Although the number of equity release plans sold has recently increased, a fall in the average case size means the total volume of advan-ces has remained fairly stable for the past four years.
There has been some debate about whether the market is continuing to grow or has flattened out. Whatever the answer, the equity release market has failed to deliver the growth that has been forecast so we must say that it has not yet come of age.
The drivers for growth in this market are well documented. Increased longevity along with improved health and greater ambitions for consumers’ later years have created the need for more money in retirement. At the same time, pension provision has declined.
The result is a significant gap bet-ween the income provided by pensions and that needed to maintain desired lifestyles. It is for this reason that many people see the 1.1trillion tied up in retired people’s properties as part of the solution.
But it is important to stress that equity release is not an alternative to well-funded pensions. It can supplement retirement income and perhaps meet the occasional large capital expenditure, but a client would need to live in a property worth more than 1m to provide a modest pension of about 20,000 per year from the age of 65.
Despite recent flat sales, several or-ganisations have recognised the stra-tegic importance of the equity release market and introduced schemes.
Since 2003, 11 mortgage providers have joined trade body Safe Home Income Plans, and there are now 21 providers sharing this 1bn market.
This increased competition has benefited consumers with the introduction of flexible products tailored to suit a range of needs. This trend was started by Prudential with its flexible drawdown plan.
Other players followed, including Stonehaven with its diverse product offering. More recently, impaired life products have been introduced to the market.
At the same time, proc fees have fallen. In early 2002, brokers were earning 2.5% margins on simple products that were relatively straightforward to fund but by mid-2006 this had fallen to 1.5%.
At the time of writing, Mortgage Express’ 6.99% rate represents a spread of just 0.75% over 20-year swap rates. Considering the high costs of guarantees, servicing and distribution associated with equity release schemes, this represents extraordinary value for money.
So despite supposed market growth, why have sales volumes remained flat over recent years? Although product inflexibility and poor value for money are commonly cited reasons, the facts don’t support these arguments. I think it’s because despite impressive product developments, the market is still immature in terms of customer access.
Most clients looking at equity re-lease instigate relationships with brokers and nearly always with ones they have no previous relationship with, having seen an advertisement.
This is a significant barrier to the development of a market in which trust is an essential part of the customer proposition. The ability to build on existing relationships would bring significantly more confidence to purchasing decisions.
Although the number of product providers has doubled, the broker market remains consolidated among a relatively small number of specialists.
Many brokers have shied away from equity release, partly because of differences between their customer bases and the equity release target market but also because of a widespread view that the risk-effort-reward equation does not stack up.
To some extent, this reflects differences in profile between brokers’ customer bases and people who are suitable for equity release, whether be-cause of their age or their wealth.
But there is a more fundamental issue – the Financial Services Auth-ority has made it clear that brokers must develop skills and processes to cover some of the advice areas that are fundamental to equity release advice but seldom relevant to other financial services products. Attitudes towards in-heritances, willingness to trade down, involvement of family, the need for legal advice and potential loss of means-tested benefits should all be standard features of equity release fact-finds.
Couple this with the increasing sophistication of products and it is clear that brokers would have to invest uneconomic am-ounts of time to achieve a high enough standard to make their first few equ-ity release sales.
Unless a broker has a steady flow of prospective customers they may never get over the economic threshold. Who would enter a market on that basis?
So the broker market is stalling but market dynamics are changing and access for customers is starting to evolve. Last year’s market entries – first by HSBC and then by NatWest/ Royal Bank of Scotland – mean customers can now access equity release through high street brands.
Instead of responding to advertisements from companies with which they have no relationship, customers can now go to their local bank branches to learn about equity release.
This is not necessarily bad news for brokers as it will fuel consumer confidence, which should drive the market forward. The opportunities for brokers should also increase, because not all consumers will want to deal with banks and many will want the traditional services of brokers. But many brokers see equity release commission rates as providing insufficient incentive to invest the time and energy needed to develop solutions for potential customers. With commission rates typically between 1% and 1.5% and customers showing their usual reluctance to pay fees directly, many feel the risk-reward-effort equation does not stack up.
Because of this, outsourcing equity release enquiries is becoming increasingly popular. Providers have also rec-ognised the importance of establishing their own distribution systems, with Prudential and Just Retirement setting up consumer sales forces in the past year.
For brokers not seeking to specialise in equity release, this model can provide an excellent solution. The commission rate is around 1% – similar to the income obtained by offering advice directly – the sales risk is borne by the firm providing the advice and clients benefit from specialist solutions.
As equity release grows in popularity it will be used for a wider range of financial planning purposes.
For example, while traditional eq-uity release to fund whole of life plans or investment solutions is inefficient in terms of Inheritance Tax mitigation (as the graph on this page shows), alternative structures will be developed that overcome longevity or interest rate issues.
For example, Close Investments and the Isle of Man Assurance Company have developed an effective IHT mitigation scheme called Property Wealth Manager.
This wraps a reversion plan with an offshore unit-linked whole of life bond which overcomes longevity and underwriting issues because the bond’s life cover, which is tax-exempt, is effectively swapped for the house value.
The bond incorporates all properties so families can buy houses back after death, subject to paying reduced IHT bills.
Normally, policies are given away, with their value being re-moved from estates assuming a seven-year survival rate.
And if death occ-urs during this seven-year period, IHT is still reduced as the bond’s value as a gift is lower than the va-lue of the property.
Growth in the equ-ity release market may lag expectations but recent developments such as high street banks getting in on the act will boost confidence.
Equity release can become a core product that helps many retired people, and innovations such as Close Investments’ IHT scheme should enable expansion beyond the traditional property rich, cash poor customer sector.
The combination of all these factors should spur the equity release market to being worth some 5bn per year in the next three to five years.
Only when it reaches this level will we be able to say that equity release has come of age.
Ged Hosty is deputy managing director of In Retirement Services