The term “tontine” may be new to many people. This is not surprising, given that the once-common term largely fell out of use around one hundred years ago. Let’s review what a tontine is and take a quick look at its history… and why it is making a comeback.
What is a Tontine?
Quite simply, a tontine is an investment scheme combined with a particular payout scheme. Monies are invested and paid out according to the tontine’s governing documents. The key differences between a tontine and an ordinary investment fund in which you might choose to invest are two-fold. First, an investment in a tontine is generally (although not necessarily always) irrevocable. Second, monies invested in a tontine are not transferred to an investor’s heirs or other designated beneficiaries upon death. Rather, such monies are apportioned to the other living members of the tontine. Thus, monies that are forfeited by those who die are credited to those who live, increasing the return that is enjoyed by the surviving members. These extra returns are often referred to as “longevity credits.”
The idea behind irrevocability is to ensure that surviving members will actually receive these longevity credits. After all, if members were allowed to freely withdraw all their money from the tontine while still living, there would be nothing to transfer when they eventually die.
With a tontine, then, you give up the ability to withdraw from the scheme at will, but you gain longevity credits on top of the scheme’s underlying investment returns. As a result of gaining longevity credits, tontines can pay out to survivors significantly more than an ordinary investment fund. Furthermore, tontines can be designed to provide lifetime payouts, making them a great alternative for retirees.
A (Very) Brief History of Tontines
Tontines were first conceived and organized in the 17th century largely as a way for governments to fund wars. These “ancient” tontine schemes typically had lottery-like elements to them. In addition to some modest amount of interest, the tontine would grant very large windfalls to the lucky few who were lucky enough to outlive the other investors.
Before long, entrepreneurs began to realize that tontines could be private ventures and redesigned to provide higher payouts in the early years with less of a last-survivor take all windfall at the end. In other words, they could be transformed from lottery-like to pension-like. The insurance industry took up the idea and began selling these new types of tontine schemes, which became very popular.
Unfortunately, some insurance providers proved to be bad actors, finding ways to effectively defraud investors through self-dealing practices. For example, one provision that served to benefit insurance companies at the expense of investors was so-called “deferred dividend” policies that paid nothing for the first few years, but required the investor to continue making periodic investments or face losing their entire investment. Furthermore, amounts forfeited this way would often go to the insurer rather than to the other investors of the tontine. After receiving complaints, regulators moved to disallow the sale of such deferred dividend policies and tontines soon fell out of favor.
In the 21st century, however, academics and others have called for the return of tontines. Benevolent tontines designed and managed under a trust law with all the modern techniques used by ordinary investment funds to prevent fraud. In addition, newer technologies in existance today can ensure the accurate operation of a tontine scheme with complete transparancy down to each and every transaction. In short, the reasons that led to the disallowance of tontines a century ago no longer exist.
Tontines versus Annuities
Pension-like tontines exhibit many of the characteristics of payout income annuities. The primary difference is that annuity income is guaranteed by an insurance company, who charges for this. Guarantees are not needed in tontines because the investors share risks among themselves by way of transferring the balances of those who die to those who survive. Because the rate at which people die is not certain, the longevity credits that a tontine investor expects to receive will experience some variability. However, if the number of investors in the tontine pool is sufficiently large, this variability is likely to have only a small effect on a tontine’s payouts. Thus, tontine investors gain by avoiding expensive guarantee charges that are inherent to annuities.
Many types of tontine schemes are possible. Tontines may be lottery-like, pension-like, or exhibit elements of both. Because retirees are likely to need pension-like income, pension tontines may become an especially attractive market.