Skip to content
Accessible Unlicensed Requires Authentication Published by De Gruyter January 30, 2015

Risk Analysis for Reverse Mortgages with Different Payout Designs

Daniel Cho, Katja Hanewald and Michael Sherris


We analyze the risk and profitability of reverse mortgages with lump-sum or income stream payments from the lender’s perspective. Reverse mortgage cash flows and loan balances are modeled in a multi-period stochastic framework that allows for house price risk, interest rate risk and risk of delayed loan termination. A vector autoregressive (VAR) model is used to simulate economic scenarios and to derive stochastic discount factors for pricing the no negative equity guarantee embedded in reverse mortgage contracts. Our results show that lump-sum reverse mortgages are more profitable and require less risk-based capital than income stream reverse mortgages, which explains why this product design dominates in most markets. The loan-to-value ratio, the borrower’s age, mortality improvements and the lender’s financing structure are shown to be important drivers of the profitability and riskiness of reverse mortgages, but changes in these parameters do not change the main conclusions.

JEL Classification: G12; G21; G32

Funding statement: Funding: Australian Research Council, (Grant / Award Number: ‘Centre of Excellence in Population Ageing Research’, ‘Linkage Grant Project LP0883398’).


Alai, D. H., H.Chen, D.Cho, K.Hanewald, and M.Sherris. 2014. “Developing Equity Release Markets: Risk Analysis for Reverse Mortgages and Home Reversions.” North American Actuarial Journal18(1):21741.Search in Google Scholar

Ang, A., and M.Piazzesi. 2003. “A No-Arbitrage Vector Autoregression of Term Structure Dynamics with Macroeconomic and Latent Variables.” Journal of Monetary Economics50(4):74587.Search in Google Scholar

Ang, A., M.Piazzesi, and M.Wei. 2006. “What Does the Yield Curve Tell Us About GDP Growth?Journal of Econometrics131(1):359403.Search in Google Scholar

Calem, P. S., and M.LaCour-Little. 2004. “Risk Based Capital Requirements for Mortgage Loans.” Journal of Banking & Finance28(3):64772.Search in Google Scholar

Chen, H., S. H.Cox, and S. S.Wang. 2010. “Is the Home Equity Conversion Mortgage in the United States Sustainable? Evidence from Pricing Mortgage Insurance Premiums and Non-Recourse Provisions Using Conditional Escher Transform.” Insurance: Mathematics and Economics46(2):37184.Search in Google Scholar

Chinloy, P., and I. F.Megbolugbe. 1994. “Reverse Mortgages: Contracting and Crossover Risk.” Real Estate Economics22(2):36786.Search in Google Scholar

Chiuri, M., and T.Jappelli. 2010. “Do the Elderly Reduce Housing Equity? An International Comparison.” Journal of Population Economics23(2):64363.Search in Google Scholar

Clerc-Renaud, S., E.Pérez-Carillo, A.Tiffe, and U.Reifner. 2010. Equity Release Schemes in the European Union. Norderstedt: Books on Demand.Search in Google Scholar

Collett, J.2014. “Centrelink Reverse Mortgage Scheme is Just for the Wealthy.” The Sydney Morning Herald. October 8, 2014. Accessed November 9, 2014. in Google Scholar

Consumer Financial Protection Bureau. 2012. Report to Congress on Reverse Mortgages. Iowa City, IA: Consumer Financial Protection Bureau.Search in Google Scholar

Deloitte and SEQUAL.2012. “Media Release: Australia’s Reverse Mortgage Market Reaches $3.3bn at 31 December 2011.” Deloitte Australia and Senior Australians Equity Release (SEQUAL).Search in Google Scholar

Denniss, R., and T.Swann. 2014. “Boosting Retirement Incomes the Easy Way – Extending the Pension Loan Scheme to All Retirees.” The Australia Institute – Technical Brief No. 34.Search in Google Scholar

Gompertz, B.1825. “On the Nature of the Function Expressive of the Law of Human Mortality, and on a New Mode of Determining the Value of Life Contingencies.” Royal Society of London Philosophical Transactions Series I115:51383.Search in Google Scholar

