We say ‘Modern’ For a Reason

\We recently read an interesting Christmas Day blog article by Henry Tapper called Pensions not tontines please! To be honest, we found the article rather confusing in that it advocates on the one hand for modern tontines (“if there is one concept we could do with right now, it’s what is described in this video as the Modern Tontine”), but then spends the rest of the article objecting quite strenuously to them. Perhaps he meant to say, “we could do without” rather than “we could do with?” We are not sure.

Antiquated Tontines

Regardless, it bears mentioning that the article appears to focus primarily on the characteristics of antiquated tontines rather than modern tontines. This is a common misstep and perhaps a forgivable one – after all, people have heard about the tontines of the past (and their stained history, so what better than citing an episode of The Simpsons that parodies them… touché!), but they may not be familiar with the concept of modern fair tontines. So, this seems like a good opportunity for us to highlight the differences.

Let’s start with Mr. Tapper’s definition of a tontine. We reproduce his full paragraph here (the bold emphasis is his):

“A tontine is a legal agreement where people make an investment into a trust in return for the right to receive a regular income for as long as they live. When a member passes away, their income is shared with the remaining members causing the surviving members income to rise.”

Correct. But notice what this definition does NOT say. It does not say the arrangement must be in the form of a closed-end pool, that there must be a last survivor, or that the members must all know each other’s identities – all of which are features that he criticizes. This represents a type of straw man fallacy: focusing criticism on the features of some types of tontines and then fallaciously extending the argument more generally to all types. But in the past few years, both academic and practitioner research has studied the boundaries of fair tontine design and found them to be not at all limited to the closed-end designs of the past.

Mr. Tapper further attempts to differentiate pensions from tontines, saying that

“while a pension is finite, a pension fund/plan/scheme need not be. Which is why ‘tontine’ is the wrong word to use in association with pensions.”

Modern Tontines

But modern tontines likewise need not be finite. Indeed, modern tontines can be open-ended, accepting new members forever. Moreover, tontine payouts can be structured similarly to traditional defined-benefit (DB) pensions, with the exception that payout levels are not guaranteed. This is the major difference between tontine pensions and DB pensions. Tontine pensions strip away the guarantee while also eliminating all of the guarantee costs, passing the cost savings on to pensioners. For a deeper discussion on the topic of tontine pensions, see here and here.

Semantics Matter

Mr. Tapper does make a good point about semantics. Whether we like it or not, the word “tontine” is often associated with many of the unwanted attributes that his article describes. So, what to do about this? Should we take every opportunity to set the record straight that modern tontines need not resemble those of the past? Or should we accept that the term has (sadly) become synonymous in popular culture with its past forms such that debating its academic definition is an effort in marketing futility? I think the right answer is to do both. We still write academically on the subject of tontines in our research, but in the practitioner world a rebranding is in order.

We had originally thought that the qualified term “modern tontine” would adequately differentiate the modern form from the antiquated forms of yestercentury. And while some may believe that this fight is still worth fighting, the issue remains that the word “tontine” is tainted and means different things to different people. Why not just call it by what it is -- longevity risk sharing?

Modern Longevity Risk Pooling

As I once wrote in this practitioner’s guide published by the CFA Institute Research Foundation:

“If most of what you know about tontines came from a fictional novel, a film, a newspaper article or an episode of The Simpsons, rest assured that you are not the only one. But this does not have to be the case.”

We can modernize pensions through efficient, low-cost longevity risk pooling that supports:

• Actuarially fair risk sharing, longevity credits, and payouts

• 100% fully funded pensions

• Both closed-end structures and modern open-end structures that accept new entrants in perpetuity in the same way that traditional pensions do

• Single-ownership and joint-ownership with a spouse or partner

• Mortality rates that can be determined by any number of different factors (not limited to age or age + gender), if desired and as may be governed by law

• Any reasonable asset allocation or investment strategy

• Both packaged products (as with a fund or trust) and individually managed accounts (such as with robo advisory platforms) that allow investors or their advisors to tailor their own investment strategies

• Immediate and deferred payouts

• Lifetime payouts, term payouts, and lump sum payouts

• Certainty periods

• Payout trajectories that can be designed to rise, fall, or remain flat in either nominal or real terms

• Payouts that can be customized by each individual pensioner, if desired

• Statistical analyses and income projections that consider factors such as pool membership size, cohort sizes, individual account balances, investment strategies, payout options, etc.

• Payout smoothing (notably, this differentiates tontines from CDCs and similar defined-ambition plans – whereas a CDC plan might allow its funding status to fluctuate within some range, a “pure” tontine must remain fully funded at all times)

• Pools that can span across multiple plans and products

• Pools that can span nationwide and even across country borders (global risk pools)

• Transparent pricing and accounting

• And in the future, immutable ledgers

And to the extent that any provider or regulator is worried that such risk pools, in Mr. Tapper’s words, once “created a moral hazard which tempted the community to put harm in each other’s way,” participants within a modern risk pool may be anonymously and randomly assigned to sub-pools, granting an extra layer of protection if this is desired.

This is what we mean by modern longevity risk pooling solutions. Our job is to help pension and retirement plan providers do it fairly, flexibly, efficiently, transparently, better.