10. Concluding Remarks: Tontine Thinking

Although its seventeenth century incarnation involved a rather standard design, there are in fact many ways to construct a twenty-first century version of a tontine. Arguably, the word modern in front of tontine could be used to describe any number of products, agreements & contracts in which individuals who live longer than average benefit at the expense of those who don’t beat their peers in longevity. Once again please see (all) the scholars mentioned in the literature review of Chap. 1.

A simple life annuity embedded inside a Defined Benefit (DB) pension that guarantees—or at least attempts to pay—a predicable income stream for the rest of one’s natural life is a type of (modern) tontine. After all, those who die early end up receiving less in total benefits, compared to those who die late, even when a spouse or beneficiary is entitled to a residual benefit. Likewise, Variable Annuities (in the US) and Segregated Funds (in Canada) involve a long position in an option on a tontine. The owner has the right but not the obligation to (eventually) convert the contract into an income stream that lasts for life. As soon as you hear the words for life, you know there is some tontine DNA embedded somewhere. In fact, one can think of simple and humble term life insurance policy—that pays a large death benefit in exchange for a small premium—as having a short position in a tontine. The longer you live, the less benefit you receive, relatively speaking. And, if you live too long you receive absolutely nothing in return for all those premiums. Fans of permanent insurance policies might disagree with this characterization, and this certainly isn’t meant to detract from the utility benefits of protection, but there is an implicit bet on a short (versus long) life.

What distinguishes the modern tontine I have attempted to describe and model in this book, from its ancient relatives and modern cousins are threefold. First, it’s structured as a financial security as opposed to an insurance contract. Second, it’s not meant to be used by everyone for their entire life. And third, nothing is meant to be guaranteed. Ever. The first distinction is really a regulatory matter, but one that has very important practical implications. The second is an economic matter, but with important psychological implications. The third permeates the entire structure of the modern tontine from start to finish, and most importantly reduces its cost. Allow me to elaborate on all three.

A financial security such as a mutual fund (MF) or exchange trade fund (ETF) is a “product” that invests in a diversified collection of stocks and bonds which is overseen by the fund manager or trustee. The owners of these fund units are entitled to benefits such as bond interest, share dividends and realized capital gains as well as the right to vote from the underlying shares. Every one of those fund owners—especially if they have invested the same amount—must be treated equally under securities regulation. All of this should be quite reasonable and exactly the type of protection investors would want.

This protection or safety assurance implies that managers can’t tell one (young, healthy & female) group of shareholders in the same class that they are entitled to less dividends, less interest and less capital gains because their mortality rate is low. Likewise, the same regulators wouldn’t allow another group (old, unhealthy, males) to receive the lion share of fund payouts in a given year for the same reasons. And, while a financial or insurance economist might argue: “but, that is fair”, the compliance and regulatory authority are unlikely to care. The legal structure of the fund prohibit such overt transfers of wealth. Yes, the fund manager could create different series of funds, or fund classes for people at different ages, genders or even health, but that becomes prohibitively expensive, administratively cumbersome and reduces the efficacy of longevity risk pooling. Remember that a pool consisting of you and a handful of your best pals isn’t much of a longevity hedge. Pleading with the security regulators for exemption and relief are likely to be met with directions to the nearest insurance regulator and hearty farewell wishes.

What all this means is that a modern tontine fund operating under securities regulation, issued by a licensed securities entity and sold to individual investors by financial advisors and their intermediaries must abide by a long list of regulatory constraints. These constraints would simply not be present or binding if the modern tontine was manufactured, offered and sold under the insurance regulatory umbrella. This is why the modern tontine I have described in this book can best be positioned and explained as an enhanced natural decumulation fund that slowly depletes and pays-out an initial sum of money over a pre-determined time horizon, albeit with mortality credits from the deceased. Technically, this was structured as a temporary income versus a lifetime of income.

