Tontines: A Practitioner's Guide to Mortality-Pooled Investments

Abstract

Tontines and similar mortality-pooled investment arrangements offer a useful and unique value proposition to the global retirement challenge.

A tontine is a financial arrangement in which members form an asset pool and agree to receive payouts from it while living and to forfeit their accounts upon death. Forfeited balances are then apportioned among the surviving members. So, members earn not only investment returns but also mortality credits for as long as they survive.

A key feature of tontines is that they pool the longevity risk of their members. Pooling diversifies the risk and allows members the assurance of lifetime income. Because they offer no guarantees, payouts will vary depending on investment performance and the mortality experience of the membership pool. Dispensing with the cost of guarantees allows tontines to be cheaper than comparable insurance products.

The study of tontine design has emerged recently as a specialty of its own. The discipline represents a paradigm shift relative to the disciplines of either traditional investments or insurance. A first step in the study of tontine design is to understand the fair tontine principle. The principle is quite strict. Yet, as a string enables a strictly bounded kite much freedom to soar, adherence to the fair tontine principle likewise enables the designer a significant (and perhaps surprising) amount of freedom.

Tontines represent an alternative product choice. They might appeal to the following:

- Employers that wish to offer defined benefit–like employee pension plans that can never become underfunded
- Defined contribution plan sponsors that wish to offer participants an option that provides the assurance of annuity-like lifetime income while avoiding the fiduciary liability and counterparty risk associated with selecting an insurance company as guarantor
- Investors who wish to increase their returns without increasing investment risk
- Anyone seeking the assurance of lifetime income with greater transparency and at lower cost than with insurance guarantees
- Policymakers who wish to encourage retiree participation in lifetime income solutions
- Governments that wish to create (or re-create) a market for lifetime income products in countries where annuity markets are nonexistent or dysfunctional