Would you invest in a Tontine (If it Was Legal)?

The tontine sounds to me like the premise for an all-star senior citizen action-comedy: You make a bargain with a group of people to purchase an annuity. You split the purchase price and the annuity payments amongst the group. As members die off, the remaining members get larger and larger payments, until there are no living members of the group.

Just because the Simpsons have already gone there doesn’t mean it wouldn’t make a great movie.

Can’t you just see the madcap fun of a cash-strapped Betty White trying to take out Clint Eastwood and Maggie Smith for the big payday? Explosions! Wheelchair chases! Little old ladies taking each other out with knitting needles and automatic rifles!

Like Highlander for investors, “There can be only one.”

What’s a Tontine?

There’s been a resurgence in interest in tontines, which have shown up in recent articles in the Washington Post, MarketWatch and CheatSheet.  The tontine is a 17th century invention, developed by Lorenzo de Tonti at the court of Louis XIV to raise money (the idea was that the individual investors would never outlive the crown.) It was one of the earliest forms of life insurance, and was used widely through the 19th century. The tontine fell out of favor  with the rise of Social Security and pensions, due to incidences of fraud and abuse.

Now the idea is being thrown around as an alternative to life insurance and annuities.

In the MarketWatch article, York University professor Moshe Milevsky explained the likely incarnation: 500 or so investors invest in a 50 year bond ladder with maturities approximately every 6 months. As each bond matured, the cash would be distributed to the survivors. In his incarnation, the value of the later maturing bonds would be less, so payouts wouldn’t necessarily increase as the pool of investors decreased.

This is only one incarnation out of many. The investment could just as easily be in an index fund, and most versions keep the increased payouts for surviving investors.

So Why Would You Invest in One?

The concept of the tontine strikes me as a little gruesome. Your profits increase BECAUSE other people die before you do.  A tontine also means:

  • There’s no way to leave your interest to your heirs, because your interest will be divided between the surviving members.
  • You’d carry some investment risk, because the payouts would vary according to survival rates of the investors.
  • Oh, yeah, they are illegal in many countries and US states, due to a history of fraud and that whole thing about being an incentive to murder your fellow investors.

Despite  these facts, there is definitely some appeal to the tontine.

  • Milevsky points out that they are cheaper to administer than an insurance policy or traditional annuity, since the payouts are not guaranteed by a third party that is assuming the risk. The lower expenses mean lower buy-ins.
  • The tontine also helps allay the fear of outliving your assets, and may provide larger payouts for elderly investors who need protection against inflation risk and may need large amounts for medical and long-term care.

That last point is the crux of the matter of why maybe a tontine isn’t such a bad idea after all. Outliving your assets is a real fear, and long-term care is really expensive. The average annual cost for a private room in a nursing home is over $91,000, and in-home care can run $170,000 annually.

It’s not rare to need long-term care, either. Over 12 million Americans needed long term care in 2007. For people 65 and older, 68% will be unable to complete at least some daily tasks or be cognitively impaired at some point in their lifetime.

Most of us have a real need to make some provision for long term care. It’s expensive and we’re likely to need it at some point in the future.

A lot of people plan for these expenses through long-term care insurance. The problem is that long-term care insurance gets expensive as you age.  By the time you need it you may not be able to afford it. You may have pre-existing conditions that insurers refuse to cover, or the premiums may become unmanageably high.You may not even be able to get coverage. If you already have coverage, you may face steep premium hikes or declining benefits as you age.

Of course, if you stop paying the premiums, you lose any of the benefits you’ve been paying for over time.

As a way of providing for long term care needs and high longevity, a tontine may be more cost-effective and appropriate than insurance or a traditional annuity. The investors have taken the risk of their pooled life expectancy, rather than a third party that need to generate excess profits (although some administrative fees would surely need to be covered). Investors would be freed of the risk of rising premiums, as well as having a hedge against inflation.

Would I Invest in a Tontine?

At the moment, it all seems a speculative exercise. While there are some pensions and annuities with tontine-like qualities, no one seems to be selling the tontine as a retirement or insurance product.  If there were institutions selling participation in a tontine, I might buy in. Not as my only retirement savings, or even my main one, but as a way of insuring against high longevity risk, a tontine could be an attractive product. It would certainly be worth investigating the investment structure, fee schedule and contract details.

If the tontine was offered by a reputable provider, with a reasonable fee schedule and investment structure, I just might buy in.

As long as I could stay out of the way of homicidal old ladies.

How about you? Would you consider investing in a tontine? Why or why not?

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