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LF36 | Tontines are the best idea for financial security for later life. Why aren't they more popular?
The three Big Risks of later life are morbidity, mortality and longevity.
Morbidity risk is the chance of getting sick. Mortality risk is the chance of dying. And longevity risk is the risk of living “too long”. This last, odd idea, is the preserve of the insurance industry and is about the actuaries getting wrong-footed by galloping life expectancy, resulting in higher than expected payouts for pensions and in particular annuities. But it also is about people’s experience of running out of money. A recent survey of Australians of all ages put running out of money in retirement as the second biggest worry, after climate change.
My bold suggestion (and one of the Looking Forward innovation topics) is that a long-forgotten financial product, a “tontine”, if properly implemented, could remove longevity risk entirely, saving pension funds’ piles of cash and salving retirees’ fears. Moreover, coupled with personalized healthy longevity services to keep older people fit, active and engaged, we probably have the magic bullet for healthy aging.
Ok, so what is a tontine, what are the benefits, and if they’re so good, why haven’t they been more popular?
What is a tontine?
To put it simply, a tontine is when a group of people put money in a pot, and share the dividends, until they die. When they die their contributions go to the other members. A few hundred years ago, they operated as a basic life insurance model for villagers going off to battle; those coming back shared the pot. GPT4 points to some of the challenges:
A tontine is a financial arrangement in which a group of individuals pool their money into a single fund, and then receive a regular income from that fund. As members of the group die, their shares in the fund are divided among the remaining members, until eventually, the last surviving member receives the entire fund.
Tontines were popular in the 17th and 18th centuries as a way to raise capital for public works projects, such as bridges or canals. They were also used by private individuals as a way to provide for their retirement or to fund their children's education.
Today, tontines are rarely used, as they are considered risky and potentially fraudulent. In some cases, unscrupulous organizers of tontines have been known to manipulate the arrangement to their own advantage, leading to lawsuits and other legal actions.
Things went pair-shaped in the US when they become very popular, and the dramatic quantities of cash on hand and poor controls incentivised bad actors to do bad things. They were outlawed in most US States and their legal status is still somewhat grey.
Benefits of tontines
Tontines are the only financial product that is guaranteed to provide an increasing payout in later life. Since the capital of the members who die goes back in to the pot, those remaining get ever more dividends and / or capital repayment. The way this would not be true is if i) nobody died or ii) fraud or poor risk management destroyed the value of the invested cash.
If well run and governed, they by definition provide an increasing payout to members, based on the ‘mortality credits’, i.e. dead people’s money. (You may start to be getting a flavour of why this concept has run into marketing challenges.) They are relatively straightforward to design, if you’re actuarially minded, and don’t rely on sophisticated market-beating algorithms or expensive asset managers. And that latter point is another key factor to why they’re not scaled…
Why haven’t they taken off?
They’re not lucrative for the finance industry. Most of the consumer surplus goes to the customers not the middlemen. In an annuity, the annuity company keeps the mortality credits for when members die, in a tontine it should (mostly) all flow back to the members themselves. (Note: This is why a coop-model of the tontine may be the killer app).
Regulation hasn’t caught up. Many US States still outlaw them based on when the previous system came tumbling down. But given that in Vermont women need permission from their husbands to get false teeth and in Indiana it’s illegal to travel at more than 10mph on a horse, sometimes the laws are out of touch with reality and need to be updated.
Brand - ‘tontines’. The word itself has a negative association, based on its rich and colourful history of scams. Tontines as a word has baggage and often is associated with Agatha Christie novels and people killing each other. Also anything that reminds people of death has a hard time getting adopted.
Brand - ‘socialism!’. We want our own things- our house, our car and our 401k. The idea of pooling seems un-American (don’t tell people about insurance). Plus we don’t get to chose what the pool invests in.
They require lump-sum up front. The upfront commitment could be ameliorated with some kind of payment mechanism (e.g. starting at 40 paying in every month like a long-term care insurance model).
There are others we could go into. It seems this is a market disconnect - these critiques aren’t substantive and in fact the first one is probably the biggest argument in favor - they’re efficient. Compared to the potential upside of solving one of the greatest fears people have, it feels worth exploring in more detail. And it would also gives us money, time and less anxious older people able to roll up their sleeves to solve the greatest risk society faces, climate change.
What gives, am I missing something here?
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