A few years ago Tim was looking at Retirement Homes with his mother. As a researcher who specialises in the analysis of complex financial products, Tim did not expect that the contracts on offer would tax his analytical capacity. There is a lot of variation in the entry fees, ongoing fees and so called “deferred management fees” across the retirement village industry. It is difficult and time consuming to get the details of how the contracts work and it is even more difficult to compare one with another. Comparison shopping is hard to do but Tim set out to make financial comparisons of retirement village contracts easier by computing a “comparison rent metric”, similar in concept to the comparison interest rate that banks must quote to consumers when they lend money for home mortgages.
Retirement village contracts are often 200 pages long and highly complex. The financial and legal skills required to review and compare these contracts block most retirees and even their advisors from adequately assessing the inherent financial and other risks. When Tim began reviewing potential retirement village agreements with his mother he quickly realised that what he was looking at was not a real estate purchase, but was in fact a complex insurance contract combined with a right to reside. The contracts have ingoing, ongoing and outgoing fees. The ingoing fee is a large lump sum, comparable with the cost of buying an apartment. On leaving the village, the resident gets back a portion of their entry fee less a so called “deferred management fee”. The amount and timing of the payment the resident gets on exit is uncertain and depends on the duration of their residence, their lifespan and their health. This transforms the contract into a combination of a death and disability insurance with the right to reside in, but not ownership of, the Retirement Village apartment.
A deferred management fee is an amount of money deducted from the amount to be refunded to the resident after their departure from the village. The amount of the deferred management fee is determined at the time of exit from the village but it comes out of the refund of the entry fee or from the sale proceeds obtained when the resident’s apartment is sold to a new resident. The deferred management fee is funded from the money paid by the resident at the time of entry or from the assets that money was used to purchase. The “deferred” nature of the fee is questionable as the resident pays the fee it at the time of entry to the village, not at the time of exit.
What Tim realised was that by committing to pay the entry fee and the ongoing fee, the consumer is paying upfront for the right to reside in the village until they either die, become unable to live independently and transfer to an aged care facility, or voluntarily depart the village. 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. What the consumer is buying, though they don’t realise it, is (i) the right to reside by paying their rent up front for the rest of their healthy lifespan, and (ii) a complex insurance / financial product from the Retirement Village despite the fact that the Retirement Village lacks the financial capacity to be offering insurance or financial policies to the public. By paying rent in advance for the rest of their healthy lifespan the consumer is in a weak bargaining position relative to the landlord compared with a normal landlord / tenant relationship.
If retirement village contracts are in fact insurance agreements then under Australian law they should be regulated in a different way. Tim has recently given evidence to the Victorian Parliamentary Inquiry into retirement housing on the matter and is working on developing two online financial calculators for comparing retirement village contracts, by computing a comparison rent metric. This is being funded by a grant from Financial Literacy Australia. One of these financial calculators is for financial planners and legal practitioners to use and the other is for prospective residents. A key element of Tim’s work is to provide tools for people to adequately compare their options in a way that they can understand given their level of financial literacy.