I first learned about tontine contracts as a child reading from Agatha Christie mysteries, like 4.50 From Paddington and The Pale Horse. A \”tontine\” is a financial contract where a certain sum of money is set aside and invested for the benefit of a group of people–but if some of those people die, their share of the funds pass to the survivors. If the group is relatively small and the members of group are known to alll, it\’s an excellent set-up for a murder mystery.
But a tontine-style contract might also has some genuine practical advantages in retirement planning. J. Mark Iwry, Claire Haldeman, William G. Gale, and David C. John tell the story in \”Retirement Tontines: Using a Classical Finance Mechanism as an Alternative Source of Retirement Income\” (Brookings Institution, October 2020).
For those, like me, who tend to associate tontines with fictional plot-lines, it\’s perhaps useful to point out that for several centuries they were useful financial products–not for small groups who would then try to murder each other, but for larger groups who did not know each other. Here\’s a working definition of a tontine: \”[T]ontine is an investment scheme in which so called shareholders create a common investment pool and derive some form of profit or benefit (usually financial) while they are alive. After the death of the shareholder his/her share gets split between the surviving shareholders in the pool and is not subject to inheritance rights. Tontine investment comes to an end when the number of surviving shareholders in the pool reaches a previously agreed on, small number.\”
The idea of a tontine contract goes back to a 1653 proposal from Lorenzo de Tonti, a 17th century Italian financier, who was advising the French government on how to borrow money. His notion was for the government to sell shares in a fund. The fund was to be divided by age groups, with each age group receiving a different rate of interest. As people in a certain age group died, their payments would be reallocated to the surviving members of that age group. However, the first government to enact something like Tonti\’s proposal was Holland in 1670, and France did not try a tontine contract until 1689, five years after Tonti\’s death.
Versions of tontine-based contracts were widely used for centuries, and were a basis for US life insurance markets in the late 1800s. As Iwry, Haldeman, Gale, and John point out (footnotes omitted):
Capital investment tontines were popular revenue-raising schemes in Europe from the 17th to the 19th century, helping governments and monarchies raise money for public works and wars. They even made inroads into the United States, as Alexander Hamilton proposed a capital investment tontine to pay off Revolutionary War debt. Although the federal government declined to pursue this option, many communities in the Colonial Era used tontines to finance local investments, and a capital investment tontine financed the construction of the original home of the New York Stock Exchange in the Tontine Coffeehouse. Tontines enabled governments to pay lower interest rates than they had to offer on other types of investment because surviving investors received not only the promised interest rate but also mortality credits, in exchange for giving up the right to pass their investment interest on to their heirs.
The life-insurance style tontine came to prominence in the U. S. in the late 1800s. Under these arrangements, policy holders paid premiums during a term (typically 20 years). If the policy holder died during the term, their beneficiaries would receive a payout. Policy holders who survived the term were entitled to a life annuity or equivalent lump-sum payout funded by the remaining pooled premiums from their deceased counterparts after insurance payouts to their beneficiaries as well as premiums from those whose policy had lapsed for failure to make a required premium payment at any point. This product drove the broad uptake of life insurance in the U.S. in the late 1800s and proved to be an effective vehicle for accumulating retirement savings before the advent of Social Security or private pensions. By 1900, two thirds of life insurance policies in the U.S. were tontine-style products, accounting for 7% of national wealth.
The popularity of life-insurance-style tontines, which essentially left large amounts of capital in the hands of insurers for decades, combined with a lack of regulation and oversight, made these policies ripe for corruption. The 1905 Armstrong Commission investigation in New York uncovered substantial embezzlement and misuse of funds, as well as unduly draconian triggers for lapse or forfeiture of the policy, leading New York lawmakers to effectively outlaw life insurance tontines as they then existed. This essentially ended the use of tontine-style products nationwide, since New York had regulatory authority over 95% of the national insurance market.
But the fact that tontine-style products were poorly regulated in 1905 doesn\’t mean that the idea itself is without merit. The Iwry, Haldeman, Gale, and John team point out that it\’s possible to design a \”natural\” or \”constant-payout\” tontine contract: instead of the most extreme murder-mystery version of a tontine, where all the payout goes to a lone survivor, the investment would be structured so that it pays out a certain amount every year (at least after a certain age). The total amount in the fund would decrease over time, as these payouts occurred, but as some members of the fund died, their payments would be redistributed to survivors.
This kind of tontines contract is one possible answer to key difficulty of retirement planning is to address the danger of outliving your assets (at least for all of us who don\’t have a pension plan that will guarantee our payments for life). One of the best-known solution is to use some of your assets to purchase an annuity, which will then make payments from some predetermined age for the rest of your life.
Perhaps the key difference between an annuity and a tontine is that when you buy an annuity contract, you are counting on the firm that sold you the contract to be able to pay off on its promises in the future. There is a thicket of rules and regulations applying to firms that sell annuities, all designed to make sure the firm will pay off in the future, but also all imposing costs on the transaction. In contrast, the amount of money put into a tontine is fixed. If the investments from the tontine went very poorly, the payments from the tontine would automatically drop. A tontine doesn\’t offer a guarantee of how much will be paid, like certain kinds of annuities (or a defined benefit pension). But precisely because it doesn\’t offer a guarantee, it can be regulated in much different and less costly ways, and for that reason it could offer both a lifetime stream of income and higher returns than many annuities.
Iwry, Haldeman, Gale, and John write:
While commercial annuities guarantee a specified income for life, tontine pooling offers more expected income with less but still meaningful protection at what should be a lower cost. They would not require the charges insurers need to impose or the reserves they need to maintain to cover their annuity payment guarantees and insurance against systematic longevity risk. Tontines would also require less and less costly regulation. …
[T]he U.S. is lagging the rest of the world in tontine-like arrangements. European Union member states permit tontines, usually as a supplement to government-paid or occupational benefits. The pension for former employees of SwissAir is structured as a tontine. In Sweden, the national pension system redistributes the accrued pension wealth of the deceased among all survivors of the same age cohort. In Japan, some workers pay into a tontine-like annuity from their 50s until retirement, when they begin receiving payouts to supplement their national pensions; when they die most of what they have contributed is reallocated among the other policy holders. Tontine-style funds are explicitly legal in the UK. Canada paved the way for tontine-style products when its 2019 budget proposed legislation to permit them under the name Variable Payment Life Annuities. In South Africa, a tontine style investment designed to improve retirement security for poor workers has begun enrolling participants.
In short, a lot of the regulatory details have already been worked out, and tontine-style contracts are working in other places. The US could steal a page from the Canadian public relations playbook and refer to these contracts as Variable Payment Life Annuities, and then proceed.