LTC Bullet: Retirement Security, Reverse Mortgages, and LTC

Wednesday, March 24, 2010


LTC Comment: Some fascinating insights on the connection between home equity, retirement security, and long-term care, after the ***news.*** [omitted]


LTC Comment: What's the connection between the three subjects in today's LTC Bullet title? In a phrase: home equity.

I keep hearing that, since the real estate crash, home equity isn't so important for retirement security after all.

Au contraire according to a new "fact sheet" from the "Center for Retirement Research at Boston College."

Special thanks to Atare Agbamu, author of the 2008 book Think Reverse, which we reviewed here, for bringing "The NRRI and the House" to our attention.

Excerpts follow but read the whole two-page report here. Then stay tuned for our analysis below.


Excerpts from "The NRRI and the House," NRRI Fact Sheet #1, March 2010

"The National Retirement Risk Index (NRRI) measures the share of American households 'at risk' of being unable to maintain their pre-retirement standard of living in retirement. The Index is calculated by comparing households' projected replacement rates - retirement income as a percent of pre-retirement income - with target rates that would allow them to maintain their living standard. To make the estimates as conservative as possible, the calculation assumes that households derive the maximum possible income from the assets they hold at retirement. A crucial component of that exercise is the highly unrealistic assumption that they access their home equity through a reverse mortgage and invest the proceeds in an inflation-indexed annuity - very few households actually take reverse mortgages or buy annuities. This fact sheet looks at how not taking full advantage of housing equity affects the share of U.S. households 'at risk.'

"Given the bursting of the housing bubble, it is tempting to forget how important housing is to the portfolios of older Americans. Indeed, housing prices did collapse. According to calculations based on Federal Reserve data, average house prices, indexed to 100 in 2000, rose to 180 between 2000 and 2006 and subsequently fell back to 120 by the beginning of 2009 (see Figure 1) [omitted].

"However, even after the decline, housing equity remains a crucial component of the assets of most households." (p. 1)

"The treatment of housing in the NRRI is as follows. In retirement, homeowners are assumed to take out a reverse mortgage, which gives them access to a portion of the eventual proceeds from selling their home while they continue to live in the home. Since interest payments are added to the loan principal over the life of the loan to be repaid at sale, the amount that can be borrowed varies inversely with the interest rate. At current rates, the formula yields an amount equal to roughly 50 percent of the value of the house for a 65-year-old borrower. The second assumption is that the proceeds of the reverse mortgage are invested in an inflation-indexed immediate annuity, a strategy that at current interest and annuity rates will generally yield a higher lifetime income than the alternative of taking the reverse mortgage lifetime income withdrawal option. Here, interest rates have the opposite effect. The lower the rate, the less the household receives in income.

"To calculate the impact of not tapping home equity, the NRRI was re-estimated assuming that households left their housing equity as a bequest. . . . Not tapping home equity through a reverse mortgage increases the percent of those 'at risk' by about 10 percentage points, raising the NRRI in 2009 from 51 percent to 61 percent (see Figure 3) [omitted]. This change is striking: its impact on the percent of households 'at risk' is greater than that of the stock market crash." (p. 2)

"The issue of home equity has implications for both households and the financial services industry. Households should be cautious about tapping their equity before retirement so that it is preserved for retirement needs. Financial services firms need to acknowledge that existing reverse mortgages are often complicated and expensive and that the industry needs to develop innovative approaches to ensure that retirees have easy and efficient access to their equity."


LTC Comment: Well now, isn't that interesting? Who would have thought that "[n]ot tapping home equity through a reverse mortgage increases the percent of those 'at risk' by about 10 percentage points" a greater impact than the "stock market crash."

Obviously, home equity is vital for retirement security in general, but what's the connection to long-term care?

Medicaid is (and has been for decades) the dominant payor of long-term care, not just for the poor, but for most of the middle class, and many of the affluent.

But Medicaid itself is bankrupt and it depends very heavily on two other bankrupt federal entitlement programs (Social Security for recipients' cost sharing and Medicare for its generous provider reimbursements.)

When Medicaid hits the fiscal wall, as it will soon, one of the first things to go will be its $500,000 to $750,000 home equity exemption.

When that happens, people will have to tap their home equity to pay for long-term care. The easiest way to do that is with a reverse mortgage. See the National Council on the Aging's (NCOA's) excellent report titled "Use Your Home to Stay at Home" for details.

But if as the NRRI report suggests, many people are going to need to tap their home equity through reverse mortgages just to sustain their retirement income security, what's going to happen to them if they also need expensive long-term care someday?

Only two choices will remain: (1) plan early to save, invest or insure for long-term care, the simplest solution being a traditional LTC insurance policy or one of the new combo (annuity, life insurance, LTCI) products.

Or (2) go bare and end up on a bankrupt welfare program newly bereft of its former eligibility loopholes and legal gimmicks that used to allow people to preserve their wealth while getting taxpayers to fund their care.

We're on the verge of a "brave new world" of retirement planning. People are well advised to follow Atare Agbamu's advice and "build reverse capacity." In other words, think of home equity as a new leg in your retirement security stool. It's going to have to replace the rotten government pegs everyone formerly relied on.

Agbamu made another interesting point in his email transmitting the article to me. He observed: "Note that the eminent academic authorities who put the fact sheet together are unaware that the HECM [Home Equity Conversion Mortgage, the most common kind] line of credit is essentially a non-portable inflation-indexed annuity. Even academe is not fully reverse-savvy yet. We’ve got work to do."

Indeed we do!