Should A 400-Year-Old Strategy Restructure The Longevity Insurance Market?

In the 17th century, the French hatched a revolutionary financial strategy. People pooled their money into a large investment fund; as participants passed away, their share was distributed to the surviving members of the group. This plan, called a tontine, originally funded the monarchies wars and debt repayments. The tontine plans made their way to the United States in 1868 and, by 1905, commanded 7.5 percent of wealth in the country.

Tontines, however, didn't survive the early 20th century. These plans, in theory, were made to yield annual payments. Instead, insurance companies used them to build their treasure chests. The deceased participants’ investments simply reverted to the insurance pool rather than making their way to the surviving investors. Regulators caught on and prohibited plans that didn't pay out on a regular basis.

Setting aside for the moment the ethical dilemmas of profiting from the death of others, tontines may be worth a reviving, according to a brief made by the Center for Retirement Research at Boston College.

What Are Tontines?

Tontines share many attributes of Social Security benefits, 401(k) payments, and traditional or fair annuities.

In traditional retirement savings vehicles, participants deposit money into funds. This often happens over time or in lump sums. Wage withholding and other deductions fund the well of 401(k) plans and Social Security. Mutual funds may have a mix of lump and periodic contributions. At a specified date, monthly payments begin to afford retirement income. Most payments are constant. Unless the rights are specifically reserved, payments don't go to a recipient’s heirs.

In a tontine, the investor receives a monthly income. Just as with other products, heirs don't receive benefits at the investor's death. But, unlike the other retirement income streams, benefits from tontine insurance go to the pool's surviving participants. This translates to the potential at least that the payments per investor can rise over time.

Are They A Good Idea In Today’s World?

Traditional annuities come with higher premiums because the insurer or provider bears the risk that the recipient lives longer than expected. Today, medical advances and healthier life habits contribute to increased life expectancy. This results in the rise of longevity risk.

With tontine insurance, the longevity risk shifts to the investors. This causes the premiums for tontines to run lower than with traditional annuities. Tontine insurers could offer lower premiums. Extra capital isn't usually required for the investors to reap their expected returns. That is, when one participant dies, their share is simply redistributed to the surviving participants in the pool. In a traditional annuity for other investment vehicles, the provider must come up with the funding.

Although traditional annuities offer higher payments in the beginning, tontines afford more in later years as participants die and “forfeit” their portions to the pool.

But, there’s a downside to tontines. Lower premiums come with the enhanced risk that the investors won't reap higher payments if the other participants outlive expectations. Again, the payment increases only when participants die, making their shares increasingly available for annuitized payments. Thus, the longer people in a tontine plan live, the lower the payment per participant.

Ultimately, tontines involve an evaluation of the trade-offs between lower premiums and the likelihood of lower income, as people generally live longer thanks to lifestyle changes and medical enhancements. Assuming that these plans, if legally allowed, would actually pay out, investors would have to overcome their moral scruples in order to anticipate the potential for higher income. It might be more realistic to use tontines as part of a larger retirement strategy with other savings vehicles.