Chart 4 shows a slight increase in the share of lending to younger customers, aged 65 or younger. Average loan-to-value ratios for these borrowers have also increased a little. We would expect risk functions to be monitoring these trends and keeping boards informed. As well as loosening of lending standards, another concern might be if insurers are making more loans outside those standards. Chart 5 plots loan-to-value ratios against age for equity release mortgages sold by life insurers in 2017. The pink swathe shows insurers’ risk limits. The great majority of mortgages are within risk appetites, but some loans exceed the limits. This may or may not be a problem. For example, it could be explained by medical underwriting of the mortgage that justifies a higher loan-to-value ratio for a younger customer if their life expectancy is impaired. Again this an area that risk functions should be watching. The most important risk factor, however, is the long-term path of UK house prices. Plausibly the risk of a long-term correction in UK house prices has increased as houses have become less affordable and rental yields have fallen. In England and Wales the ratio of median house prices to median individual annual  3  Equity release rebooted: the future of housing equity as retirement income, Rob Thomas and Dr Louise Overton, April 2017  4  All speeches are available online at www.bankofengland.co.uk/speeches  4  4  earnings has increased from 3.6 times in 1997 to 7.6 times in 2016 .
In particular, to quote Solvency II directly, “the Matching Adjustment must not include the Fundamental 9  Spread, reflecting the risk retained by the insurance or reinsurance undertaking” . Since the credit rating is the main driver of the Fundamental Spread, this means the credit rating must reflect the risk retained by the insurer. One key characteristic of illiquid assets is that they are not usually externally rated. Instead, Solvency II permits insurers to use internal ratings to determine the Fundamental Spread. Since illiquid assets will often not have market valuations, insurers will often also base the asset valuation on the internal rating by mapping to equivalent traded assets of the same rating. The internal rating may therefore drive both determinants of the Matching Adjustment: the spread over risk-free rates and the Fundamental Spread. Getting it right is important! The PRA set out its views on this subject in a supervisory statement (SS 3/17) last year. 10  We said that  internal ratings must lie within a plausible range of the ratings that would be given by external rating agencies. Individual ratings may vary, depending on credit judgements, but there should be no overall upward bias in internal compared to external ratings. Supervisors are reviewing insurers’ internal ratings and may seek greater assurance where assets have spreads that look large for the rating, leading to a large matching adjustment in absolute or relative terms. We will also consider the complexity of the assets and their materiality to the overall solvency position of the insurer.