A tontine may sound like some kind of delicate French dessert, but it's actually a potentially sinister financial vehicle. This venerable and long-outlawed financial product, though, is one some people think should be revived to serve the needs of 21st-Century American retirement savers.
Tontines resemble annuities in that people invest a sum up front and get in return a regular payment for life. The difference is that the tontine payout can vary depending on how long investors in the tontine live. As people die, the survivors get more money.
Tontines are named for 17th-Century Italian financier Lorenzo Tonti, who proposed one as a way to finance the government of France’s King Louis XIV. That tontine was never implemented, and an English tontine set up soon after by King William flopped. A later French tontine did get off the ground but collapsed in scandal when it turned out to be cover for a Ponzi scheme.
Two centuries later in America, a kind of tontine-like life insurance was tried again about the time of the Civil War and became hugely popular, eventually dominating the industry. That ended after a 1906 investigation uncovered rampant corruption, with the result that tontines were and remain outlawed in the U.S.
The tontine’s sketchy history is reviewed in the recent book King William’s Tontine: Why the Retirement Annuity of the Future Should Resemble Its Past (Cambridge University Press, 2015) by York University finance professor Moshe Milevsky. As the title suggests, Milevsky says tontines have a place in today’s retirement finance scene.
“People need more choice when it comes to retirement products,” Milevsky says. He says tontines would offer lower costs, better predictability and less complexity than similar products such as annuities.
Sure, the vehicle was mocked in a classic Simpsonsepisode-- in which Grandpa Simpson and Mr. Burns are eager to be the last survivor, and thus beneficiary, of the spoils -- and addressed in "The Double Deuce" episode of archer, but despite the history of making retirement planning something of a blood sport, there are some practical elements to solving the current retirement crisis in the U.S.
“You can think of them as a life annuity where the owners bear the actuarial risk -- i.e., the possibility that if the annuitants live too long, that payouts will suffer,” explains William Bernstein, co-principal at Efficient Frontier Advisors in Eastford, Connecticut.
This gambling angle of the tontine, in which investors bet that they’ll outlive the other investors, may be one factor in their historical appeal. Another is that, like annuities, tontines promise to keep paying benefits as long as an investor lives. That eases the common fear of outliving savings.
Another plus is that, unlike annuities, investors rather than insurance companies are taking the lion’s share of the risk, so investors get a larger share of the rewards. The chance to take on more risk in return for more reward is one Milevsky thinks retirement savers would appreciate and benefit from.
Whatever their sterling qualities, tontines today are burdened by their scandalous history and continue to be barred by regulators. However, Milevsky points out that some very large retirement systems, including those sponsored by TIAA-CREF and the government of Sweden, incorporate variable payout features similar to those of tontines.
Milevsky would like tontines back, with some changes. “I think it is important to clarify that I am not advocating the re-introduction of the original tontines promoted by the 17th century Lorenzo de Tonti,” Milevsky says, noting that Tonti spent nearly a decade in the Bastille for his activities. But the concept of sharing mortality risk within a limited pool of investors, according to Milevsky, has merit and should be featured in a new generation of retirement income products.
While appreciating their pluses, Bernstein doubts tontines will return soon, noting their unsavory history. And if they did, he says, it might not be to investors’ benefit, given that they would be sold by some of the same insurance companies that abused the concept leading to their outlawing a century ago.
Meanwhile, the historical tontine remains unavailable to the average investor. “The closest thing you might find is a participating annuity, which is not offered by many companies and is quite opaque,” Milevsky says.
But he thinks that’s likely to change. “I believe that in the next three to five years a tontine-like product will be available to people who are within ten to five years of retirement,” Milevsky says, “although it might not be called a tontine per se.”