By: Richard Fullmer
Richard Fullmer is Actuarial Strategist and Director of Asset Allocation, Tontine Trust, and Founder of Nuova Longevità Tontine Research.
Fintech innovators have the multi-trillion-dollar global retirement income market in their sights. An exciting example is the advent of blockchain-secured tontines as an alternative to traditional pensions and annuities.
What in the World is a Tontine?
A tontine is an investment pool managed in an actuarially fair way, according to a plan for distributing fully-funded payouts to investors. There are two key differences between a tontine and an ordinary investment. First, tontines investments are generally irrevocable. Second, account balances are not transferred to a member’s beneficiaries upon death. Instead, remaining assets are equitably apportioned among the pool’s surviving participants. Accordingly, monies forfeited by those who die increase the returns to those who survive.
These extra returns are referred to as “mortality credits.” In this way, tontines allow members to collect lifetime income by collectively self-pooling longevity risk among themselves. This obviates the need for (and cost of) an insurer as guarantor. Tontines are not insurance, though they can deliver lifetime income similar to payout annuities and pensions. Tontines simply cut out the middleman.
A key feature of a tontine is that it can never be underfunded, since – unlike many defined benefit pension plans – no explicit financial promises or guarantees are made without assets to back them. Critically, tontines make no explicit payout promises: instead, the benefits they pay adjust up or down in a continually self-correcting manner, ensuring that the present value of a tontine’s payouts never exceeds the present value of its assets. Tontines can never become underfunded!
Where do Tontines Come From?
Tontines originated in Europe in 1653 as government-sponsored programs. Later, insurers began to offer them as “tontine insurance” policies. Unfortunately, many of these were non-transparent and some issuers took advantage of this by misappropriating assets. Insurance regulators stepped in to stop the misuse, and tontine insurance faded away in the United States.
But that was then, and times have changed. Financial regulation is now far stronger. Recordkeeping, custody, and auditing systems have improved. Crucially, fintech innovations now offer further improvements in efficiency, security, and transparency for this product whose time has come again.
Why is the Time Ripe for Tontines Again?
Academics have long advocated for tontines as an efficient retirement income solution. Yet financial services companies have largely resisted the call, perhaps daunted by the uncertain regulatory environment or a desire to protect their customary business models. Enter fintech venture capitalists who see opportunity in the retirement marketplace, where millions deserve better solutions.
To be successful, tontine providers must reestablish the trust of investors, sponsors, and regulators. This is where blockchain technology comes into play. A blockchain is a continuous ledger that keeps a permanent record of all transactions in chronological order. Blockchain technology promotes security and transparency by providing an immutable and public log of all contributions, payout distributions, fees, and expense payments. Transparency of a tontine’s financial ledger allows regulators, analysts, and indeed anyone to audit its operations and status at any time. Accordingly, while tontines of the past were opaque and thereby susceptible to misappropriation, tontines of the future will be openly transparent.
One venture actively working to bring back tontines is the Gibraltar-based Tontine Trust. This company’s mission is to create secure, low cost, highly transparent lifetime income solutions via tontines invested passively in a highly diversified set of exchange traded funds (ETFs). The firm utilizes blockchain technology with pseudonymous immutable ledgers and biometric authentication, providing full transparency into every transaction with privacy protection.
The fintech revolution is rapidly changing the financial services industry, most notably in the banking sector where blockchain-based technologies are upending traditional business models by facilitating near-instantaneous financial transactions anywhere in the world at near zero cost, cutting out banks as a middleman.
Technology now presents an opportunity to build efficient new ways to protect old-age consumption. Tontine providers must still clear significant regulatory hurdles, yet this innovation holds immense potential to disrupt the industry. Defined contribution plan sponsors may find tontines attractive as low-cost lifetime income solutions for plan participants, unburdened by the potential fiduciary liability that comes with selecting a guarantor. Defined benefit plan sponsors may find them attractive as a low-cost way to take risk off their books. Tontine plan sponsors bear no investment risk, no longevity risk, and no underfunding risk.
Consumer choice is good for society. Let’s bring tontines back, better than ever.
This piece was originally posted on January 30, 2018, on the Pension Research Council’s curated Forbes blog. To view the original posting, click here.
Views of our Guest Bloggers are theirs alone, and not of the Pension Research Council, the Wharton School, or the University of Pennsylvania.