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Retirement village contracts are not real estate arrangements, but de facto insurance policies

Posted on Jul 5, 2017

Retirement village contracts are not real estate arrangements, but de facto insurance policies

Some years ago, I looked at various retirement villages with my mother. As a researcher who specialises in complex financial products, I didn’t expect that the contracts on offer would tax my ability to analyse. They did.

What I found was great variation in the entry fees, ongoing fees and so-called “deferred management fees” across the retirement village industry. The entry fee is substantial, usually comparable with the cost of buying an apartment.

It is difficult and time-consuming to get the details of how the contracts work and even more difficult to compare one with the other. In fact, some operators in NSW demand a $1,000 deposit for the privilege of looking at a contract. They will give you the money back if you decide not to proceed, but it really inhibits comparison shopping.

I also realised that what I was looking at was not a normal real estate purchase or lease, but a complex insurance contract combined with a right to reside during the residents’ healthy lifespan.

Tenancy for these retirement village contracts terminates usually on death or ill health, and then (or some time later) the resident receives a partial refund of their entry fee. The amount and/or timing of this payment is contingent on death or disability. This means these contracts are bundling together a right to reside with a de facto insurance policy.

The resident is entitled on exit to a refund of the entry fee they paid, plus possibly some share of the capital gain or loss, less the “deferred” management fee. The payment can be delayed for months or even years in some cases. (One contract I read gives the retirement village operator up to three years to pay this partial refund.)

The term “deferred fee”, however, is misleading and is not really deferred as it comes out of the entry fee paid in at the start, or from the assets purchased with that entry fee. The operator had the use of the money from when the entry fee is paid.

Retirement villages are mostly small private companies or not-for-profit organisations.

They aren’t required to publish their annual financial statements, hold reserves, or have reinsurance arrangements like an insurance company. Their assets are probably illiquid, undiversified and not divisible.

This means there is substantial risk for consumers in buying these de facto insurance products, and it is very difficult to assess the financial soundness of these retirement village operators.

The consumers are senior citizens, many on low incomes, unable to easily recover from financial mistakes, and mostly female. Such people would be ill advised to invest their money in junk bonds issued by firms with a high risk of default. Buying the retirement village’s embedded de facto insurance policy is tantamount to buying “junk insurance” from organisations that lack the financial capacity to be permitted to operate in the insurance industry.

These retirement village contracts are complex and confusing for both consumers and their advisors. Some contracts are over 100 pages long.  Indeed, the financial and legal skills needed to review and compare these contracts block most retirees and even their advisors from adequately assessing the inherent financial and other risks.

For consumers, such a contract involves paying rent in advance for the rest of their healthy lifetime and buying a de facto insurance policy.

After signing the contract, the resident is in a weaker bargaining position to the retirement village operator compared with a normal landlord/tenant relationship. In negotiations over maintenance and other matters the resident is disadvantaged.

At the end of the tenancy the resident may be forced to spend a lot of money on installation of a new bathroom and kitchen before they can get the exit payment.

All up these contracts are cunningly disguised insurance arrangements. Many consumers think it is like a purchase arrangement where you own the apartment.  It isn’t, and you don’t own it. Residents only have the right to live there until they become too sick or voluntarily relocate, or die.

If retirement village contracts are in fact insurance agreements then they should be regulated differently – by APRA (Australian Prudential Regulatory Authority) and not by State governments, as is now the case.

Dr Timothy Kyng PhD FIAA is a lecturer of Actuarial Studies at Macquarie University’s Department of Applied Finance and Actuarial Studies. He gave evidence to the Victorian Parliamentary Inquiry into retirement housing and has produced the Macquarie University Retirement Village Calculator as a comparison tool.