This brings me to the second and third point differentiating the modern tontine that is issued within a securities framework from products offered under an insurance regime, and that is the lack of any lifetime income guarantee. It’s technically and institutionally impossible for an entity other than a regulated insurance company or pension fund to promise or guarantee something for the natural life of any individual investor. The manager of a mutual fund or exchange traded fund makes an assortment of promises and covenants when issuing securities, but one of those cannot be to pay an investor for as long as they live. A company like Tesla can issue and float shares that pay dividends to the shareholder for as long as they own the shares, but Elon Musk can’t float securities that pay you dividends for as long as you are alive and cease upon death. Yes, he can enter into a private agreement with you that stipulates almost anything—he is Elon Musk after all—but when operating within the securities regulation even he faces limits, and he has learned this the hard way. For similar reasons, a conventional fund company can not issue life annuities, or a pension or a tontine that promises to pay an income for as long as the investor is alive. This is not a quirk or fact limited to securities regulation in North America. It’s the nature of the institution itself, and the lawyers really don’t care that the Law of Large Numbers operates regardless of the type of paper it’s written on. Guarantees require capital to back those promises and that’s precisely the role of insurance companies.

Now, what a securities-licensed entity can do is create a binding contract in which the parties can agree among themselves that units of the fund are cancelled if-and-when their owners happen to die. You own something while you are alive, or provide proof that you are alive within a certain time limit. If such proof isn’t supplied, your investment and legal rights in these units are forfeited and ownership of the underlying securities is distributed among those who did supply such proofs—that is they are still alive. This is a type of tontine agreement—but dictates nothing about the time horizon of the agreement. This fund could be set up in advanced to disband in a mere year, or when half the initial pool of investors is dead, in 30 years or even when the Toronto Maple Leafs win the Stanley Cup. But, again, what it cannot do is promise to pay me as an individual investor in this fund for the rest of my life. And, one certainly can’t promote, advertise or position such a fund as providing a lifetime of income, or being a substitute for a pension annuity. What it does, however, is provide (very) valuable mortality credits, a concept I will not repeat or explain here yet again.

So, what happens if the individual investor lives beyond the terminal horizon of the modern tontine fund? From whence will they derive their income if-and-when they reach the age of 95, or 100 or beyond? This longevity risk looms large in the minds of most retirees and drives them to hoard financial resources and wealth for a very advanced age, albeit one that in all likelihood may never come. If the modern tontine that I have described in the prior chapters of this book can’t substitute for a pension annuity. Does it not defeat the purpose? Won’t investors remain fearful of running out of money and shun such a fund?

The answer relates to something I echoed in the introduction to this book. Note that in today’s western society nobody runs-out of money and starves to death. The social safety net and numerous government pension programs exclude that from ever happening.

Indeed, if this was the main fear driving all asset allocations at retirement we would observe a much greater demand for pure, simple and generic life annuities that pay an income for the rest of their natural life. And, for those with strong bequest motives they could purchase a cashable term certain annuity for a period of 30, 40 or 50 years which would last until well-after their time on earth, and it would continue to the next generation. Rather, the lack of demand for all these instruments likely implies other reasons for why retirees don’t purchase longevity insurance. In sum, the modern tontine doesn’t provide that sort of insurance. For consumers and retirees who would like to insure or protect themselves against living to a very old age, I urge them to purchase an advanced life delayed annuity (ALDA) which only begins to payout at age 85 or 90. As you can imagine, they are quite cheap at younger ages—given the slim odds you will ever put in a claim—and is exactly why I purchased an ALDA many years ago.

What the modern tontine does do, and can be seen quite clearly when placed and positioned right next to a natural decumulation fund—is that it offers a group of investors the ability to enhance their investment rate of return by harvesting mortality credits from those investors who predecease them. As I demonstrated, even if investors are offered a money back feature that allows their beneficiaries to reclaim unearned principle, the mortality credits will enhance returns by triple digit basis points. And, in today’s ultra low interest rate environment those precious credits are even more valuable.

In sum, the modern tontine isn’t a silver bullet for the silver or white-haired crowd nor is it a substitute for a proper life annuity, defined benefit pension or deferred life annuity. All of those will continue to have an important role to play in the optimal portfolio for the rational decumulator. Likewise, the modern tontine is not another asset class, or product class or a revolutionary breakthrough in financial engineering. As you know by now its humble origins are hundreds of years old. Rather, the modern tontine is a clever way to squeeze just a bit more consumption life from your financial assets, in exchange for sharing those assets with someone else in your cohort. That’s all it is, pooling risk for a higher return. Think of it as the twenty-first century version of diversification. You spread your financial assets among many …others.

The next step in the evolution of “tontine thinking” is to design a modern accumulation tontine for investors who are younger and who want to harvest mortality credits earlier in the life cycle. Stay tuned for that one…