“The Tontine is perhaps the most discredited financial instrument in history” - Edward Chancellor, The Spectator, Vol. 286, No. 9007, 24 March 2001.
Let’s fix this! We stand ready to restore the tontine’s good name through actuarially fair design and highly transparent operation.
The global retirement challenge
Retirement Decumulation: the “nastiest, hardest, problem in finance” - Nobel laureate William Sharpe
Indeed, this may well be true… at least for those who try to manage longevity risk on their own. But by pooling their risk with others, people can greatly diversify and reduce this risk. In fact, risk pooling is so effective that it can facilitate the virtual assurance of lifetime income for everyone. Not only that, but it also allows individuals to achieve significantly higher levels of retirement income.
It’s really quite simple. Through risk sharing, a tontine changes the conditional distribution of retirement outcomes in a very useful way – those who live long lives are subsidized by those who die earlier. For those who are relying on a portfolio to generate income over a highly uncertain and potentially long remaining lifetime, this is exactly what they should want.
“As it turns out, everything we need to know about building a perfect retirement product we learned in kindergarten. Life is better when you share.” - Michael Finke
Brief history and a checkered past
Tontine finance has been around since the 17th century. The science has come a long way since then. In fact, the new generation of modern tontines will bear little resemblance to those of the distant past.
Tontines were originally used by national governments (kings) to raise money in financing wars against other nations. By the 19th century, private insurance companies determined that they, too, could issue tontines and they did so under the name “tontine insurance”. By the end of that century, these privately issued products had become quite popular in Europe and the United States. Sadly, success did not last long because the products fell victim to misappropriation and fraud on the part of tontine issuers. As a result, regulators in several jurisdictions moved to ban the fraudulent practices early in the 20th century, and tontines largely faded away.
It is important to note that the problem was not the tontine principle. Rather, it was fraudsters who took advantage of their products’ lack of transparency to misappropriate the assets. But that was then and times have changed. The tontine risk-sharing principle is enjoying renewed interest given its potential to alleviate the so-called global retirement crisis amid a recognition that investor protections have come a long way in the past century. Record keeping and auditing have improved greatly. Financial assets can now be held by independent custodians. Required disclosures are stricter.
Modern tontines represent a complete redesign. They can be open-ended and able to continually accept new members. As a result, modern tontines need not suffer from a membership pool that gradually grows smaller over time. In fact, the membership can continue to grow year by year.
Moreover, modern tontines can be:
- A) Highly transparent
- B) Perpetual
- C) Flexible
- D) Simple to understand
- E) Actuarially fair to all investors at all times
The tontine principle… and the fair tontine principle
There is one thing that all tontines, whether ancient or modern, have in common – they operate under the tontine principle. Under this principle, individuals pool their resources together and agree that the ownership interest belongs to the surviving members. Those who die give up their interest and as a result, the remaining survivors each gain an increased share of the pool. Thus, those who live long lives continue to receive an ever larger share, which to a retiree means higher levels of retirement income that lasts as long as they live. So when we talk about tontines as a risk-sharing tool for retirement, we are talking about the risk of outliving your money.
Ancient tontines were not necessarily fair to all investors, however. There often existed a bias that advantaged some investor cohorts at the expense of others. This bias was typically not intentional. Rather it was due to a poor understanding of mortality rates and the mathematical principles of fair tontine design.
Today, we know how to make tontines precisely fair. In a tontine, investors lose their balances when they die. Lost balances are apportioned and given to the surviving members in the form of longevity credits. The objective is to ensure that the longevity credits received by each and every survivor each period (month, quarter, or year) offsets the amounts that they risk losing should they die in that period.
The intuition for how this must be accomplished is the same as for simple games, such as guessing the toss of a coin (win 1 coin if guess correctly, lose 1 coin otherwise) or the roll of a die (win 5 coins if guess correctly, lose 1 coin otherwise). So the concept of fair tontines is readily understandable. In addition, the operation can be very transparent and is easily auditable.
Because the risk of dying increases with age, a tontine’s longevity credit yield also increases with age. So being a tontine member is not only a gift that keeps on giving, but one with benefits that increase exponentially for as long as you live. These tontine longevity credits represent amounts received as a result of longevity risk pooling, over and above any investment returns that may also be earned. Thus, a tontine investment delivers both a traditional investment yield and a tontine survivor yield.
The pooling of longevity risk serves to diversify it through the law of large numbers. When number of member investors is sufficiently large, risk is minimized. This allows a tontine to provide the assurance of lifetime payouts.
In addition, investing in a tontine changes the conditional distribution of outcomes in a very useful way – those who live long lives do substantially better. For those who are reliant on their savings to generate income over a highly uncertain and potentially long remaining lifetime, this is exactly what they should want.
Modern tontine design
Rockets were once quite crude… it was relatively easy to create one that burned fuel and flew in some general direction, but a much more challenging task to create one that flew with precision to a fixed target on the ground, a moving target in the sky, and even the moon and beyond. But scientists and engineers with enough skill figured out how to make it happen. So, too, now with modern tontine engineering.
Tontines are conceptually very simple. The task of engineering a truly perpetually fair tontine is considerably more complicated, and that is where Nuovalo really shines.
Ancient tontines of the past were typically limited to closed-end structures with an initial subscription period. Some number of investors would subscribe and receive payouts that increased over time as others died. The membership would gradually decline until there was a single survivor (or perhaps some small set of last survivors who split the remainder of the pot). Payouts would start small and grow exponentially in very old age for the lucky few who made it that far. The pool was inflexible – everyone got the same investment portfolio and received the same payout. These tontines were much more like lotteries than anything else. Nice if you win, but not so helpful otherwise. After all, who wants to sacrifice income early in retirement for a small chance at obtaining a fortune when you have little time and perhaps little health by which to enjoy it ? Such tontines are not very efficient for either the members or the providers.
Modern tontines can be much more efficient and flexible. A single tontine pool can be open-ended, designed to run forever, continually able to take in new members, allowing portfolio choice, and providing a number of different payout options. Sure, payouts can be lottery-like for those who wish, but they can also be engineered as annuity-like, with higher payouts in the early years and flatter trajectories.
Tontines offer no guarantees, which is why they are less costly than insured annuities. Thus, their payouts may rise or fall. Those that desire more stable payouts can select conservative tontine portfolios, especially one that holds bonds according to a tailored duration matching strategy. Additional smoothing techniques can be constructed by combining a tontine account with regular investment accounts.
With modern tontines, asset managers can finally offer assured lifetime income solutions that compete favorably with annuities. Annuity providers can finally offer assured lifetime income solutions at low cost. Financial advisors can finally have a tool that provides lifetime income while also allowing them to continue advising on the underlying assets.