The 2024 launch of the first collective defined contribution scheme in the UK is encouraging fresh thinking on tontines. Once a plotline for murder stories, tontines, or at least a modified version, may offer some solutions for the UK’s pensions crisis.
When the UK state pension was introduced in 1946, the UK retirement age for men was 65 and for women it was 60. Their average life expectancy was 66 and 71 respectively. Now, a 60-year-old woman in the UK has an average life expectancy of 87 and a man can expect to live to 85, which means around twenty years of being reliant on a pension. That costly longevity challenge for pension systems is the reason why many defined benefit pension schemes in the UK have closed and why the purchase of an annuity is no longer mandatory.
The onus is now on the individual to provide for their old age through defined contribution schemes. They put money into their own ‘pot’ within a DC scheme. However, nearly 40% of working age people in the UK, according to the government’s analysis of future pension incomes, are not saving enough for retirement.
What to do? People need and want pensions that offer them sufficient income for however long their retirement lasts. But when each has to fill an individual pot, it many not be possible for them save enough for the full length of their retirement.
That’s not a new problem, of course. Back in the 1700s an Italian financier called Lorenzo de Tonti suggested a solution that is named after him: the tontine. It is a common savings pool that pays out dividends to members until they die. There is no guaranteed return, and membership is irrevocable, but the longer you live the more likely you are to see increased dividends. That’s because, as members die, there are fewer people to share the dividends. The last remaining member gets the whole income stream. Businesses such as the Tontine Hotel in Ironbridge in the UK were funded in that way. However, given that members had an interest in seeing other members die, tontines developed an unsavoury reputation and became a favourite plot line in crime fiction, such as Agatha Christie’s “4.50 to Paddington”.
Tontines are currently illegal in the UK. However, they are used in many other countries. France allows them, for example, and the Swedish pension scheme has a tontine approach called “inheritance gains”, when people in a cohort die. The Swedish system is complex partly because is designed to remove one of the glaring problems with tontines: they can be unfair. For example, a small child would likely gain much more from investment in a tontine than someone in their seventies would. The Swedish scheme sorts savers into cohorts, among other measures.
Collective defined contribution – tontines by another name?
Given the enormous and increasing pressures on the pension system in the UK, there are calls to bring back tontines in the UK. Arguably, the UK is already a good part of the way there with collective defined contribution schemes. CDCs, in which “those who die younger effectively subsidise the pensions of those who live longer”, were permitted by the Pension Schemes Act 2021. As things stand, only one has been authorised: the Royal Mail CDC scheme, which is due to launch in 2024. More, however, are expected.
In a CDC, savers are less exposed to longevity risk than they would be with an individual pension pot: ie getting older doesn’t necessarily increase the risk of getting poorer. The Pan-European Personal Pension Product (PEPP), which is grappling with the same problems as the UK system – that is a growing number of people living into old age and a shrinking number of young people to support them – allows tontines.
Should people be concerned about being bumped off by other members of a tontine? Much of the concern may have more to do with queasiness about the prospect of benefitting from the deaths of others, rather than any actual examples of skullduggery. The bad actors in tontines, especially in the US, were the insurers who engaged in sharp practice.
There has been some objection in the US to the use of life settlements – that is when a life insurance policy is sold to a third party for a lump sum. Buyers cash in when sellers die though they may, or may not, make money on the deal depending on how long sellers live. The policies are pooled and securitised, so buyers don’t know whose death they have an interest in. (The securitisation also spreads the risk.) Still, they have been called “death bonds”.
The reality, though, is that death comes for all of us. The only uncertainty (usually) is when. There is also no getting away from the fact that the UK faces a pensions crisis. Insurers cannot afford to shoulder the risk of most of living well into old age. Given both those facts, it may be that part of the answer is ‘mortality-pooled investments’, aka tontines. Q4_EP_Tontines_feature.pdf (europeanpensions.net)