Strategic Report | Governance | Financial Statements | 93
SIGNIFICANT JUDGEMENTS APPROACH
ACTION BY THE COMMITTEE
Measurement model for Lifetime Mortgages
A key feature of Just’s Lifetime Mortgages (“LTMs”) is the No-Negative Equity Guarantee (NNEG). Determination of the appropriate measurement model to measure the fair value of these contracts requires significant judgement.
The Committee noted that in line with industry practice, the Group continues to apply a variant of the Black-Scholes option pricing formula with real-world assumptions to determine the fair value of the NNEG component of LTMs. The Group has selected to use real-world assumptions instead of risk-neutral assumptions due to the lack of relevant observable market inputs to support a risk-neutral valuation approach. Longevity assumptions are a key area of focus for the Board and the Committee. The expected impact on future mortality rates over the short and long term was considered. Mortality experience has been highly volatile and at times significantly higher in aggregate than expected since March 2020 because of the COVID-19 pandemic. There is some evidence that the outlook is stabilising; with insights emerging since mid-2021 strongly suggesting that the pandemic will have enduring, direct and indirect influences on future mortality experience. From 31 December 2023, the explicit allowance for the impact of the pandemic on future mortality experience was revised to reflect the change in the Group’s estimates in light of the emerging evidence of the future impacts of COVID-19 infections and continuing and likely long-lasting disruption to healthcare services. The Committee reviewed the key assumptions including detailed analysis from management. Whilst there is uncertainty over the extent of short-term property valuation changes, there is no clear indication of longer-term effects. It was determined that the assumptions for property price volatility and future house price growth should remain unchanged from the 2022 year end.
Longevity assumptions
Assumptions regarding the length of time that Retirement Income and LTM customers are expected to live are key assumptions when valuing the Group’s insurance liabilities and LTM assets.
Property assumptions used to value the Group’s Lifetime Mortgages
The values of the Group’s LTMs are reliant on a range of assumptions, of which the key ones are future house price growth and house price volatility. These assumptions determine the expected shortfall of the house value compared with the outstanding LTM balance on redemption that is covered by the NNEG which is given to all LTM customers. The matching adjustment is a mechanism prescribed in the Solvency II Directive that allows the Group to adjust the relevant risk-free interest rate term structure for the calculation of a best estimate of a portfolio of eligible insurance obligations. Under IFRS, the Group reduces gross yields by a credit default assumption to allow for both expected and unexpected credit default losses. Judgement was applied in determining the appropriate adjustment to the market value of the Group’s portfolio of residential ground rents in light of the uncertainty introduced by the Government consultation regarding residential ground rents.
Solvency II Matching adjustment / IFRS Credit default assumptions
The Committee concluded it was appropriate for the IFRS methodology to remain unchanged from the 2022 year end.
Valuation of residential ground rents
The Committee reviewed management’s assessment of the estimated impacts of the range of scenarios described in the Government’s consultation regarding residential ground rents, and the possibility of an outcome other than one of the five options considered. The Committee considered management’s approach to estimating the fair value of the Group’s investment in residential ground rents and reviewed the disclosure within the Annual Report in light of the significant uncertainty regarding the conclusion of the consultation. The Committee concluded that the adjustment to the fair value in light of the uncertainty was appropriate and was satisfied with the disclosures made.
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