Discounting the Discounted Projection Approach.

Abstract

UK equity release actuaries are using a flawed approach to value the no-negative equity guarantees in their equity release mortgages. The approach they use, the Discounted Projection approach, incorrectly uses projected future house prices as the underlying prices in their put option pricing equations. The correct approach uses forward house prices. The Discounted Projection approach entails significant under-valuations of no negative equity guarantees and over-valuations of equity release mortgages and can produce valuations that violate rational pricing principles. The Discounted Projection approach is also inconsistent with both actuarial and accounting standards. Our results have significant ramifications for equity release industry practice and prudential regulation.