Profitability and risk profile of reverse mortgages: A cross-system and cross-plan comparison

Publication date: January 2018
Source:Insurance: Mathematics and Economics, Volume 78
Author(s): Yung-Tsung Lee, Ko-Lun Kung, I-Chien Liu
This study conducts a cross-system and cross-plan comparison of reverse mortgages. We compare the systematic distinctions and analyze the risk and profitability of reverse mortgages in two prominent types of market arrangements: (1) A market where a public external insurer exists (i.e., the Home Equity Conversion Mortgage program in the U.S. market). (2) A market where an external insurer is absent (i.e., the Australian market). Two typical payment plans, the lump-sum and annuity payment, are examined and compared using stochastic dominance criteria. This paper provides a complete framework to analyze the profitability and risk profile of reverse mortgage products, particularly the stochastic dominance criteria. This study argues that the modern solvency capital requirement such as Solvency II may depress the loan-to-value ratio and the intervention of government may be necessary. We also demonstrate that the lender prefers the lump-sum products and this may explain why the lump-sum products dominate the market in practice. Our work can help financial institutions and governments understand the properties of reverse mortgages, and provides a necessary incentive for these organizations to develop a reverse mortgage market.