"It's sleazy, illegal, and could be the future of retirement"--Tontines

[samclem]

That's probably true, but much of what they take covers marketing, record keeping, customer service, accounting, compliance, capital ...

It seems to me that Milevsky's tontine would require all of those things.

The question is "What is the insurance company's load for the mortality guarantee?" That is the only service or activity that goes away in the tontine case.

Yes. And is there some "silver lining" of additional safety for subscribers as a result of dropping that guarantee? Depending on how the tontine is structured, the subscribers could have a direct call on the value of the underlying stocks/bonds to make the annual payouts (though the value of these payouts might vary somewhat). Just as we don't count on the financial strength of Vanguard or Fido for the safety of our stock/bond portfolios they hold for us. With an annuity, since the insurance company is making the mortality and market value guarantees, the subscribers are depending entirely on the company's ability to pay.
Also, I do think these tontines would not need to be run by insurance companies at all. Regulators might find that to be more convenient, but it brings a level of costs and a bar to market entry that is inappropriate since the payments would depend only on the value of the underlying assets, not the strength of the company selling subscriptions. It's the elimination of this "pass through" that would result in the most significant cost savings.

 

[sengsational]

I'd be surprised if insurance companies take less than 10% off the top on their annuity products.

Also, I do think these tontines would not need to be run by insurance companies at all. Regulators might find that to be more convenient, but it brings a level of costs and a bar to market entry that is inappropriate since the payments would depend only on the value of the underlying assets, not the strength of the company selling subscriptions. It's the elimination of this "pass through" that would result in the most significant cost savings.

I was thinking the members of the tontine would be the owners of the company, just like Vanguard. No insurance company and no stockholders. Good luck getting THAT past the lobbyists, lol!

But if you think of it like a closed-end mutual fund with very restrictive withdrawal rules, and a beneficiary designation of the fund itself, it would seem like it could be made legal. You could even design the payouts such that there's very little left at the end, so the last guy doesn't "win" that much, which seems to be the sticking point for some people. If you didn't make it an insurance product, you'd need to pay income tax on the gains, but that's probably better than an insurance company skimming a big cut. If Vanguard offered them, I'd be in line to get one.

 

[samclem]

If you didn't make it an insurance product, you'd need to pay income tax on the gains,

Probably true, unless it was funded with Roth IRA money

If Vanguard offered them, I'd be in line to get one.

Me, too. And within a particular year group there could be a variety of investment mix options. The most appealing to me would be something like their target date funds--equity-heavy until approx 10 years from the date distributions begin, then gradually going to assets with lower volatility. Some people might prefer to join a pool invested only in fixed income investments, etc.
The product would not replace annuities, since many people still want a guaranteed dollar amount for their coming checks. It's more of a way to improve lifetime yield on a pot of investment money by taking advantage of mortality credits (those who no longer need their money and gains pass them to those who are still alive). I don't think it would be any more unsavory or "ghoulish" than buying an annuity.

 

[Independent]

Yes. And is there some "silver lining" of additional safety for subscribers as a result of dropping that guarantee? Depending on how the tontine is structured, the subscribers could have a direct call on the value of the underlying stocks/bonds to make the annual payouts (though the value of these payouts might vary somewhat). Just as we don't count on the financial strength of Vanguard or Fido for the safety of our stock/bond portfolios they hold for us. With an annuity, since the insurance company is making the mortality and market value guarantees, the subscribers are depending entirely on the company's ability to pay.
Also, I do think these tontines would not need to be run by insurance companies at all. Regulators might find that to be more convenient, but it brings a level of costs and a bar to market entry that is inappropriate since the payments would depend only on the value of the underlying assets, not the strength of the company selling subscriptions. It's the elimination of this "pass through" that would result in the most significant cost savings.

Yes, it seems that if you take out the mortality guarantee, you don't need an insurance company.

However, I think this would require a "sponsor", probably a mutual fund company. In theory, any "group of friends" could set this up. But, look at the requirements to form a group. We would need people who all:
- think this is a good retirement income concept
- have similar mortality expectations
- agree on pure life or certain plus life?
- make the same choice regarding single life vs. joint life
- agree on a slope, do they want payouts biased to be increasing, level, or decreasing?
- Or even deferred payouts?
- have similar ideas on the "right" mix of assets
- all want to start now, not at some future date.

Then look at the practical issues of determining the "right" legal structure, assuring safekeeping of assets, getting prompt notification of deaths, doing the accounting, communicating with all the members (and their families) as questions come up, actually withdrawing funds and cutting checks.

This board is probably an ideal place to find a group of people to set one of these up. What's the odds that we could get at least nn people from this board who all answered the same way on the seven choices above?

