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 US, 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 5 or 6 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, benefitting all HECM
The tontine has a bad reputation because the objective of most tontine programs throughout history was fund-raising, 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.