Wednesday, June 8, 2016

It’s Sleazy, It’s Totally Illegal, and Yet It Could Become the Future of Retirement

Over 100 years ago in America — before Social Security, before IRAs, corporate pensions and 401(k)s — there was a ludicrously popular (and somewhat sleazy) retirement scheme called the tontine.

At their peak, around the turn of the century, tontines represented nearly two-thirds of the American insurance market, holding about 7.5 percent of national wealth. It’s estimated that by 1905, there were 9 million tontine policies active in a nation of only 18 million households. Tontines became so popular that historians credit them for single-handedly underwriting the ascendance of the American insurance industry.

The downfall of the tontine was equally dramatic. Not long after 1900, a spectacular set of scandals wiped the tontine from the nation’s consciousness. To this day, tontines remain outlawed, and their name is synonymous with greed and corruption. Their memory lives on mostly in fiction, where they invariably propel some murderous plot. (There’s even a "Simpsons" episode in this genre.)

Tontines, you see, operate on a morbid principle: You buy into a tontine alongside many other investors. The entire group is paid at regular intervals. The key twist: As your fellow investors die, their share of the payout gets redistributed to the remaining survivors.

In a tontine, the longer you live, the larger your profits — but you are profiting precisely off other people’s deaths. Even in their heyday, tontines were regarded as somewhat repugnant for this reason.

Now, a growing chorus of economists and lawyers is wondering if the world wasn’t too hasty in turning its back on tontines. These financial arrangements, they say, have aspects that make a lot of sense despite their history of disrepute.

Some academics even argue that with a few new upgrades, a modern tontine would be particularly suited to soothing the frustrations of 21st-century retirement. It could help people properly finance their final years of life, a time that is often wracked with terribly irrational choices. Tontines could even be a cheaper, less risky way for companies to resurrect the pension.

“This might be the iPhone of retirement products,” says Moshe Milevsky, an associate professor of finance at York University in Toronto who has become one of the tontine’s most outspoken boosters.

Though they seem alien today, tontines have a storied pedigree that reaches back at least half a millennium. The name comes from an Italian financier, Lorenzo de Tonti, who perhaps did not invent the tontine but did famously pitch a tontine scheme to the French government in the 17th century as a way for King Louis XIV to raise money. Historians suggest that Tonti’s idea originated with folk ways of finance in his native country. The idea didn’t catch on at first, and Tonti eventually landed in the Bastille (while his son, an explorer, would eventually help found the city of Detroit).

A few decades later, though, tontines became widespread in Europe. This is because royal financing in the late Middle Ages was a tricky thing. Taxes were often out of the question, so European monarchs borrowed to fund their internecine wars.

Back then, if you paid the king 100 pounds, he might promise to pay it all back to you with interest over the course of a dozen years — that would be a bond. Or the king might make small annual payments to you and descendants for the rest of eternity — that would be a perpetuity. Or the king might make you slightly larger annual payments until you died — that would be an annuity.

For denizens of the realm, tontines were a very popular twist on the annuity because they appealed to the gambling spirit. An annuity would pay you a steady trickle of money (boring). A tontine would pay you more and more as time went on because other people would be dying and you would be accumulating their shares.

It was the ultimate lottery. If you died, you lost everything in a tontine. But if you were the last person standing, you stood to collect huge annual payments.

Kings loved tontines because they could get away with paying out a lot less since everyone counted on being alive — and collecting the big bucks — at the end of the scheme.

These arrangements were so widespread in the 18th century that the young United States almost ran a tontine itself: Alexander Hamilton proposed a tontine to pay down national debt after the Revolutionary War. Though his idea was rejected, local communities often set up tontines in Colonial times to raise money for large projects. Scattered in cities all along the East Coast, including in the nation’s capital, there have been buildings that were financed through a tontine. Some roads continue to bear the name Tontine, a sign of how they were paid for.

Milevsky, who recently published a history of the tontine, emphasizes that it was not originally envisioned as a retirement scheme. The tontine of the 1700s was a financing trick that owed its popularity to the human tendency for optimism. The seductive risk of a tontine is one of its defining features — a feature that may sorely be needed today, for entirely different reasons.

by Jeff Guo, Washington Post |  Read more:
Image: Shutterstock