One motivation may be to pass on wealth to children, who otherwise may not inherit until well past the most expensive child-rearing years. Other motivations can include supplementing pension income, repaying debt and making home improvements. The risks in this market though are very different to those on insurer’s other assets. It is a retail product bringing conduct risks that fall under the FCA’s responsibilities. From a prudential perspective, the main risk is long-term stagnation in UK house prices. Economically, the no-negative-equity guarantee is a written option on house prices. Where insurers have recently entered the market and/or are growing their loanbooks rapidly, the average expected maturity of these options is likely to be some decades in the future. Low loan-to-value ratios mean the short-run risks to insurers are limited. They can ride out a property market crash as long as the market subsequently recovers. But loan-to-value ratios increase over time unless house price growth keeps pace with the rate at which interest is accruing. So what you have is a sort of race to the value of the property illustrated by Chart 3. The time it takes for the value of the loan to exceed the value of the property will be governed by: the interest rate charged (higher is more risky), the loan-to-value ratio (higher is more risky), house price inflation (lower is more risky) and the age of the borrowers (younger is more risky). Underwriting standards do appear to have weakened a little over recent years.
On data due diligence, it seems obvious to say that insurers should not enter into bulk purchase transactions without understanding in some depth the nature of the annuity liabilities they are taking on. But this is an area where we see firms taking different approaches and willing to price with different levels of risks. One particular aspect is whether insurers have a full picture of their potential obligations to pensioner spouses and dependents. Insurers need to be clear about their appetite in relation to data risks. Most of the longevity risk on new transactions is currently being reinsured, often outside of the UK. 2  Estimates of BPA market from LCP and Towers Watson market reports 2  All speeches are available online at www.bankofengland.co.uk/speeches  2  One reason is to mitigate the impact of the risk margin. As Sam Woods and I have said before, we recognise that the risk margin on long-dated insurance risks such as longevity is too sensitive to the level of interest rates and therefore too high currently. We are actively looking at further steps available to us within the constraints of Solvency II to address this issue. We expect that a more appropriate level of risk margin – similar to that envisaged when Solvency II was negotiated – would lead to a better balance between longevity risk being retained and reinsured by UK insurers on new business. While significant reinsurance continues, insurers should be paying close attention to counterparty and operational risks.