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Analysis

Saving pensioners from penury

King William showed the way

by Brian Reading

Fri 28 Oct 2016

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The British Queen sends personal birthday greetings to Britons who reach 100 years of age. In the past 30 years this workload has increased fourfold. Life expectancy almost everywhere has increased. Retirement pension age has not kept pace. More people will live longer after their earning years are over. They depend on pensions. Many will grow old in penury. Increased longevity and negligible, even negative, bond interest rates undermine both state and private pension provision. Both are diminishing as the dependency rate rises. Is there a solution? One answer is to remember King William, who came to the British throne with his wife Queen Mary following the 1688 ‘Glorious Revolution’.

He was Dutch – William of Orange – fighting a war with France. Parliament made him king. Until then all state spending was from the sovereign’s personal pocket, financed by property, taxes granted by Parliament, or loans. William would have none of this. Parliament must pay the bills and borrow the money, especially for his war. This was the origin of the National Debt. Financing it showed ingenuity.

A Neapolitan banker, Lorenzo de Tonti, is credited with initiating a new financial instrument in 1653, known as a ‘tontine’. Subscribers buy shares in property. The income is shared. When one dies, the income is divided among the survivors. The last one gets the lot, the entire income and capital. Parliament used tontines to finance William’s war. But, like an annuity, the government kept the capital.

Annuities are no better than gambling in Las Vegas. The odds are stacked against you. Nobody knows when they will die. Buy an annuity today and you lose it all if you die tomorrow. Live to be 100 and you win. The profits from annuity sales are based on probability. Insurance companies statistically guess this for large numbers of buyers and bias the odds in their favour. Inflation erodes the value of annuity pensions which are never index-linked. The buyers are either cheated by early death or live in penury as their pension’s value is eroded.

Tontines are mostly illegal. But a properly regulated tontine annuity product would have immense appeal. It would guarantee survivors live in affluence with their increasing income share and sellers would collect management fees and the remaining capital.

The details of this product are too many to fully adumbrate here. Each tontine would be limited in numbers and by age, say 10,000 aged 65. The contributions would be set and the money invested in long-term bonds of appropriate maturity. The initial income to the individual investor would be less than for a traditional annuity. The purchaser would enter a lottery, but one ensuring income increased with age. The promoters would collect management fees and the capital when the last survivor died. In some cases that could take a long time. Following the American civil war veterans got pensions which passed on to widows. Some octogenarians married teenagers. The last pension payment was over a century later. King William’s tontines had a similar problem. Shares could be bought in the name of new-born offspring. By defining age and non-transferability this problem is avoided.

The other merit to this scheme is that tontines could be bundled and securitised as a new asset class. Unlike sub-prime mortgages they could rightly be triple-A securities. This would be an attractive solution for both buyers and insurance companies in the present low interest rate environment (and in the UK with the abolished obligation to buy annuities from pension pots). If it cannot legally be done onshore, watch out for offshore internet action.

Brian Reading was an Economic Adviser to Prime Minister Edward Heath and is a Member of the OMFIF Advisory Board.

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