Field Work

Arcane but Shrewd Retirement Solution?

Louis XIV

Hyacinthe Rigaud’s portrait of King Louis XIV, courtesy of the Getty Open Content Program

Tontines might be a nifty idea for retirement income. Too bad they haven’t been legal here for a century.

Tontine is a fancy word for betting on how long you’ll live – in a good way. Here’s the concept in a nutshell: many people pool their money in return for guaranteed regular payouts for life, similar to an annuity.

The people who live to, say 90, will receive ever-increasing financial payoffs, because the number of participants in the pool will invariably shrink over time.  The catch is that the investors who die young won’t receive as much income as the men and women who live the longest – but they won’t need the money either.

A new study by the Center for Retirement Research (CRR) takes a close look at an idea that is tossed around among finance experts: modifying tontines to use them as a source of retirement income.

Some criticize them as a dubious investment, but they’ve stood the test of time. King Louis XIV of France was the first monarch to raise public funds using tontines, a 1650s creation of Italian financier Lorenzo Tonti. More than a century later, they caused financial hardship among middle-class investors, laying some of the groundwork for the French Revolution.

Tontines made it into American popular culture in the M*A*S*H* television show. Because Col. Potter was the last man standing among his World War I Army buddies, he got the only remaining bottle of brandy from a cache they’d found and drank while camped out in a French chateau. Tontines popped up again in an episode of The Simpsons: grandpa Abe Simpson and Mr. Burns fight over some valuable German paintings in a tontine their Army unit had created back in World War II.

Credit for the idea of a retirement tontine goes to a paper by two professors at York University in Toronto, Moshe A. Milevsky and Thomas S. Salisbury. In his new report, CRR researcher Gal Wettstein agrees that tontines might be a useful way to get regular retirement income – with modifications.

Tontines’ big advantage is their guaranteed payouts to each investor. But a tontine costs less than annuities, because its investors – rather than an insurance company – bear the risk. A modified tontine for retirees would address their current downside: very old people get the largest payoffs, by default, as others in the pool die, but age and poor health can prevent some from fully enjoying the money. The modified retirement tontine could make equal, regular payments to all the participants over the years – rather than give the biggest payouts to those who live the longest – Wettstein said.

Milevsky and Salisbury have proposed ensuring the equal payments by basing them on the investor group’s overall survival probability. As investors die, Wettstein explains, the total number of fixed monthly payments would naturally decline, leaving enough funds in the pool to continue the equal payments. But the catch is that if everyone in the pool lives into their 90s – longer than average longevity predictions – lower payments would inevitably follow as the pool ran low.

Retirement tontines are still fanciful. But if they were legal, Wettstein wrote, they “would likely make the most sense as part of a larger portfolio.”

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7 Responses to Arcane but Shrewd Retirement Solution?

  1. Paul Brustowicz says:

    Tontines sound enough like Ponzi scheme to make me nervous. Unless, of course, I’m the last man standing at 93.

  2. Dave G says:

    Tontines were part of my early insurance education 40 years ago, courtesy of New York Life. I recall they existed in the U.S. in colonial times. Current forms of annuities already reward the healthiest, so I’d expect any new Tontine version to be even more skewed. But I see how “private” versions may be appealing, for example, within families or among friends.

    My dad was part of a group of hunters who jointly owned property with a tontine-like aspect. The value of “shares” was set every two years, so if anyone died or wanted to drop out, payment amount was pre-determined though skewed to below-market value. The last man standing ended up with it all…several hundred acres of prime central Virginia land. My dad outlived all but the last man! Oh well…nice while it lasted.

  3. Ken Pidcock says:

    “Lax regulation, coupled with the large accumulated funds at insurers’ discretion, ultimately led to extensive corruption…” Seems like something that could happen again. If insurer’s are relieved of longevity risk, what’s to keep them from reckless handling of the assets?

    • Dave G says:

      There is plenty to keep insurers from “reckless handling of the assets” if “something” arises. Legal reserve life insurance companies are subject to a whole host of regulations plus oversight by state insurance commissioners. The life insurance industry is one of the most heavily regulated in the country.

      If an insurer faces insolvency, a buyer is typically found to assume all liabilities and assets. If not, insurance commissioners can force assumption or risk onto other admitted carriers in their state. The last level of protection are the many state guarantee funds, which indemnify individual policyholders up to certain amounts. State guarantee funds are supported by premium taxes and other insurer assessments. The life insurance industry does not rely on taxpayer bailouts.

      And old industry saying sums this up rather neatly: “We bury our own dead.”

  4. Marjorie says:

    A Tontine was the key to the mystery in the classic Agatha Christie book, The 4:50 from Paddington. It was part of the will of the patriarch of the family, and only involved surviving family members.

    I think it’s an interesting concept but can see how it became an idea whose time has passed.

  5. Mortimer McCorkle says:

    Barney Miller had a whole episode about a tontine. Season 8, episode 8. I’ll have to rewatch it tomorrow.

  6. Dave A says:

    When longevity risk is managed by a life insurance company, they either get it right (and make a profit after paying all expenses (so it is not a “good deal” for the annuitants)) or get it wrong (and lose money after paying all expenses (which is a good deal for the annuitants but a bad deal for the insurance company).

    TV shows and novels have incorporated “tontines” in their plot lines BUT these depictions are not any where close to how tontines could be used as a safer way to manage longevity risk (than having it priced by an insurance company). It would be more helpful if Squared Away didn’t include the M*A*S*H* or Simpsons references as they really just distract from the issue of showing how a tontine could replace SPIAs (single premium immediate annuities).

    The link in this article to the academic paper by CRR is, in fact, a pretty decent summary of Milevsky’s book on the topic, “King William’s Tontine: Why the Retirement Annuity of the Future Should Resemble its Past.”

    It’s a very interesting book, well worth reading. But if that’s not your cup of tea, the link provided to the study by the CRR is a quick read and provides enough detail so it’s readily apparent how a tontine COULD be an effective, and safer approach to providing life time income than an buying an annuity.