Jun 15th 2017

Modern-day enthusiasts hope to revive an ancient financial instrument

WHEN members of a private club in Manhattan suddenly start dropping dead at an alarming rate, Matt Scudder, a private detective, suspects more might be at play than bad luck to explain the bizarre series of suicides and violent accidents. If this sounds like the back-flap of a murder mystery, your deduction skills are as sharp as Mr Scudder’s. In Lawrence Block’s “A Long Line of Dead Men,” the cunning detective eventually uncovers the motive for the killing spree: the club of 31 men were all part of a tontine.

These ancient financial instruments are built on members paying money into a pool, which is invested and then pays out dividends once they reach a pre-agreed age. Those who live longest will see their income increase as others die; the last one standing receives the most. They are essentially a form of insurance against an unexpectedly long life.

Although most people will know them from the works of Agatha Christie or Robert Louis Stevenson, tontines were once real. Originally dreamed up by Lorenzo de Tonti, an exiled Italian banker in France, by the late 17th century the instruments became a tool for European kings to raise funds for wars or to pay off debts. Adam Smith wrote in “The Wealth of Nations” that governments would be wise to raise funds in such a way because they appealed to people’s gambling spirits, allowing governments to borrow at a lower rate. By the turn of the 20th century, according to a study in 1987 by Roger Ransom and Richard Sutch, two academics, as many as half of American households may have been saving for retirement via tontine insurance, a variation of the product that combines life insurance with a tontine.

But too much of a good thing led to excesses, fraud and mismanagement and by 1905 these insurance products were banned in New York state, with other states following soon after. Tontines in their purest form had already been banned in Britain under the Life Assurance Act of 1774, primarily because of the perverse incentives inherent in a product that offers benefits when others die. Although there is no known evidence that tontines inspired murder plots, they did encourage fraud. Moshe Milevsky, of the Schulich School of Business in Canada, has uncovered data that suggest parents in 17th-century Britain would take out a tontine, nominate a child and if the child died, as was all too common, simply give another child the same name so as not to forgo their dividend. This led to lower-than-expected returns.

Despite their troubled past and negative portrayal in popular fiction, tontines—or a modern variant—may just make a comeback. A small but increasingly voluble group of academics, as well as some asset managers and actuaries, think that an adapted form of tontine might be just the product to provide insurance against the risk of outliving one’s savings, an issue with which retirement planners, corporations and governments around the world are struggling to cope.

Pooling lives has always been one of the most cost-effective ways to cover such longevity risk. “It’s what’s missing in the current DC [defined-contribution pensions] set-ups; nothing has replaced the old longevity pool which the employer used to form,” says Chip Castille of BlackRock, an asset manager. Although annuities offer a guaranteed lifetime income, they are relatively expensive because their issuers must hold a large capital buffer. Retired people tend not to like them as they pay a low rate. Tontines are simple to understand and could be much less costly than annuities because the risks are not taken onto the balance-sheet of an insurer.

Enthusiasts believe modern technology and data-crunching could help overcome the instrument’s shortcomings. Electronic records make it easier to verify whether someone is dead; crowdfunding could help source a tontine pool; and the blockchain, a type of decentralised ledger, could anonymise it (and thus avert any murder plots). “The eventual disruption will come not from a traditional asset manager, but from a 22-year-old kid in Silicon Valley,” predicts Mr Milevsky, who has seen the number of tontine-related patent applications increase recently. Tontines are a thing of the past. But they may yet come back from the grave.