Continuing my thinking about the purpose of pensions, I came across the resurgent Tom McPhail who appears to be a one man think tank in his new role at the Laing Cat.

To what extent, if at all, do final salary schemes invest in the equity release market?

— Tom McPhail (@PensionsMonkey) November 1, 2021

I didn’t know, but I thought I should do some research, for myself, for my readers and for Tom. Here’s my brief history lesson

In the beginning….

The source of funds for the equity release market has historically been the money backing a lifetime annuity. Whether the annuity was bought from an insurer to buy out a defined benefit or swapped for a retirement savings pot, the investor was the insurer, looking for a better matching asset for the wage for life on offer.

But the market for individual annuities has shrunk since the introduction of pension freedoms in 2015, so insurers have looked to bulk buy out defined benefit pensions  and to do this have found large untapped reserves of funds for the equity release market. You could say that many people being paid their company pension by Pension Insurance Corporation, L&G or Scottish Widows (to name but three) are getting paid from investments in other people’s houses.

The market for the money is today’s pensioners (equity release providers refer to their products nowadays as “lifetime mortgages” or LTMs)

Put another way, while DB plans provide proper pensions, by investing in LTMs, they can also help those without those proper pensions to achieve their retirement goals

The development of LTMs as an investable asset for DB plans

Speaking to the FT in 2016 Bernie Hickman, then  managing director for individual retirement at Legal & General, explained large annuity funds need assets to invest in which have strong, stable, long-term income streams.

“If it is good for an annuity fund, then it would also be sensible for defined benefit, however it needs to be well understood, so the investor would need to be close to origination to ensure good quality assets,”

Five years ago, few pension schemes felt sufficiently confident to source money directly from investors. The FT could only find Railpen as actually investing in equity release,

But this appears to be changing as the equity release market changes. In its initial years, equity release was regarded as “back street” stuff. The UK equity release sector has evolved considerably since the first product was introduced over 50 years ago. Through regulatory reform, product development and the introduction of customer safeguards, equity release has rebranded as the lifetime mortgage.

Lifetime Mortgages have become the fastest growing segment of the UK mortgage market while generating the fewest registered complaints across all home finance products. They have also become a preferred investment for insurance companies and are now being offered by high street lenders to their customers.

Pension schemes are coming late to the party. Having swallowed the bad reputation of yesteryear, pension schemes now see the returns available as attractive and there appears to be competition for this money between insurers, asset managers packaging the loans and direct investors

LTMs are emerging as a core product that can help consumers meet financial needs in later life. An ageing population with substantial proportions of their wealth in residential property and inadequate retirement savings has led to increased consumer demand.
These demographic trends will continue.

My guess, in answering Tom’s question is that packagers of this debt will sell it on to DB investors. One such organisation is Alpha Real Capital who have done research into the intentions of pension scheme CIOs.

A survey of 100 UK professional pension fund investors  revealed that over the next two years, 88 per cent expect pension schemes to begin investing into Lifetime Mortgages, with 29 per cent predicting significant demand.

According to Alpha’s press release

“When compared to other long-dated assets, 87 per cent of survey respondents saw the attractiveness of Lifetime Mortgages for pension funds and other institutional investors increasing between now and 2024. In the current environment, 97 per cent of UK professional investors interviewed agree with the view that Lifetime Mortgages offer a combination of factors that pension funds and other long-term investors find attractive including duration, yield, a link to mortality and potential inflation protection. Over half (54 per cent) ‘strongly agree’ with this view.”

Alpha’s research found some 86 per cent say an attractive feature for pension fund investors is the fact that Lifetime Mortgages have durations which are highly correlated to a borrower’s life expectancy – loans are repayable when they either die or move into long-term care. In fact, 29 per cent say this is a ‘very attractive’ feature.

When asked to select the three most important benefits of investing in Lifetime Mortgages for institutional investors, 73 per cent of professional investors surveyed selected providing secure, clearly defined cashflows, this was followed by 61 per cent who chose the ability to receive long-dated secure cashflows, and 45 per cent who selected their longevity linkage.”

“Pension funds and other institutional investors are increasingly looking to diversify their portfolios, and for asset classes that can delivery steady and reliable returns.

To answer Tom’s question

The vast majority of defined benefit money  in equity release is infact from insurance company balance sheets and is not properly a DB investment, there appears to be some direct investment from large schemes such as Railpen and I am sure that there are many DB CIOs who are looking enviously at long dated investment grade quality cashflows at 4 per cent higher yields than comparable government bonds.

To what extent they are “looking” and to what extent “investing” depends on the capacity of packagers of these loans to offer the right deal.

The strong social advantages of releasing equity for those with limited pensions is obvious, but so are the risks. People can live too long, house prices can fall, interest rates can rise and this is a highly illiquid form of investment.

But , with most DB plans heading for buy-out, having an allocation to assets which most buy-out providers favor, looks strategically shrewd and mitigates the illiquidity risk. And after all, people living long and happily in retirement is what a pension scheme was set up for.

My hope, Tom, is that we see more investment in equity release from DB plans but that to date this is a market that has been dominated by the insurers. It may be that equity release is given a further boost by the newly launched long term asset funds which will make investing in illiquids easier for DB trustees. But we will have to wait and see on how such funds develop.

There is an alternative view!

Though Con Keating may be uncomfortable with his fellow traveler,  it’s clear that Government policy accords with his suggestion, posted in the comments on this blog.

There are good reasons not to encourage this market. It means that the recycling of housing stock will be reduced – many elderly couples really should be downsizing, making way for a more efficient use of the housing stock.

There does seem to be a disproportionate amount of litigation around these structures.

There is probably a better way to gain house price exposure (other than the obvious buy to rent) and that is the rent to buy model of Wayhome and some others – a model in which house price gains are shared among financier and home occupier. That has the societal good that it will enable more younger owner-occupiers and provide the security of tenure desired.

A rather more thought through approach than the Housing Minister’s , but to the same effect.

Housing Minister Chris Pincher wants older people to move to smaller homes to help solve housing crisis. Why is it assumed that if you have more bedrooms than people you are ‘rattling around’? pic.twitter.com/zuk1QOsaDE

— Paul Lewis (@paullewismoney) November 3, 2021