While rising interest rates in the UK have strained parts of the economy, they have also had the benefit of increasing the net asset value of the £2.1tn defined benefit pension ecosystem.
This increase in value has triggered a wave of risk transfer deals from pension trustees to specialist pension and insurance managers, a wave that shows no sign of slowing in the medium term.
In the UK, these pension and insurance managers are tightly regulated by the Prudential Regulation Authority, which dictates how each manager invests with a view to ensuring that policyholders are protected, and that systemic risk is mitigated.
The capital and investment policy of each manager is carefully monitored with those twin objectives in mind. As a result, these managers need to invest in assets with specific properties.
These characteristics include, but are not limited to, long duration (often greater than 15 years); high-quality, predictable (in the case of insurance managers, contractually fixed) cash flows; bankruptcy remote structures that offer liquidity; and well-defined third-party verification of said cash flows.
Traditional asset classes, like stocks, corporate bonds and even standard structured credit, often cannot provide managers with all of these required qualities. As a result, managers must be more thoughtful about asset allocation, and seek tailored solutions in more esoteric markets – typically infrastructure, real estate and some commodities.
One niche asset that has real potential to fill this growing gap is equity release.
The product offers homeowners, typically migrating to or in retirement, a way to refinance the mortgage on their main property, or release equity built up in that property, in a manner that maximises free cash flow.
For the lender, the product is long dated, secured, bankruptcy remote and backed by high-quality collateral. All qualities vital to meet the criteria of the PRA.
Equity release assets are structured specifically for insurers and pension funds in exact use cases, with these assets not only offering attractive risk-adjusted yields but crucially, creating much coveted 17-year-plus duration cash flows that align with clients' liabilities and (often narrow) regulatory requirements.
In addition, the notes are listed and rated, creating a standardisation that encourages liquidity.
The healthy demand picture described above coincides with rising supply. Britain’s aging population is seeking out new mortgage products that match their needs, as they look to remain in their home while also maximising spending capacity in the near term.
With 16mn people over the age of 60, the addressable market for equity release is set to double in volume terms over the next 20 years.
The right equity release mortgage product, particularly one that offers borrowers the flexibility to refinance over time, can be the better option versus a more traditional mortgage.
It allows homeowners to access the equity built up in their property, providing a tax-free lump sum to supplement regular income, while still retaining ownership and the right to live in their home for life or until they move into long-term care.
