5. METODOLOGÍA
6.2 FUNDAMENTOS
I have started this chapter with the life-cycle theory and the role of housing equity in it. Next, I explained how reverse mortgages could play a role in releasing this housing equity. I explained what reverse mortgages are and how they work. I continued with a description of the international and local Dutch market for reverse mortgages. In The Netherlands, the market is almost non-existent with only one provider and very low sales volumes.
After that, I looked with a consumers view to reverse mortgages. A consumer can use reverse mortgages for four purposes; a planned, one-time expense; an unexpected, one-time expense; as a supplement to daily expenditures; and for additional comfort or hobbies. The main reasons to enter into a reverse mortgage contract for a consumer are that they offer supplemental liquidity and thus enable consumption smoothing, increase access to credit at old age, and shift the house price and (possibly) the longevity risk from individuals to financial institutions. There also are some disadvantages to reverse mortgages. It is a highly complex product that comes with high additional costs. The amount that can be borrowed in the future is uncertain. This makes it hard to include reverse mortgages in financial planning. Reverse mortgages also come with hidden costs, such as a maintenance obligation. Furthermore, reverse mortgages deplete all housing wealth and they come with ownership restrictions. Nevertheless, in a society (as the Dutch) in which pension benefits are likely to decrease in the future, while at the same time fiscal incentives to repay the ordinary mortgage are increased, demand for these product can be expected to increase.
Next, I have looked at reverse mortgages from a providers point of view. The most important reason to offer reverse mortgages mentioned by providers are the expected high profits. Other important reasons are entering a niche market, increasing market share in the pensions or mortgage market, the opportunity to cross sell to elderly, building a social reputation, and complementing the existing product palette. Reverse mortgages also bring some risks with them. The most important risk is the crossover risk. This risk occurs if there is a no negative equity guarantee in place. Furthermore, risks of adverse selection and
MAIN HYPOTHESIS:
REVERSE MORTGAGES CAN OFFER SUBSTANTIAL DIVERSIFICATION AND
HEDGING POTENTIAL FOR DUTCH PENSION FUNDS AND CAN THEREFORE OFFER A
VALUABLE INVESTMENT OPPORTUNITY
SUB HYPOTHESES:
1. ADDING REVERSE MORTGAGES TO AN ASSET-ONLY PORTFOLIO INCREASES
THE EFFICIENCY OF THIS PORTFOLIO
2. REVERSE MORTGAGES ARE BOTH ABLE TO GENERATE EXCESS RETURNS AND
INCREASE THE LIABILITY MATCHING OF A PENSION FUNDS’ INVESTMENT
PORTFOLIO
3. ADDING REVERSE MORTGAGES TO THE INVESTMENT PORTFOLIO INCREASES
THE INTEREST RATE RISK HEDGE
4. REVERSE MORTGAGES ARE SUITABLE IN A PENSION FUND PORTFOLIO TO
MAINTAIN PURCHASING POWER
moral hazard are associated with reverse mortgages. Another risk for financial institutions is that timing of repayment of the outstanding debt is uncertain. This can cause liquidity problems.
After this discussion, I have described how the financial management of pension funds in The Netherlands occurs. The main contradiction pension funds face is that they try to match the liabilities as much as possible on the one hand, while on the other hand they aim to make excess returns. I identified as main risks for pension funds relevant for this thesis the interest rate risk and the inflation risk.
In the search for assets that match the liabilities and generate excess returns, I have proposed to investigate reverse mortgages. I have come up with four sub hypotheses (see blue box). Furthermore, pension funds might be very well positioned to deal with some risks of reverse mortgages other possible providers might face. The crossover risk is a risk that is present for all providers, but the risk of adverse selection and moral hazard might be less severe for pension funds if reverse mortgages are sold to their own population. That is because pension funds know their population very well, so should be able to estimate and price these risks. Furthermore, given the long term nature of pension funds, the timing and illiquidity issues of reverse mortgages might not be much of a problem for pension funds.
As assumed in my hypothesis and based on this theoretical chapter, it is very well possible that reverse mortgages might be an attractive investment opportunity for pension funds. If my hypotheses are correct, pension funds become more efficient investors by offering reverse mortgages. That alone is a benefit to society. Even better, more reverse mortgage providers likely results in a more competitive market. Consumers should be able to benefit from this, resulting in better liquidity for pensioners and more efficient use of the wealth that is stored in stones. This could be a “double win” for society. In my next chapter, I will try to quantify the benefits to pension funds using scenario analysis.