MORAL HAZARD IN HOME EQUITY CONVERSION: Implications of this Analysis for Contract Design 2

2. Home equity insurance. Here, the contract could merely specify that the policy covers the decline in the real estate price index for the region and kind of home, and not at all the decline in price of the home itself. That was, in fact, our original proposal, Shiller and Weiss (1994). This indexing would completely eliminate the moral hazard problem.

3. Shared appreciation mortgages. With these mortgages, it is clear again that the amount owed for appreciation to the lender could be measured by a real estate price index. Obviously, the moral hazard problem is eliminated since the amount owed has nothing to do with the value of the home.

4. Housing partnerships and shared equity mortgages. The advice that is suggested by our analysis of moral hazard is that the limited partner should share in the index risk only, the risk of the selling price of the home entirely borne by the homeowner.

5. Sale of remainder interest. The situation here is much the same as with reverse mortgages. The contracts are again likely to be signed with elderly homeowners with little other assets. It is advisable to provide to the homeowners somewhat less than the entire value of the home, keeping some fraction of the value of the home in escrow for penalties if the value of the home does not keep up with the index.

All of the above changed contracts should make the home equity conversion investments more marketable to other investors and more securitizable. Investors in the securities need not trouble themselves with investigating how well the manager of the home equity conversion contracts is dealing with the myriads of moral hazard issues that we have described.