Thank you so much, and I appreciate your being environmentally friendly and letting me testify without flying.
In my seven minutes, in terms of seniors' well-being I want to talk about problems and prospects in the reverse mortgage industry, with a little bit of special reference to Canada.
Housing is a very important part of most seniors' retirement portfolios, particularly at the lower end of the income distribution. Of course, should you arrive at retirement without a home, as a renter, that's the lowest end of the income distribution, but for lower-middle-class households, the ones for whom I'm assuming you have the most concern, a house is typically a dominant part of the portfolio.
Reverse mortgages are a tiny industry. Of course, a reverse mortgage lets a senior borrow against their home. If most of your wealth is in a home and you're struggling to pay bills, using some of that home equity seems like a fantastic idea. In markets like Victoria, Toronto, and of course Vancouver, there are countless seniors with enormous home equity holdings but maybe rather meagre retirement wealth and income, so finding a way to use home equity to finance seniors' retirement is something I think you should put considerable thought into.
Home equity represents one leg of the holy trinity of retirement finance puzzles. Life annuities and long-term care insurance are the other two.
Life annuities let you hedge an enormous financial risk, which is, how long am I going to survive in retirement? There are some problems with life annuities, the biggest of which is that they're illiquid. If I'm somebody with a home and very little cash, putting that remaining cash into a life annuity that requires that I sip but never gulp runs into problems if, for example, I have large long-term care needs.
That takes us to the second leg of retirement puzzles, which is long-term care insurance. Canada is a bit different from the U.S., but state-funded retirement or long-term care facilities may not be very pleasant places. If you want to have a comfortable long-term care stay, that of course can be extraordinarily expensive, but because of the existence of the public sector in long-term care, private insurance is very difficult to make work. It's particularly difficult to make long-term care insurance work without a reverse mortgage, because home equity really is a dominant form of long-term care insurance, at least in the United States. Should you need to privately pay for long-term care, it's typically in a state of the world where you will have disposed of your home, so the home is an important buffer stock. Should long-term care expenditures be an important risk in any province, home equity becomes unattractive to spend because it's serving as a buffer.
On the other hand, without long-term care insurance, life annuities are going to be unattractive, and people won't hedge longevity because of the need to go for catastrophic expenditures. What you see is that as long as there's any unhandled uncertainty in retirement, should it be home equity that's illiquid, longevity, or catastrophic expenditure risk, the other products don't work very well.
Let me talk about reverse mortgages. Again, they should be huge in Canada, but it is a trivially small market. There's CHIP, the Canadian Home Income Plan, and I think they do a decent job, but it's a very small product. It carries a high interest rate because of some funding problems. Essentially, if you don't have government insurance, it's very difficult to securitize reverse mortgage loans, and that makes them expensive and difficult to fund for the long period they really need to be funded.
There's another reverse mortgage product in Canada, for which there is almost incredibly low demand, and that is property tax deferral in British Columbia. British Columbia has, I believe, maybe the most generous property tax deferral for people over 55. They can defer, and defer not at a spread over the federal cost of borrowing, but at a very low rate. I believe it's 1% per year. My understanding is that take-up is moderate. You hear people complain, “Well, prices are rising and so my property assessment has gone up, and I'm a grandma on a fixed income”, but that's not a serious concern if you take the property tax deferral. Property tax deferral in British Columbia might be seen as the world's most generous reverse mortgage program.
The fact that there's not a 100% take-up is surprising. I don't know the income distribution of the people who use it, and it's something I want to look into, but I think it's worthy of serious consideration because the home equity of seniors is such an important part of their wealth.
Let me talk a little bit about why reverse mortgages are so hard to make work in the private sector. You've got moral hazard—that is, borrowers may behave in a way not advantageous to lenders—and adverse selection, which are very serious problems.
Jeanne Calment, the women who lived to be 123 in France, was a reverse mortgage borrower. The French call it viager. It was the worse case of adverse selection imaginable, you might think, because the guy who contracted with her paid and paid and paid and finally got the house for his grandson long after he was dead and I believe his son was dead. You worry that you're going to lend money to seniors who are not going to make any payments until they move or die, and if they don't move or die for a long time, and the property value declines, it's a big problem.
In the U.S. we saw a horrible geographic adverse selection. Reverse mortgages were predominant in the SAM states, the shared appreciation mortgage states, that saw the biggest housing crashes. They were predominant when prices rose.
Very quickly, reverse mortgages imbed a lot of default option value. Borrowers, unfortunately, are able to under-maintain the home and not move when they should move, and they tend to take the loans at the wrong time in the cycle. They don't understand the default option value. There's a lot of evidence that reverse mortgage borrowers do not understand just how valuable the rights imbedded in a reverse mortgage to default are.
Therefore, in Canada, if you want to expand home equity borrowing among seniors, I strongly recommend you do so in the form of a life annuity, whereby the seniors receive enough income from the property that they get a life annuity with cash, plus enough interest to keep the balance on the reverse mortgage loan constant rather than growing. That would solve a lot of problems. Should the industry expand, it would prevent seniors from consuming more wealth then they have.
I would be delighted to talk more about that because I do think seniors housing is a promising form of retirement finance.