Determining an Optimal Principal Limit Factor for Reverse Mortgages under Economics-Based Models

Abstract

Determining an optimal principal limit factor (PLF) is important for a reverse mortgage (RM) contract because it mainly influences the development of the RM market. The goal of this study was to develop a model for calculating the optimal PLF values for both uninsured and insured RMs based on two models: breaking even and maximum profits from the lender’s standpoint. We provide numerical analyses to illustrate the application of our model and compare PLFs calculated by our models with that calculated by using the traditional model in Szymanoski (1994). The results show that our PLFs are all higher than that in Szymanoski (1994) given the same basic parameters. We also provide the sensitivity analyses of PLFs on the parameters of the longevity risk, the collateral risk and the interest rate risk. The sensitivity analyses for these risks can help policymakers and market participants modulate a reasonable PLF responsive to changes in these relevant main risks. Our model provides useful information that can help them determine a reasonable PLF and manage risks with the goal of enhancing RM market development.