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.
The American twist on the tontine emerged in 1859. Henry B. Hyde, who founded what is now the insurance company AXA Equitable Life, designed a hybrid tontine that blended life insurance with a retirement scheme. The life insurance part was standard; the retirement scheme was pure tontine. As people got older and older, their retirement payments would escalate as more of their peers died.
This retirement tontine came at a critical moment, says economic historian Richard Sutch. The American economy was rapidly industrializing, which was creating a new problem: What to do with all the old people?
“In the agricultural economy, the system to support people in old age was children,” he says. “Children were expected to take care of their elderly parents.” That was not so difficult when parents lived with their children and could also help out with light work around the farm.
But the new urban factory jobs were completely different. “These were often debilitating, strenuous occupations,” Sutch says. “People couldn't work in their old age.”
As families started to disperse, cultural attitudes about filial obligation began to change. “The new ethic was that a man wasn't going to be a burden on his children,” Sutch says. “He was going to take care of himself.”
But how? There were banks, but the interest rates were disappointing. Furthermore, there was the fear that a man might outlive his savings. The tontine, which offered to pay you until you died, was a comforting guarantee. The fact that the payments would grow over time was an added perk.
By the late 1800s, newspapers were running breathless ads about tontines: “The adaptation of the Tontine principle to life insurance … has done more to place the society in its present position than all other causes,” claimed Equitable Life in 1892 in the Spokane Daily Chronicle. For regular retirees, tontine arrangements paid better than any other available investment. For financial institutions, they were a much-needed hit product.
“At the time tontine insurance was as ubiquitous and familiar to Americans as the mutual fund or mortgage is today,” Milevsky writes.
The popularity of tontines would be their downfall. Tontines raised so much money for insurance companies that the industry attracted intense scrutiny. Much of the suspicion was warranted. There was rampant shadiness back in the day, including countless swindles perpetrated on the public, both related and unrelated to the tontine. Bribery of newspapers and politicians was also routine, as was embezzlement and plain theft. Magazine exposés riled the public with stories of secret payments and secret blackmail of public officials.
The nature of the tontine also made many uneasy. “The form may be fitly characterized as the gambling form, inasmuch as the only hope of profit to a few is that the many will be robbed of their savings,” wrote a critic in 1886, according to law historian Kent McKeever in his history of the tontine.
In 1906, New York state launched a major investigation into the insurance market that resulted in the banning of tontines. As Sutch, the economist, and his colleague Roger Ransom argue, this was an overreaction.
They wrote in a 1987 paper:
Considered as a financial innovation, [the tontine] was very successful. Considered as insurance, it was actuarially sound. Considered as a gamble, it was a fair bet in as much as there was no percentage for the house beyond a charge to cover administrative costs. Considered as a life-cycle asset, it proved to be an excellent investment, earning a rate of return substantially in excess of that generally available on other assets.
Soon, other states were passing their own bans, and the tontine would not be heard from again.
The demise of the American tontine, Sutch says, may well be credited for the rise of another peculiarly American institution: the corporate pension. But today, with pensions on the decline, there are few guarantees left in modern retirement. Most people now rely on Social Security and savings accounts. A common headache is figuring out how slowly retirees should spend their nest eggs. No matter how frugally they live, there’s always the risk that they’ll survive surprisingly long and end up utterly broke.
Economists have long said that the rational thing to do is to buy an annuity. At retirement age, you could pay an insurance company $100,000 in return for some $5,000-6,000 a year in guaranteed payments until you die. But most people don’t do that. For decades, economists have been trying to figure out why.
James Poterba, an economics professor at MIT who has extensively studied American retirement, says it’s still a mystery why annuities are so unpopular. A number of theories have been advanced — people might like to leave some money for their children, or they might worry about medical expenses late in life. Poterba and his colleagues have also pointed out that Social Security is already like an annuity, promising constant payments for life.
But there’s also some evidence that people just irrationally dislike annuities. As behavioral economist Richard Thaler wrote in the New York Times: “Rather than viewing an annuity as providing insurance in the event that one lives past 85 or 90, most people seem to consider buying an annuity as a gamble, in which one has to live a certain number of years just to break even.”
Here is where tontines come in. If people irrationally fear annuities because they seem like a gamble on one's own life, history suggests that they irrationally loved tontines because they see tontines as a gamble on other people's lives.
A simple modern tontine might look like this: At retirement, you and a bunch of other people each chip in $2o,000 to buy a ton of mutual funds or stocks or whatever. Every year, the group withdraws a predetermined amount and divides it among the remaining survivors. You might get a bonus one year, for instance, because Frank and Denise died.
Suzanne Shu, an associate professor at UCLA's business school, argues that such an arrangement can feel more psychologically fair. Retirees often object to annuities because they worry about not living long enough to make the money back. This is the nightmare scenario: If someone dies the day after she buys an annuity, the insurance company walks away with the cash scot-free. In a tontine, that money passes on to help fund other people's retirements. (Depending on how psychopathic you are, this is either a positive feature or a murder incentive.)
To think about it a different way, a tontine is like an annuity in which the middleman has been cut out -- another advantage that tontines have over annuities, proponents say.
Annuities are expensive to administer, and so their payouts are rather low. The costs stem in part from paying the insurance company to shoulder all the risk. To guarantee it can make good on all its annuity contracts, the insurer has to set aside a lot of money in reserve — just in case people live longer than expected, or in case the market crashes.
A tontine does away with all that overhead, so more money is available to the retirees. By Milevsky's calculations, a tontine might offer a 10 percent to 20 percent premium over an annuity — a bigger pie to be divided among the group. The downside is that retirees would see their payouts fluctuate depending on the various times other people in the tontine group died. Compared to an annuity, a tontine abandons certain payouts for much higher returns.
Recently, in the University of Pennsylvania Law Review, Jonathan Forman, a law professor at the University of Oklahoma, and Michael Sabin make the case that existing large pension organizations like the California Public Employees' Retirement System might switch to a tontine-like model. Instead of setting aside so much money to make sure all the pensions are fully funded, why not let the pension payouts vary? If people are dying faster than anticipated, redistribute their shares so that the remaining pensioners get slightly larger checks. If people are dying slower than anticipated, shrink those pension checks a bit.
Such a system would be cheaper to operate and would always, by definition, be fully funded. The funny thing is that some retirement systems already carry out a version of that process. As Milevsky documents in his book, there is "tontine thinking" embedded in various national pension schemes, and even in a product offered by TIAA-CREF in the United States. These plans adjust payments according to mortality. They just don't use the word tontine.
Tontines are a bit like the dinosaurs of the retirement world. They perished in a dramatic extinction event, but their DNA lives on in many of the financial products we see today. Tontines were some of the first popular ways to save for retirement, and historians say their demise left the door open for corporate pensions, and Social Security, which continued the tontine promise of a guaranteed retirement.
Milevsky's point is that it's time for tontines to return again on the private market. He envisions tontines competing against annuities and longevity insurance and all the other products available to people hoping to smooth out the last stretch of their lives. He's certain many people would find them appealing.
"Look, I’ve got thousands of mutual fund that I can choose from." he says. "I’ve got like 800 ETFs that I can buy. I’ve got God knows how many different investment accounts. Give me some choice at retirement. That’s really my point."