The answer is that the loss from absence of complementarity is not generally recognized, the population segment that is victimized is not identified, and the regulatory structure responsible for the separation of functions is oblivious to the harm separation of functions has caused. The bottom line is what HUD, the regulator responsible, ought to do in penance.
The Complementarity of Annuities and Reverse Mortgages
Reverse mortgages allow elderly homeowners to convert their home equity into spendable funds during their retirement years, but not necessarily for life. The annuity increases the payment amount through mortality sharing, and assures that the payments will continue for life.
Consider the case of a male of 62 who owns a debt-free house worth $500,000 but has no financial assets. His only stand-alone option is a HECM tenure payment, which provides a fixed monthly payment. On February 23, 2023, the largest tenure payment quoted by the 6 lenders who report prices to my web site was $1,010, shown by the lower horizontal line (red) on the chart below.
If instead of taking a tenure payment, the borrower combines a HECM credit line with an annuity on which payment is deferred 10 years, his monthly payment would be $1,226, shown by the higher horizontal line (green) on the chart. During the first 10 years the payments would be drawn from the credit line (shown by the dotted segment of the line), after which they would come from the annuity. The payment on the annuity would continue until the borrower died whereas a tenure payment terminates when the borrower moves out of the house – into a nursing home, for example.
Another advantage of the combo is that the payment amounts can be graduated. This is illustrated by the two schedules on the chart that incorporate annual payment increases of 2%. Most borrowers probably would select a rising payment option, and HUD as the insurer should also prefer it. Borrowers with rising payments are better positioned to pay their property taxes and insurance.
The two rising payment schedules illustrate the importance of providing retirees with competitive annuity prices. The annuity price used in calculating the higher of the two schedules was the best of the price quotes accessed from a network of annuity providers rated A or above by AM Best. The lower rising payment schedule was calculated using the worst quoted price.
The Disadvantaged Population That Is Overlooked
It consists of retirees, most of whose wealth is in their homes. As shown in Table 1 below, retirees aged 65-74 had net worth of only $266,000 in 2019, of which $240,000 was in their homes.
As shown in the table below, furthermore, wealth inequality has been rising. Between the third quarter of 1989 – the earliest date for which wealth data are available from the Survey of Consumer Finances — and the second quarter of 2021, the wealth of the lower half of wealth holders rose by 304% whereas the wealth of the top 1% rose by 800%. In addition, the share of wealth comprising the residences of the lowest wealth group, has increased over time, whereas the concentration for higher-wealth consumers has declined.
Regulations Separating Annuities and Reverse Mortgages
The impetus for the regulations that separate annuities and reverse mortgages arose in the early days of the HECM reverse mortgage program when one or more HECM lenders combined with one or more annuity providers to offer loan/annuity combos to gullible seniors at extortionate terms. In response, HUD instructed the counselors who potential borrowers must consult before submitting a loan application, to warn borrowers to beware of annuities. HUD also prohibited HECM lenders from having relationships with other financial institutions.
On the annuity side, because some of the early combination deals led to law suits against insurers by disgruntled heirs of HECM borrowers, the industry adopted the rule that annuities could not be financed with proceeds of a reverse mortgage. The only combos that are written today are the few in which the retirees conceal the source of the funds used to pay for the annuity. This private regulation would disappear if HUD legitimized HECM/annuity combinations.
Legitimizing HECM/annuity Combinations
To enlarge the availability of spendable funds for homeowners with very limited financial assets, and replenish the mortgage insurance reserve fund in the process, HUD policy should swing from discouraging HECM/annuity combinations to encouraging them, rising payment annuities in particular.
HECM lenders who want to offer combos should be subject to the following rules.
- HECM lenders must provide demonstrably competitive terms on the annuity. This is easy to do because there are third party data bases that show annuity amounts offered by large numbers of insurers. The annuity amounts shown above are drawn from such a service.
- No lender involved in the origination of a HECM / annuity combo can receive fees from the annuity provider.
- The HECM / annuity combination developed for the borrower must be demonstrably superior to the alternative of a stand-alone HECM, taking account of any differences in tax treatment.
- Combos must be simplified by limiting annuities to those with fixed payments, including rising and deferred payment options. Variable annuities should be barred.
- The role of loan counselors should change from warning potential borrowers about the hazards of annuities to explaining how an annuity might enhance their retirement plan.
HUD is not known for the rapidity with which it gets things done. In the hope of seeing action in my lifetime, I plan to form a task force of industry leaders with the mission to prod HUD.