Reverse mortgages – risks, pricing, and market development

As life expectancy and the dependency ratio continue to rise, and because many retirees are "asset-rich-cash-poor", reverse mortgages would serve as a viable means to unlock the equity in home properties and provide supplementary retirement funding. This market in Australia, however, is still far from reaching its full potential, and these products are relatively new in the Asia-Pacific. In this paper, we provide an overview of different features of reverse mortgage products and the underlying risks of issuing such products, including longevity risk, house price risk, and interest rate risk. In particular, we discuss the demand and supply constraints and recent market development. Moreover, we introduce a theoretically sound and also practically feasible approach, called maximum entropy, for risk-neutral pricing of a reverse mortgage, under the current regulatory environment, which emphasises market-consistent valuation.