Endowment Mortgage Research Articles

How can we improve the customers’ experience of our life products?

AbstractIn the last three decades the life insurance industry was rocked by a series of mis-selling scandals such as endowment mortgage, personal pension and payment protection insurance mis-selling. Regulators have stepped in to try to address the underlying causes and improve customer protection by introducing more stringent regulation targeted at sales practices and remuneration, product design, disclosure and ongoing monitoring together with significantly larger financial penalties for non-compliance. Against this background, the paper considers whether customers understanding of risks and outcomes associated with life insurance products can be further improved and how poor customer outcomes can be avoided in the future. We acknowledge the complexity of these issues, which involve many stakeholders, covering all stages of the product lifecycle and customer journey and being impacted by a constantly changing regulatory landscape. We first review the current regulatory landscape across both the United Kingdom and other jurisdictions, concluding that whilst regulators have acted to improve customer protection, gaps still remain, particularly around the areas of disclosure and consideration of changing customers’ needs throughout product lifetimes. The paper then considers how the current situation could be improved for customers in a cost effective manner. We focus on improvements in disclosure, needs-based selling, ongoing assessment and communication as a means of ensuring that products continue to meet the customers’ needs and risk profile, and on introducing a duty of care which would force financial services firms to act in the best interests of their customers. In this paper we present our preliminary thoughts and recommendations. Some of the recommendations will cost something to implement, and should therefore be supported by cost-benefit analyses that would weigh these costs against the potentially larger benefits to both customers and the insurance industry.

Determinants of Outstanding Mortgage Loan to Value Ratios: Evidence from the Netherlands

This paper studies the determinants and behavior of outstanding mortgage loan to value (LTV) ratios for a panel data set of 5,179 households over the period 1992-2005. We find that outstanding LTVs are driven by household characteristics, life-cycle eects and mortgage type characteristics. LTV declines with the time elapsed since mortgage commencement, but its level is consistently higher (by around 10%) for non-repayment mortgages (such as interest-only or endowment mortgages) than for repayment mortgages (such as linear or annuity mortgages). The dierence results from higher debt capacity associated with the possibility of deferring the principal repayment for non-repayment mortgages. Our results indicate that the recent proliferation of non-repayment mortgages is driven by tightening financing constraints due to declining aordability in

Measuring Transparency in the Dutch Mortgage Market

This paper is an empirical study of pricing in the Dutch mortgage market. For a narrowly defined set of endowment mortgages (with a fixed lending rate of 10 years), we find that the price dispersion within lenders is larger than the dispersion across lenders. Prices remain dispersed across lenders, even after controlling for characteristics of the borrower, the municipality and the government bond rate. Apparently, the mortgage market is not fully transparent, which impedes competition in the mortgage market. We also find that the price dispersion for mortgages sold by banks is smaller than that for mortgages sold by other lenders. A likely explanation is that lenders using middlemen have higher agency costs.

What to do with an endowment mortgage shortfall

MANY UK householders planned to pay off their mortgages with endowment policies, but since the stock market falls in the 1990s, the future of some policies looks far from certain....

Why should we pay the NMC’s deficit?

I think the Nursing and Midwifery Council (NMC) registration fee is far too high (news February 4). I agree we should not have to pay for bad investments by the UKCC in the past, which is particularly applicable to new registrants. I do not expect anyone else to cover the deficit in my endowment mortgage or pension fund, so why should I pay to cover the NMC’s inherited deficit? The government should pay more towards the cost of public protection. I also feel the burden of a fair rise in fees could be reduced if we were allowed to pay them by monthly direct debit, as I do with my household bills.

