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Asia-Pacific Journal of Risk and Insurance

The Official Journal of the Asia-Pacific Risk and Insurance Association

Editor-in-Chief: Kwon, W. Jean

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2153-3792
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Risk Analysis for Reverse Mortgages with Different Payout Designs

Daniel Cho / Katja Hanewald
  • Corresponding author
  • Australian School of Business, University of New South Wales – ARC Centre of Excellence in Population Ageing Research (CEPAR), Sydney, New South Wales 2052, Australia
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/ Michael Sherris
Published Online: 2015-01-30 | DOI: https://doi.org/10.1515/apjri-2014-0012

Abstract

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.

Keywords: reverse mortgage; income stream; equity release; vector autoregressive model; stochastic discount factor; risk-based capital

JEL Classification: G12; G21; G32

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About the article

Published Online: 2015-01-30

Published in Print: 2015-01-01


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


Citation Information: Asia-Pacific Journal of Risk and Insurance, Volume 9, Issue 1, Pages 77–105, ISSN (Online) 2153-3792, ISSN (Print) 2194-606X, DOI: https://doi.org/10.1515/apjri-2014-0012.

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