Opening the door

According to A recent report by the actuarial profession, the majority of people in the UK ' some 70% ' save up over their working life to buy a house and pay off the mortgage. Over the years, these owner-occupiers have built up considerable amounts of capital appreciation as house prices have steadily increased. However, although they are asset rich, they are often cash poor, as their wealth is tied up in property.

Equity release mechanisms (ERMs) are financial schemes, normally mortgage or reversion-based, which enable householders to draw down some of the equity in their property. The amount borrowed is then repaid either when the homeowner dies or moves out of the house. Repayment can be deferred until death or exit of the planholder or a surviving spouse. In some schemes, interest is paid each year, but in others, interest or equivalent capital appreciation is rolled up and paid when the capital is repaid. With most ERMs, the scheme can be transferred to another house if the owner moves.

A closer perspective

Whatever the reasons, the perception of ERMs varies widely from person to person and financial advisers need to establish their clients' views on inheritance and other issues at an early stage of any discussion.

Given this history, what is the potential of the market? Who is the target audience and what are their needs? But most importantly, how can advisers meet these needs and benefit from their business?

In 1991, the Council of Mortgage Lenders (CML) estimated total equity value owned by people over 65 in the UK was £298bn. By 1997, that figure had risen to £367bn and in 2000, the total was estimated to be over £400bn. This means a lot of money is tied up in bricks and mortar across the country.

As far as equity goes, , the interesting fact to note (see table 1) is that the median property value is roughly constant over all age bands. However, there is considerable variation according to income status. For property owners in the highest quartile of income, the median was £108,100, compared with £56,600 in the second poorest quartile. Median prices also varied according to region ' £54,800 in Scotland, £58,500 in the north of England and up to £114,400 around London.

Although the ERMs market has huge potential, the actual market is still relatively small, at around £500m in total up to the end of 1999.

The proportion of homeowners, with or without a mortgage, is shown in table 2. This shows that people over 65 have a slightly lower percentage of home ownership than people aged between 45 and 64. However, home ownership by retired people will, given these figures, inevitably grow over the next few years.

This gives some credence to evidence that ERM contracts are attracting younger people, such as those who are recently retired or approaching retirement. This new type of customer is not only younger, but owns a higher value property on which substantial capital appreciation has been made, and who now wish to realise part of that gain.

Although they are likely to be high income earners now, they may wish to avoid interest and repayment of capital over future years. This new generation of potential ERM purchasers may have a different attitude to traditional buyers. They are likely to be more familiar with personal pensions and with investment products such as Isas and other Government sponsored savings.

There is still reluctance in the population generally to use ERMs even though the market may expand. This reluctance appears to stem from two reasons. The first is peoples' attitudes to inheritance. Most still wish to leave an inheritance to their children, particularly those in the lower income groups who feel most strongly about this issue, while middle and high income groups are more willing to consider using the house to provide income at the expense of inheritance.

It might be a generational issue, with future generations more likely to use their assets to provide income and allow them to enjoy their retirement. They may wish to leave their homes to their children, but are less likely to suffer to do so in future.

The second reason appears to be a reluctance to using the house to pay for services which have traditionally been provided by the state, for example, long term care (LTC) This view reinforces the practice of when ERMs are used. Currently, this is when there is a sudden shortfall of income, for example, the pension stops or the fixed income has been seriously outstripped by inflation or a new need has arisen, such as the cost of LTC or private medical treatment.

In future, the trend may be one of choice in retirement, rather than necessity. To add weight to this trend and to counter the perception that it is either leaving an inheritance, or enjoying income in retirement, advisers may like to consider the implications of inheritance tax (IHT).

Many people have IHT problems, but are unable to do much about them because the majority of their assets are tied up in their property ' the classic 'asset rich, liquid asset low' scenario.

ERMs allow the release of capital which can then be used in the following ways to pay for, or mitigate, IHT liability:

• Use some of the income generated from investment of the released capital to pay for a life cover product written under trust.

• Use some or all, of the capital to invest in a lump sum IHT mitigation plan. These plans potentially reduce the IHT liability and give the investor either a limited access to the capital or a regular payment.

• Use the capital to enable wills to be updated so that a married couple can utilise some, or all, of the nil rate band on first death.

The reduction in IHT ' because of the debt on the estate of the outstanding loan and any combination of IHT mitigation or payment scheme ' could potentially leave more of the estate available for future generations. However, this will depend on when the individuals die, the return on any lump sum investment and the sums withdrawn and spent.

Awareness of equity release schemes is high ' nearly 70% of homeowners know about them and between 15% and 20% consider they may one day use an ERM. It is now up to the industry to build more confidence in this market, so older people have more choices in their retirement and the money now tied up in bricks and mortar can be released.

ERMs are a major financial transaction for most people and a CML survey showed that there is an overwhelming preference for simplicity. Providers and advisers alike can help meet that need, to the benefit of all.