A life-cycle model approach to explore Reverse Mortgage in the Italian framework

The stochasticity of lifespan and state of health may severely affect elderly’s financial status. In industrialized countries, life expectancy is rapidly growing, causing the inadequacy of pension systems and the increase of out-of-pockets medical costs. The need to provide adequate solutions for retirees, whose wealth is mostly illiquid and composed by real estate, is one of the major concern among scientists and specialists. In this framework, home equity release products may constitute a valid support. In particular, the Reverse Mortgage (RM) contract allows elder homeowners to borrow money using their home as security for the loan maintaining the right to live in the house. The debt is repaid by the heirs when the borrower moves out or dies. The non-negative equity guarantee ensures that the exceed of the proceeds of the sale of the property is intended for heirs. This product has been widely analyzed to identify the reasons for its underdevelopment in the European market. The lender faces the house price risk and the longevity risk. Conversely, borrowers cope with trust issues, product complexity and, above all, emotional attachment to the property. In this work, we consider the perspective of the elderly and formulate a lifetime utility function to determine the optimal decision between entering into a reverse mortgage (RM) or not. Taking into account long-term care expenses and house mainteinance costs and exploiting the demographic technical bases made available by ANIA (Italian Association of Insurance Companies), we conclude that reverse mortgage provides an important aid to relieve elder’s pressure on consumptions. In particular, elders receive higher utility gains when contracting a reverse mortgage. Our results are in line with the existing literature and may provide an alternative tool to explain elderly skepticism in buying this kind of product.