My Lords, the Government take the issues raised in this report very seriously. Equity release offers an effective way for home owners to enhance their standard of living in later life, but must not threaten their financial stability or place consumers at risk. The Prudential Regulation Authority is alert to the issue. It is acting to set a clear and more precise prudential expectation for insurance companies’ risk management of equity release mortgages.
The equity release mortgage market has trebled over the last five years and continues to grow strongly. Many of these mortgages have no negative equity guarantees—in other words, the loan value is capped at the price of the house when sold. The Adam Smith report says that insurance companies selling these mortgages have so misjudged the risk that another and bigger Equitable Life scandal is in prospect. Will the Minister say what action is being taken to prevent that?
The responsibility for that lies directly with the PRA, the responsible regulator. It is in regular contact with the industry on setting new guidelines. That was already done in 2016. Just before the report, to which the noble Lord referred, was published, a new consultation was published by the PRA on this issue—the effective value test, which was used to calculate an appropriate amount that must be held in capital on the balance sheet to reflect the risks being entered into. That consultation is open until 30 September. There are some proposals, which, if they find support, will be implemented by the end of the year.
Is the Minister sure that the PRA is genuinely on top of this issue? We would all agree that it is essential that sufficient capital is held to deal with the risk inherent in equity release guarantees. When evidence was given to the Treasury Select Committee, in the same Session, in February 2017, Sam Woods, speaking for the Bank of England said that the capital required to be held was in the range of £126 billion. David Belsham, speaking for the then PRC gave the figure as only £80 billion. They were presumably part of virtually the same organisation. Does this suggest that there is some coherent thinking within the regulator and that it fully understands the risks it is facing?
What it reflects better is an issue of pricing, which is a fair debate. The no negative equity guarantee, which is very important to lots of consumers, because they do not want to leave their families with the potential liability, is a key part of the offer. The pricing of that, depending on which measure you take, says either that we assume there will be house price growth over the next 15 to 25 years, or that there will be no growth at all, or that interest rates will accrue at 5% to 6% or at 1% to 2%. The variance that the noble Baroness has identified lies in whether you apply the effective value test at a different point between those two extremes to come up with a different number. The purpose of the consultation paper is to get clarity so that all interests are protected.
My Lords, the rate of increase in the market has been exceptional over the past five years, and there are clear indications that this will carry on at a rate not dissimilar for the immediate future, so I do not know the extent to which the regulators are being effective in this respect. It is obvious that home owners will be eager to borrow in circumstances where incomes can scarcely keep up with inflation, but we have to guard against things going badly wrong. What if house prices shudder to a halt or even fall? There are reasons to think that such issues could arise in the economy and we would be back to Equitable Life, which caused such tremendous damage to people 20 years ago.
That is of course why within the industry itself—and indeed with the regulator—the normal level at which borrowing is taken from the home is between 30% and 40%, to allow for that cushion. We have to recognise also that this has two benefits: to individuals as, for most people, their home is their largest asset and being able to release some capital to enhance their quality of life in later life is good; and to the annuity holders on the other side of the balance sheet from the equity release, who have been suffering badly as a result of gilt yields being around 1.5%. The ability of life insurance companies to match these two needs and to offer a better deal to both is something to welcome. The noble Lord is absolutely spot on when he says that we need to watch it; we need to watch it very carefully and what I have outlined is what the regulator is doing already and the rules that it has applied, and also the consultation that is open at this moment to see whether more needs to be done.
My Lords, I support wholeheartedly what my noble friend has said about the importance of the equity release market for certain families. Does he also agree with me that, as the Equity Release Council figures show, most equity release loans are only about 30% of loan to value—some may be around 50%? Even if house prices were to decline by 30% or more, the problems in the conventional mortgage market would be far greater than those in the equity release market. I was rather surprised to see such scary headlines on this particular segment of the market.
My noble friend has great expertise in this area, which she brings to our consideration. Of course, the amount of capital at risk in the non-asset linked security on balance sheets amounts to some 3% of the total. It is, therefore, a relatively small amount but it is growing fast. We want to make sure that two things happen: first, that balance sheets correctly reflect the risks that are inherent in them and, secondly, that consumers get independent advice, take the right decisions and are aware of the risks that they face. Both are responsibilities that have to be shared between the PRA and the Financial Conduct Authority. We are watching this very carefully; we are not complacent and we want to make sure that that happens.