Real Estate as a Pension Device: The Case of Reverse Mortgage Insurance

Specialeforsvar: Louise Beck Dinesen

Titel: Real Estate as a Pension Device
The Case of Reverse Mortgage Insurance

Abstract: Lower interest rates applies pressure on the Danish public pension schemes. To ease the burden the wealth accumulated in the retiree’s real estate could constitute a funding source for added pension. In this thesis, we study real estate as a pension device using the French viager system and reverse mortgages as a means of home equity conversion. In the viager system a piece of real estate is sold where the payment is a life annuity. This is a risky contract as the counterparty often is a private person. To lower the counterparty risk we consider reverse mortgages. Here an annuity payment is paid to a home owner by a bank and a debt is accumulated. This debt can only be paid via the value of the house and the loss the bank consequently might face, if the debt exceeds the value of the house, is insured. This contract is less risky for the home owner and yet satisfies as a home equity conversion pension device. Our main contributions are as follows. We formulate the contractual payments of reverse mortgage insurance and provide a general valuation framework with three main risks: interest, housing price and mortality. Using specific yet flexible models, we derive a market-consistent price for the contract and an associated computational scheme. Based hereon, and using in parts Danish data, we calculate fair benefits for a realistic contract with given premiums. Finally, the sensitivity of the benefits is analyzed by investigating the effect of lowering the interest and mortality rate, respectively testing the valuation framework.

Vejleder: Christian Furrer
Censor:   Jingye She