Hickey, J.2012. “Deloitte/SEQUAL Reverse Mortgage Survey 2011.” Deloitte Touché Tohmatsu.Search in Google Scholar

Horneff, W. J., R. H.Maurer, O. S.Mitchell, and M. Z.Stamos. 2009. “Asset Allocation and Location over the Life Cycle with Investment-Linked Survival-Contingent Payouts.” Journal of Banking & Finance33(9):168899.Search in Google Scholar

Horneff, W., R.Maurer, and R.Rogalla. 2010. “Dynamic Portfolio Choice with Deferred Annuities.” Journal of Banking & Finance34(11):265264.Search in Google Scholar

Hosty, G. M., S. J.Groves, C. A.Murray, and M.Shah. 2008. “Pricing and Risk Capital in the Equity Release Market.” British Actuarial Journal14(1):4191.Search in Google Scholar

Human Mortality Database.2012. “University of California, Berkeley (USA), and Max Planck Institute for Demographic Research (Germany).” Accessed July 3, 2012. or www.humanmortality.deSearch in Google Scholar

Institute of Actuaries UK.2005. “Equity Release Report 2005, Volume 2: Technical Supplement: Pricing Considerations.” Institute of Actuaries, UK- Equity Release Working Party.Search in Google Scholar

Ji, M., M.Hardy, and J. S.-H.Li. 2012. “A Semi-Markov Multiple State Model for Reverse Mortgage Terminations.” Annals of Actuarial Science6(2):23557.Search in Google Scholar

Key Retirement Solutions.2013. “UK Equity Release Market Monitor - 2012 Review.” Preston: Key Retirement Solutions.Search in Google Scholar

Lee, Y.-T., C.-W.Wang, and H.-C.Huang. 2012. “On the Valuation of Reverse Mortgages with Regular Tenure Payments.” Insurance: Mathematics and Economics51(2):43041.Search in Google Scholar

Li, J. S.-H., M.Hardy, and K.Tan. 2010. “On Pricing and Hedging the No-Negative-Equity Guarantee in Equity Release Mechanisms.” Journal of Risk and Insurance77(2):499522.Search in Google Scholar

Nelson, C., and A.Siegel. 1987. “Parsimonious Modeling of Yield Curves.” Journal of Business60(3):47389.Search in Google Scholar

Olivieri, A., and E.Pitacco. 2011. Introduction to Insurance Mathematics. Springer-Verlag Berlin Heidelberg.Search in Google Scholar

Pelizzon, L., and G.Weber. 2009. “Efficient Portfolios When Housing Needs Change over the Life Cycle.” Journal of Banking & Finance33(11):211021.Search in Google Scholar

Qi, M., and X.Yang. 2009. “Loss Given Default of High Loan-to-Value Residential Mortgages.” Journal of Banking & Finance33(5):78899.Search in Google Scholar

Shao, A. W., M.Sherris, and K.Hanewald. 2012. “Equity Release Products Allowing for Individual House Price Risk.” In Proceedings of the 11th Emerging Researchers in Ageing Conference, Brisbane, November 19–20, 2012.Search in Google Scholar

Shao, A. W., M.Sherris, and K.Hanewald. 2014. “Reverse Mortgage Pricing and Risk Analysis Allowing for Idiosyncratic House Price Risk and Longevity Risk.” UNSW Australian School of Business Research Paper No. 2014ACTL01.Search in Google Scholar

Sherris, M., and D.Sun. 2010. “Risk Based Capital and Pricing for Reverse Mortgages Revisited.” UNSW Australian School of Business Research Paper No. 2010ACTL04.Search in Google Scholar

Venti, S., and D.Wise. 1991. “Aging and the Income Value of Housing Wealth.” Journal of Public Economics44(3):37197.Search in Google Scholar

Wyman, O.2008. “Move Beyond the HECM in Equity Release Markets?” Oliver Wyman Financial Services.Search in Google Scholar

Published Online: 2015-1-30
Published in Print: 2015-1-1

©2015 by De Gruyter