It is now a year since UK regulator the Financial Conduct Authority (FCA) brought in its new Consumer Duty (Duty), a regulation requiring all financial services firms to ‘act to deliver good outcomes for retail customers’ for all new product offerings. This month, the FCA closes the loop with the implementation of the duty for closed product offerings.
One of the markets that is impacted by the Duty is the country’s equity release market (ERM). Participants ranging from independent financial advisors right through to the funders themselves (life insurers and pension funds, in the main) have had to get with the program, ensuring compliance at the beginning, middle and end of the customer journey.
Prior to the implementation of the Duty, one might have been forgiven for assuming that the ERM would be significantly impacted here. According to Ben Grainger, Partner at EY, however, a number of the principles of the Duty have already been in place in the ERM for some time.
“The Consumer Duty is an important formalisation of prioritising good outcomes for customers across the financial services sector. Looking specifically at the UK equity release market, the foundations for a lot of these practices were already in place prior to the implementation of the Duty,” he said. “However, the Consumer Duty has introduced the need for firms to formalise and demonstrate how they are meeting its requirements. In this regard, there has still been work to do, such as firms formalising their value for money methodology.”
One of the potential upsides of the Duty and the standards it mandates is in consumer perception. The 2023 Global Equity Release Survey, produced by EY and industry group the European Pensions and Property Asset Release Group (EPPARG) and published at the beginning of the year, cited customer perception as one of five main growth barriers, with 17% of survey respondents saying this was an impediment to the market kicking on.
Another question posed of the respondents was ‘If you could change one thing about the equity release market in your country, what would it be?’ with ‘Improving customer perceptions’ the joint most popular response in the resulting word cloud.
EY and EPPARG’s survey was global, not UK-specific, but clearly, perception remains an issue, so arguably, anything that advances this would be welcomed by the industry.
But the 800lb gorilla in the room is still the prevailing interest rate environment.
The ERM in the UK is currently in something of a treading water mode. According to data published in April by industry group the Equity Release Council, new customers coming to the market have continued to fall quarter on quarter since Q3 2022, when nearly 14,000 Brits took the plunge; just 4,698 did so in the first quarter of this year. That decline is mitigated, to a certain extent, by the stability shown in the returning customer segment, which drove a 6% increase in drawdown activity in Q1.
The decline in new customer activity correlates highly with the upwards trajectory in interest rates in the UK, which began in late 2021. Correlation is not causation, but on the flip side, there is no smoke without fire.
Interest rates are, of course, one of the most significant influences of activity in the ERM; higher rates means that it’s more expensive to buy a new mortgage and reduces the available loan amount for homeowners as well. But there is a level of anticipation that the corner might be turned sooner rather than later.
“New customer numbers are lower than last year with feedback from the market suggesting that older homeowners are adopting a more cautious approach to borrowing as there are hopes of interest rate reductions in the near future,” said David Burrowes, Chair of the ERC, in a press release back in April.
Life insurers in the UK will be hoping that it does. There are very few assets available to invest in that have a duration as lengthy as a mortgage – and with a similar risk profile (a good one, incidentally). And these firms are awash with quite literally billons of pounds from their activities in the booming UK bulk purchase annuity market, all of which needs to find a home. Sadly, it’s not as if there are many other similar markets in which to park long-dated capital and even if there were, entering them would be a slow process.
“A logical step is to then look abroad to markets like Australia, Canada and some in continental Europe where there is an undersupply of funding, but many of these markets don’t have an established infrastructure to drive activity yet,” said Grainger.
“Also, while there are hurdles in the way of establishing markets, these are surmountable. It’s just that it takes insurance companies a long time to get happy investing in a new asset class. This needs to get to the top of the list before they are willing to dedicate the time to do that,” he added.
Which means that insurers are putting a good chunk of their bulk purchase annuity premiums into liquid fixed income. After all, what’s not to like about gilts at the moment, where you can get 4.37% on a 10-year, (comparatively) safe haven investment?
Until rates start to fall, it’s likely that the UK ERM will continue treading water. The Duty, while generally accepted as a positive development for the consumer, simply isn’t a significant factor in the supply of risk. But when rates do start to fall, and new customer activity starts to pick up, insurers will be poised to deploy capital.
“There is a significant gap in the UK equity release market in the sense that there is roughly $3bn of activity but more than £6bn of demand,” said Grainger.
“Strategic asset allocations haven’t changed – there will be a rebalancing when illiquid markets open up again, and, as one of the few long-dated assets available, equity release mortgages will be in high demand from insurers.”
