Equity Release and Long Term Care

The Government's recent proposals on the funding of Long Term Care have increased awareness of the potential financing opportunities afforded by equity release schemes, Cecil Hinton analyses the effectiveness of the various schemes under these proposals, and calls for the products and the market to be regulated under the FSA.

Background

You will be aware from recent Press articles and, indeed, earlier issues of this publication that the subject of funding long term care (LTC) is very much in the forefront of public and professional attention. On 7th May Stephen Dorrell, Secretary of State for Health issued the Government's consultation paper entitled "A New Partnership for Care in Old Age" and these proposals included the use of equity release as a means of paying for long term care. The paper invited responses from interested parties by 14th June and, in fact, over 500 were received: the Government is now considering how to take the proposals forward. Mr Dorrell is expected to provide pointers on the Government's current thinking in a speech he is scheduled to make at the end of September.

As a financial adviser who has specialised for more than twenty years in equity release plans and within the last five years helped to form the Safe Home Income Plan (SHIP) Group for providers of safe schemes, you will readily appreciate my interest in the Government's proposals and my concern that any new developments would be both secure and marketable. In as much as the Government philosophy continues to encourage a self-help mentality I have tried to assess how the suggestions outlined in their consultation paper meet the stated objectives and what additional proposals should be considered. The principles of safe equity release schemes have been described quite fully in earlier issues of ECA (Volume 1, Issues 1, 2 and 3) so I will not go into detail but broadly speaking there are two types of safe plans: (1) mortgage/annuity schemes (usually known as Home Income Plans) and (2) Reversion schemes.

With a Home Income Plan a fixed interest mortgage is taken out and the proceeds are used to buy an annuity which provides a guaranteed income for life. Part of the income is used to pay the mortgage interest and the balance is paid on a monthly basis to the planholder for life. The maximum loan is normally £30,000 and only changes in income tax can affect the benefits.

The normal minimum age is 69 for single or widowed people: in the case of a couple their combined ages must total at least 145, with the younger 70 or more. Below these ages the benefits are not really worthwhile.

With a Home Reversion Scheme part or all of the property is sold in return for an income for life or a discounted lump sum and the lifetime right to live in the property.

Slightly younger minimum ages can sometimes apply to reversion schemes but worthwhile benefits are not usually available below age 67. For higher priced properties (over £70,000) the benefits obtained under Reversion Schemes are often appreciably higher than the Home Income Plan, because there is no £30,000 scheme limit.

Existing Planholders

The prime purpose of equity release schemes is to enable elderly homeowners to continue to live in their homes whilst at the same time providing them with extra income or cash. Clearly if someone is at the point of having to go into residential care or a nursing home on a permanent basis these plans are not appropriate; the home would be sold and the proceeds can then be used to pay for LTC, whether via an LTC policy or directly in cash. Therefore, equity release schemes can only be of use where the elderly person wants to stay in his or her home.

Funding Long Term Care Policies

So let us consider how these plans could finance long term care and how attractive or otherwise these schemes would appear to elderly persons. The figures I have used are based on equity release rates provided by Carlyle Life Assurance and LTC rates by PPP Lifetime Care. If a single product were introduced combining these two concepts, it is likely that the resulting benefits/costs will be more favourable to the consumer.

The main aim of the Partnership Scheme outlined in the Consultative Paper is to enable someone to protect his or her assets by taking out Long Term Care Insurance. Two options are suggested:-

1) For each £1 of insurance benefit paid out an extra £1.50 of capital would be disregarded in LTC means testing.

2) For each £1 of insurance benefits paid out, the amount disregarded would be an extra £1 of capital plus an extra £15,000 of capital once the individual had funded his own residential care (with the help of insurance) for four years.

I do believe the second plan is too complicated and in this article I shall only be evaluating the first one.

Firstly, I am going to consider a scheme which would provide money to pay annual LTC premiums; I shall be looking at both mortgages/annuity and reversion schemes.

I am taking as an example, a lady of 75 living in a range of property values - £50,000, £100,000 and £125,000. I have assumed she has no substantial assets other than her house and wishes to protect the balance of her property after taking out a suitable equity release plan. I am allowing for the standard £10,000 capital exemption and ignoring the transitional arrangements up to £16,000. Let us look at the position if this lady was living in a property worth £50,000 and took out a mortgage/annuity plan.

A typical plan with a £13,000 mortgage for a lady of 75 would provide net income, after tax, of about £530p.a. Assuming the property value was £50,000 this would mean the lady's estate, after deduction of the £13,000 loan, would be £37,000. Deduct the basic capital disregard £10,000. The amount of protection required is £27,000. Based on £1.50 protection for a £1 LTC benefit a policy would be required which would pay out up to £18,000; such a policy would cost about £530p.a.

This means this lady has provided additional protection of £27,000 over the standard £10,000 protection (i.e. a total cost of £37,000), if she should have to go into residential care, and the cost to her estate would be £13,000; she also has a LTC policy which would pay out up to £18,000 if needed.

Table 1 summarises the results for the other property values mentioned:-

I have done the same exercise for both Reversion schemes and the results for this lady of 75 are broadly similar to the mortgage pattern already set out. Whilst the capital cost with reversion schemes is generally slightly lower compared with the mortgage scheme, it is not significantly less.

The question is how attractive would these figures be to a lady of 75. If she had a property worth £50,000, would she be willing to take out a mortgage of £13,000 to protect her estate for the extra £27,000, in case she had to go into residential care, plus a long term care policy of £18,000? Of course, it depends very much on her personal circumstances - if she had no family she wished to protect, then I cannot see that she would be interested. If she did have family to whom she was very anxious to leave around £37,000, then she might consider it; however, it does look an expensive exercise to provide for something which might never arise, since long term care is only required by one person in five or six. Her state of health and family health record could influence her thinking; equally her family could have ideas one way or the other.

If the property was worth more - say £100,000 - would she, for example, be willing to take out a mortgage for £29,500 to obtain £60,500 additional protection plus a long term care policy £40,000? Again it looks very expensive but it does depend on the individual's personal circumstances.

In my opinion it would be difficult to sell plans on this basis.

A Plan To Provide Income As Well As Protection

Another possibility is to take out a higher loan, or sell a greater proportion of the property under a reversion plan, to provide extra income as well as protection of the house.

A particular point to note here is that if you take out any equity release plan the amount of LTC cover needed to protect the asset is reduced by the amount of equity you have used up. For example, if someone takes out a plan using say half the house and this provides LTC cover and also extra income, the amount of LTC cover needed to safeguard the remaining half is that much smaller (namely half). This means the LTC premium is less and there is more income available for the pensioner.

Mortgage Scheme (Home Income Plan)

If we take again the case of a lady aged 75 owning a house worth £50,000, we can see the effect. If she takes out a normal £30,000 MIRAS loan with a mortgage annuity scheme, this would provide her with net income after tax and interest of £1,240p.a. This means her net equity in the property is £20,000. Deducting the basic capital disregard of £10,000 means the amount required to be protected is only £10,000 (20,000-10,000). An LTC policy of £6,700 only is required and this would cost £198, thus leaving a net income of £1,042 pa.(1,240-198).

Therefore, what this lady has done is to provide herself with extra income of £1,042 p.a. and is assured that at least £20,000 of her property remains for her family (subject to house prices); £10,000 of this is the standard protection and her LTC policy for £6,700 provides the extra £10,000 protection.