The ideal sponsor would seem to be Vanguard, as they have a big client base and they know how to, or could learn how to, do the practical stuff above. They would be starting scores or even hundreds of tontines every quarter (I'd guess). It wouldn't be too long before they would have thousands outstanding, each pretty small. And, of course, they have to commit to continue to do this for 40 years into the future - what happens to the tontines if Vanguard decides it doesn't want to fool with them any longer? Somewhere, some regulator is going to want assurance that the sponsor isn't going to disappear with the money, or walk away from long term commitments. Looking at that list, I think the sponsor would want to charge enough to cover all those expenses and commitments.

(Note that Milevsky's concept was that the sponsor would guarantee investment performance - something that's reasonable if the investments are bonds. We've moved away from that.)

 

[calmloki]

Too much a romantic spirit. When I hear tontine I picture a fine bottle of brandy that the last surviving pilot of the band of gallant classmates cracks open to drink a toast to their memory. Not getting the sleazy part.

 

[bingybear]

What happens when one or more of the subscribers goes into LTC and runs out of funds, sans that tontine? To get medicaid to pay would they demand payment from the asset value of their share of the tontine or the just use their payout? This really goes to how it laws are written around it. Also would a subscriber's assets be protected from creditors and judgments?

If you really want to do it, why not set up a partnership (like an investment club). This would divide the taxes (K-1), proceeds, etc. The question would be how estate taxes (if any) would be taken out when a subscriber dies.

The paper on the new tontine for retirement is more interesting, but subscribers do take most of the risk (market, sequence of returns, mortality, etc).

some have asked about putting in $ from IRA/Roth, could you mix subscribers? If you bought shares like a MF, yes.. but then would accounts effects would that have on taxes and protection from creditors? How would taxes on internal gains be paid? OK, an annuity does not have taxes paid until distributed, but what legal aspect allows that?

Maybe all these and other questions are answered somewhere.

It will be interesting to see how these will be setup if they ever are in the US.

 

[samclem]

But if you think of it like a closed-end mutual fund with very restrictive withdrawal rules, and a beneficiary designation of the fund itself, it would seem like it could be made legal.

Yep. And, while the administrative expense would be somewhat higher than a "regular" CEF (due to the need to verify who is alive and who is dead), that wouldn't seem to cost very much. Annuity companies and SS do it.

The ideal sponsor would seem to be Vanguard, as they have a big client base and they know how to, or could learn how to, do the practical stuff above. They would be starting scores or even hundreds of tontines every quarter (I'd guess). It wouldn't be too long before they would have thousands outstanding, each pretty small. And, of course, they have to commit to continue to do this for 40 years into the future - what happens to the tontines if Vanguard decides it doesn't want to fool with them any longer? Somewhere, some regulator is going to want assurance that the sponsor isn't going to disappear with the money, or walk away from long term commitments. Looking at that list, I think the sponsor would want to charge enough to cover all those expenses and commitments.

These concerns are valid, but aren't insurmountable, esp if done at large scale. And there would seem to be enough value to allow the sponsor to adequately recoup costs.
Back-of-the-envelope: Let's say we set up a pool of 55 year olds who will begin collecting their longevity insurance checks at age 75. Based on a squinty-eyed look at the SS survival graph for the year 2000, of 93 people alive at age 55, 65 will still be alive at age 75, so 30% of the people have died. Thus, those remaining in the pool when the checks start can expect to receive 30% more in their lifetime than they could have received by just investing their own money in the same way. That's a pretty big delta. The average 75 year old lives another 10 years, so even if Vanguard took 1-2% off the top every year during the distribution period (the only time their costs would be significantly higher than any other account), our pool of survivors would still be well ahead of the game (plus the sponsor would get the ERs from the underlying funds in which the money was invested).

Maybe this type of thing isn't exactly in Vanguard's "no frills" lane, but Schwabb or Fido would be big enough to do it.

 

[orplanner]

But maybe the US could us this as a way to pay out debt (again this was a proposal in the early years from that paper you referenced). Would you buy into that tontine in the present day? Could pay for entitlements and everything else!

On a total lark, based on the Washington Post article, I added a basic tontine to the Optimal Retirement Planner retirement calculator (i-orp.com). The early returns are that a tontine could be a useful and interesting retirement financing tool, if it were allowed. The literature indicates that there are financial products out there that skirt on being tontines, by Vanguard and TIAA/CREF, but of course that they don't use that dirty word.

 

[pb4uski]

Wouldn't any life annuity with mortality credits be a milder version of a tontine? Just a matter of degree it seems to me.

 

[samclem]

Wouldn't any life annuity with mortality credits be a milder version of a tontine? Just a matter of degree it seems to me.

I guess, if a bond is a milder version of a stock. Like an annuity, a bond depends on an entity to pay the interest and to stay in business. Like (most) annuities, a bond has a guaranteed rate (and that guarantee comes at a price). A tontine invested in equities (or other assets) gives the surviving members a direct claim to the equities (or other assets). They also benefit directly from any price appreciation (with an annuity, any appreciation above that needed to pay claims goes to the insurance company).
So, there are some important differences.