A European comparison of the costs and risks of mortgages for owner-occupiers

Mortgage take-up by homeowners differs enormously across Europe. The loan-to-value and loan-to-income ratios are quite dissimilar, ranging from some 20% and 0.9 respectively in Italy to more than 90% and 3.5 respectively in some countries in northwest Europe. In addition, the mortgage characteristics vary from a short-term serial loan to a high-risk endowment mortgage based on shares. To a certain extent, a statistical comparison of the loan-to-value and loan-to-income ratios can provide a good indication of the risks that owner-occupiers run in financing their own home. At the same time, this kind of comparison ignores the causes of the risks, namely the volatility or uncertainty of future interest rates, house prices and changes in income. It also disregards the main mortgage characteristics, the cost of taking out a mortgage, and the direct and indirect subsidies, including interest deductibility, factors that have a big influence on the real costs and risks for homeowners. A Monte Carlo simulation mod...

Measuring tax incidence: an application to mortgage provision in the UK

This paper derives measures of the average and marginal incidence of a tax or subsidy in imperfect competition, in the context of the UK housing market. We argue that one form of mortgage, common in the UK but not elsewhere (the endowment mortgage), exists primarily because of the structure of taxation in the UK. We estimate the determinants of the choice of the type of mortgage, and the size of mortgage conditional on the choice, using data from the Building Societies Association on 43 000 individual mortgages taken out between 1985 and 1989. The estimated parameters are an input to the incidence measures. Results suggest that between 70 and 80% of the additional subsidy to endowment mortgages is captured by lenders, rather than borrowers.

Fixed-Rate Endowment Mortgage and Mortgage Indemnity Valuation

Fixed rate endowment mortgages differ from fixed rate repayment mortgages primarily because, in the event of early termination, the amount owed by the borrower is a function of the evolution of the term structure of interest rates, whereas for a repayment mortgage it is pre-determined. We use a contingent claims framework for valuing the embedded options in certain British fixed-rate endowment mortgages, with a (capped) mortgage indemnity guarantee (MIG). We assume a mean-reverting interest rate and a lognormal house price diffusion process to arrive at a partial differential equation as the basis of the contingent claims and include conventional mortgage terms such as arrangement fees and prepayment penalties. This methodology provides a template for the borrower, lender and insurer to compare mortgage terms, including the fairness of contract rates, fees and any MIG premiums required, when borrowing more than 75% of the house value at origination. Given the conventional terms and the diffusion processes, we assume the parties have common expectations for some diffusion parameters, including expected future rate and price volatilities. Also we assume that borrowers are 'economic actors' regarding default and prepayment options, and that factors such as mobility, divorce, unemployment, and transaction costs are deterministic and can be ignored in this model, along with moral hazard problems between the insurer and the lender. Since the partial differential equation incorporating the general features of these mortgage contracts does not have a closed-form solution, an explicit finite difference method is used for the valuation (and sensitivity) results. We provide graphical representations (and interpretations) of each mortgage component as a function of house prices and interest rate levels. After empirical studies on the input parameters, each mortgage component may be compared with 'market values'. This model may also be useful as a 'mark-to-value' proxy for all parties, as expected parameters change (especially interest rate and house price levels, and expected future volatilities), for purposes of determining 'value added accounting', appropriate reserves, and indeed for setting premiums and business decisions. Finally, we compare endowment and repayment mortgages for different levels of loan-to-value ratios, interest rate and house price volatility.

