What Is a Tontine? Should You Invest In One?

Ruth Saldanha: Last month, Canadian investors, specifically retirees or soon-to-be retirees, were given access to a new type of product called the modern tontine. Now, tontines originated in Europe in the 1650s and were designed as an annuity that was shared among subscribers, with each subscriber's share increasing as the others died, until finally the last survivor got the whole pot. The modern tontine works a little differently. To explain how and also whether you should consider this type of product at all, we have Spencer Look, Associate Director of Retirement Studies at Morningstar here with us. Spencer, thank you so much for being here today.

Spencer Look: Thank you. Thank you so much for having me. I'm excited to be here.

What is a Tontine?

Saldanha: So, what's a modern tontine and how does it differ from the original?

Look: So, I think, I'll start by saying that the modern tontine and the original tontine, the underlying premise has actually stayed much the same. Really, in both cases, a group of participants in the tontine will pull their assets together and then payments out of the tontine are going to be in some way contingent or based on survivorship of that original group of individuals. So, kind of the same underlying premise. Earlier tontines, though, were characterized, or a common feature was that payments would start pretty low and then increase overtime as individuals in that group pass away. This is, obviously, not probably the desired income stream for most retirees. And so, the modern tontine has improved upon that by with actuarial techniques providing a feature that can be designed to provide a targeted, smooth payout rate for all survivors in the pool. So, that obviously makes the modern tontine a lot more viable for retirement investors. Modern tontines can also have annuity-like features, like a death benefit feature and even a feature that could allow for participants in the tontine to liquidate their shares in the tontine. So, definitely, some major enhancements that make it more viable for retirees today.

Is a Tontine Better than a Target Date Fund?

Saldanha: Now, the aim of this type of product is to decumulate and generate a steady cash flow while also adding a layer of survivorship benefit. Now, what I wanted to understand is, isn't that just a target date fund with an added layer of longevity risk? Why would this product be better than, say, a target date fund?

Look: Yeah. So, some of the marketing and some of the messaging for both of those products may sound very similar, focused on income. But with tontines, there's a key difference and that's that the payments are going to be directly linked to how many of the individuals in the group have survived overtime. This is part of a concept called risk pooling. It's actually the same concept that underlies annuities, just applied a little bit differently. With risk pooling, the way it works is that the group of individuals come together, and they pool their longevity risk, and with this method, those who pass away earlier affectively some of their capital will subsidize the payments to those who live longer. So, it's something that allows – like, this method allows tontines to provide higher payouts or higher expected payouts than an investment product. And I think that's where a tontine has a potential leg up on a target date fund or a retirement fund.

Is a Tontine the Best Way to Get Income in Retirement?

Saldanha: Why would an investor looking for cashflows choose this relatively complicated product rather an simpler, retirement ETF that has say a targeted 4% or 6% per annum return?

Look: I think that's a great question. I think it really does go back to the impact of risk pooling or that survivorship benefit. It may sound like a slight nuance or not a major differentiator, but the impact can be quite significant. And so, while the actual impact will, of course, vary by the specific product features, the capital market environment, the group's mortality experience, they can provide payouts that are 1%, 2% or even more than a retirement fund without that survivorship benefit.

Is a Tontine an Annuity?

Saldanha: Is this another type of an annuity?

Look: So, the industry doesn't do a great job here. Sometimes tontines are referred to as tontine annuities. So, there is definitely overlap. But the way the products typically work there is a key difference. So, with tontines, the group of participants are going to share the investment and the mortality experience collectively. And so, what this means is that if investment returns are quite low, tontine payments will go down. And similarly, if the group of individuals in the tontine, if a large portion lived longer than expected, tontine payments will have to go down. There's no insurance or guarantee with a tontine. With annuities – and I'll use a fixed single premium immediate annuity in my example – the fixed single premium immediate annuity – the payments are fixed and guaranteed for life. So, if investment returns are poor or if a large portion of the group of individuals in an insurance company's book of business live longer, in both cases, the payments will stay the same, they're not going to go down. So, that's kind of the key difference here between an annuity and a tontine.

Should I Buy a Tontine?

Saldanha: What type of investor should consider this product?

Look: I think it's a pretty broadly applicable product. As more of these products are designed, obviously, the key features and the nuances with them are important to understand and look into. But they are broadly applicable for investors looking for a way to generate an income stream in retirement. And so, some of the key considerations though compared to a retirement ETF or something similar – as I mentioned earlier, if you invest in a tontine, there has to be an understanding that if you do pass away earlier, some of your funds may be used to help others who are other members of the tontine. And then, comparing it to like an annuity product, investors just need to be aware that there is no explicit insurance guarantee. And so, a tontine will have a higher expected payout than an annuity but does not have that insurance aspect. So, another thing for investors to consider when looking at these types of products.

Saldanha: Thanks so much for being here, Spencer!

Look: Well, thank you. Thank you so much for having me.

Saldanha: For Morningstar, I’m Ruth Saldanha