Why are so many companies closing their final salary pension schemes? High on the list of reasons is the longevity risk: a final salary scheme commits the company to continue paying a pension no matter how long the pensioner lives. When these schemes were widely adopted in the 1950s and 1960s, few pensioners lived past their early eighties, so this commitment was not a threat to the solvency of schemes, let alone to the companies themselves. But the spectacular improvement in our longevity is changing all that. The number of people aged at least 90 living in England and Wales has increased from 40,000 in 1951 to 369,000 in 2004, and is forecast to exceed 1m by the early 2030s. Companies feel that they can no longer afford to carry this risk, and are adopting "defined contribution" schemes instead, in which the retiring employee receives a lump sum based on the past contributions made by the company and employee. Thereafter it is the retired employee who has to manage the fund and carry the longevity risk.
The chance of an active, satisfying life at 90 is appealing. But fear of outliving one's financial resources and having to rely on a minimal state safety net, or on children and grandchildren, worries many people.
The tontine provides a neat solution to the problem. As any fan of Robert Louis Stevenson's novel The Wrong Box knows, the tontine is a club to which each member contributes a sum of money. The total sum is then given to the last surviving member when he or she has outlived all the others.
Let us imagine a tontine for today's circumstances to help with the funding of care in extreme old age. In such a scheme, say, 100 men (or women) all aged 65, form a tontine and each contributes a single lump sum. The total of the contributions is invested, until such time as only 25 per cent of the cohort still survives. The tontine is then distributed to the dwindling number of survivors over the subsequent ten year period.
Let us now put numbers to this. The most recent UK mortality tables tell us that of 100 men joining a tontine at age 65, all but 25 will have died by age 87. This 25 per cent survival threshold triggers the distribution. If each 65 year old makes a single payment of £5,000 on joining, and the total is invested for the 22 years from age 65 to age 87 with a real return of 3 per cent a year after management fees, there will be enough money to provide ten instalments of £111,000 each year when the tontine is opened. The first year payout to each of the 25 survivors will therefore be about £4,500. Fewer than three of the 100 will survive to the tenth payout year at age 96, so in the tontine's final payout year each survivor receives £38,000.
Membership of a tontine to pay for care in old age is likely to be quite reassuring for many people. There is, however, a snag: the legal status of tontines in Britain is unclear. A partner in a top city law firm points to the 1982 Insurance Companies Act and advises that tontines are illegal in Britain (although not in all EU countries). A spokesman for the Financial Services Authority, on the other hand, argues that tontines are not actually illegal, but do fall foul of the Life Assurance Act 1774.
The authors of the 1774 act were worried about fraud and murder. The long period between the time a tontine was set up and the time the money was disbursed gave a splendid opportunity for dishonest administrators to siphon off excessive annual fees.
The second mischief is the Kind Hearts & Coronets peril. In the marvellous Ealing comedy film, Dennis Price murders the eight senior members of his family (each played by Alec Guinness) so that he can inherit the title. By the late 19th century, it was widely believed that the survivors of small-membership tontines were more likely to have been ruthless than lucky. A hundred years ago these mischiefs posed a serious risk; today they can be eliminated without too much difficulty. Internet encryption techniques make it possible to keep confidential the identity of all surviving members of a tontine, while at the same time permitting them to monitor the tontine's administration and progress. But the best protection against the murder risk is scale: if a tontine starts with 1,000 members rather than ten, even the most ruthless would be deterred.
The details on tax, misselling and administration would have to be sorted out, but that should not be too hard. Meanwhile as increasing numbers of baby-boomers find themselves responsible for nonagenarian parents, the pressure on the state to "do something" will grow. One small step the government should take now is to overhaul the law on tontines, and permit them to be marketed in an orderly way.
