdom;2. Department of Econometrics, Riskcenter-IREA, University of Barcelona, Avinguda Diagonal 690, 08034 Barcelona, Spain;3. Cass Business School, City University London, 106 Bunhill Row, London EC1Y 8TZ, United Kingdom;1. Temple University, United States;2. Illinois State University, United States;1. Cass Business School, City University London, United Kingdom;2. Pensions Institute, Cass Business School, City University London, United Kingdom |
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| Abstract: | Reverse mortgages provide an alternative source of funding for retirement income and health care costs. The two main risks that reverse mortgage providers face are house price risk and longevity risk. Recent real estate literature has shown that the idiosyncratic component of house price risk is large. We analyse the combined impact of house price risk and longevity risk on the pricing and risk profile of reverse mortgage loans in a stochastic multi-period model. The model incorporates a new hybrid hedonic–repeat-sales pricing model for houses with specific characteristics, as well as a stochastic mortality model for mortality improvements along the cohort direction (the Wills–Sherris model). Our results show that pricing based on an aggregate house price index does not accurately assess the risks underwritten by reverse mortgage lenders, and that failing to take into account cohort trends in mortality improvements substantially underestimates the longevity risk involved in reverse mortgage loans. |
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| Keywords: | Equity release products Idiosyncratic house price risk Stochastic mortality Wills–Sherris mortality model Longevity risk |
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