The tontine: a 17th century solution to a 20th century problem
The tontine is an investment scheme where each of a group of participants pays a specified sum into a fund and receives a pro rata share of the income generated by the fund, but when a participant dies her share is divided among those remaining. As the number of participants dwindles, those remaining receive increasingly large distributions.
Tontines have a long but not a very distinguished history. They have been used and often misused for a variety of purposes, usually by governments. At various times, the governments of Britain, France and the Netherlands used tontines as a way to raise funds. The operational details of these schemes often diverged sharply from the description in the paragraph above. Private tontines had their own problems, including suspicions that some participants may have hastened the demise of other participants. Ultimately, they were made illegal in Britain, and they are probably illegal in most or all states in the U.S., although I am not sure about that.
Despite this checkered history, the core function of the tontine, which is to shift income from those who die early to those who live longer, is one that is badly needed today. Longevity is increasing faster than our capacity to accumulate the wealth required to avoid outliving it. The challenge is to create the instruments that will accomplish the shift of income to survivors without generating any of the abuses that have beset tontine arrangements in the past. The most effective way to do this may be to insert tontines into already existing institutions that have stood the test of time. I will describe two such applications, one that applies to seniors in a retirement community, the other applicable to seniors who stay put in their own homes but take out a reverse mortgage to supplement their income.
My wife and I live in a retirement community that provides us with a range of services for which we are billed monthly. While the corporation that manages the community examined our finances when we entered and found them adequate, it has no assurances that we will be able to continue to pay when we reach 105, which is no longer unusual. If we outlive our money, they will not throw us into the street, which means that they must have some way to cover our expenses.
The simplest way is to add a surcharge to the monthly bill of all residents of the community. But this has the disadvantage that it raises the bar to potential new residents who will need more wealth to qualify for admission. A tontine approach, in contrast, imposes the cost on the estates of the tontine participants who die early. That makes a lot more sense.
I would not propose a tontine for my retirement community because it is a stand-alone with only a few hundred residents, so that participants would have a financial stake in the health of their neighbors. The way to do it would be to join forces with enough other communities to make the tontine feature entirely impersonal. The national corporations that have multiple communities are already well positioned to adopt a tontine approach. Exactly how to do it is a subject for another day.
The second possible application of the tontine applies to seniors who elect to stay in their own homes, and borrow against their equity under a HECM reverse mortgage. To reduce the likelihood that they will run out of money by living too long, each new HECM borrower could be offered the opportunity to purchase shares in an investment fund to be owned jointly by all those in a given age category. Over the program as a whole, there might be five or six separate funds. Each investment fund would be operated as a tontine, with the shares of survivors rising over time as others die or vacate their homes.
This would provide a new option to seniors taking out a HECM reverse mortgage - an addition to the current options of drawing cash, a monthly payment, or a credit line. The funds would invest entirely in GNMA-backed HECM securities, which carry no credit risk. The increased demand for the securities would drive down the rate, benefiting all HECM borrowers.
The tontine has a bad reputation because the objective of most tontine programs throughout history was fundraising, which generated a wide range of abuses. The applications sketched above, in contrast, are designed to help protect investor/participants from outliving their money, which should eliminate all or most of the potential for abuse.
• Contact Jack Guttentag via his website at mtgprofessor.com.
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