Fixed-Rate Endowment Mortgage and Mortgage Indemnity Valuation

Fixed rate endowment mortgages differ from fixed rate repayment mortgages primarily because, in the event of early termination, the amount owed by the borrower is a function of the evolution of the term structure of interest rates, whereas for a repayment mortgage it is pre-determined. We use a contingent claims framework for valuing the embedded options in certain British fixed-rate endowment mortgages, with a (capped) mortgage indemnity guarantee (MIG). We assume a mean-reverting interest rate and a lognormal house price diffusion process to arrive at a partial differential equation as the basis of the contingent claims and include conventional mortgage terms such as arrangement fees and prepayment penalties. This methodology provides a template for the borrower, lender and insurer to compare mortgage terms, including the fairness of contract rates, fees and any MIG premiums required, when borrowing more than 75% of the house value at origination. Given the conventional terms and the diffusion processes, we assume the parties have common expectations for some diffusion parameters, including expected future rate and price volatilities. Also we assume that borrowers are 'economic actors' regarding default and prepayment options, and that factors such as mobility, divorce, unemployment, and transaction costs are deterministic and can be ignored in this model, along with moral hazard problems between the insurer and the lender. Since the partial differential equation incorporating the general features of these mortgage contracts does not have a closed-form solution, an explicit finite difference method is used for the valuation (and sensitivity) results. We provide graphical representations (and interpretations) of each mortgage component as a function of house prices and interest rate levels. After empirical studies on the input parameters, each mortgage component may be compared with 'market values'. This model may also be useful as a 'mark-to-value' proxy for all parties, as expected parameters change (especially interest rate and house price levels, and expected future volatilities), for purposes of determining 'value added accounting', appropriate reserves, and indeed for setting premiums and business decisions. Finally, we compare endowment and repayment mortgages for different levels of loan-to-value ratios, interest rate and house price volatility.

Inappropriate sales in the financial services industry: the limits of the rational calculus?

AbstractThe paper explores the notion of ‘misselling’ in the context of financial services. ‘Misselling’ is treated as a special case of error in the classification of a discrete dependent variable. A simulation study is conducted using the sale of mortgage debt to outright owners of property as an example of how inappropriate sales manifest themselves. This is followed by the actual case of endowment mortgage sales. The results and discussion suggests that ‘misselling’ can be viewed (i) in the context of empirical regularities and a rationalizable view of the data and/or (ii) as a non rationalizable situation where the ‘misselling’ becomes ‘pathological’. The paper highlights the need for a behavioural perspective, in addition to a more conventional economic treatment of the ‘misselling’ phenomenon. Copyright © 2000 John Wiley & Sons, Ltd.

An econometric analysis of choice of mortgage design in the United Kingdom

The research seks to better understand the choice of mortgage design by households in the United Kingdom. Family Expenditures Survey data is used to test the various hypotheses on the determinants of the choice between an endowment and a repayment mortgage. A bivariate probit model with sample selection is estimated to detect any likely selectivity bias arising out of tenure choice. The theoretical modelling reflects the behaviour of liquidity constrained households comparing comparative periodic mortgage costs and households concerned with the oppurtunity cost of equity in a property. Actual choices appear to reflect the impact of nominal interest rates, income and cash flow considerations. There is little direct evidence that the choice of mortgage repayment vehicle is motivated by portfolio design. There is some tentative evidence of supply side pressure on endowment mortgage take up.

Privatized Default Risk and Real Estate Recessions: The U.K. Mortgage Market

A mortgage pricing model is developed when a borrower goes through a series of distress states, including delinquency, long‐term nonpayment and ultimate default. These steps are sequential, and depend on prices and alternatives faced by the borrower. The multistate default model is applied to the mortgage market in the United Kingdom. As a byproduct, a pricing structure for the U.K. endowment mortgage, which combines a good and a life insurance policy, is developed. Income and liquidity constraints are shown to affect the decision to keep a mortgage current in different states of distress. Solvent borrowers may thus keep their mortgages current, even when equity is negative.

Real estate market institutions in the United Kingdom: Implications for the United States

Abstract The characteristics of the recently stressed U.K. housing and real estate markets are compared with market behavior and performance in the United States. Four distinguishing characteristics are examined: the mortgage instrument, long‐term price declines, asset derivatives, and a privatized secondary market. In the United Kingdom, lenders shift interest rate risk to borrowers since the market for selling this risk is limited. The market is circumscribed by the inherent characteristics of the prevailing endowment mortgage and the absence of implicit government guarantees for default risk. To improve liquidity, the United Kingdom has attempted to develop derivative markets for house equity. It has also created a secondary market by privatizing mortgage‐backed security guarantees. Both nascent markets have policy implications for house and mortgage credit risk in the United States.

Endowment mortgages--a viable proposition?

Endowment mortgages--a viable proposition?