Those who are just beginning their retirement journey – or considering it in the near future – undoubtedly know the anxieties that come along with it. In the absence of an inflation-indexed defined benefit pension plan, the good news of increasing longevity may prove to be a double-edged sword. And as the turbulent markets of the first quarter of 2018 sharply reminded us, defined contribution pensions, RRSPs and RRIFs, which rise and fall with the stock market, are no substitute for a “real” pension.
As finance professor and author Moshe Milevsky often reminds us, a “real” retirement provides a guaranteed lifetime income, no matter how long you live. And the closest thing to a “real” defined benefit retirement plan is building your own retirement with annuities. We’ve looked at this topic more than once here, but in this column we explore something that might be better than an annuity.
READ: An annuity that pays off if you live long enough
It turns out that solution 21street The situation of a retiree without a “real” pension could have been invented as early as the 17th centuryvol age. Yes, we’re talking about tontine, a topic that Milevsky champions in academic articles and that will hopefully be taken up by the financial industry in Canada, if not the world. For example, there is a “tontine annuity” program implemented in Johannesburg by the company NOBUNTU and even tontine trust using blockchain technology.
So tontines are of more than academic importance, even as scientists like Milevsky try to interest government and industry in bringing them to market. Milevsky and three other Canadian co-authors have just published a paper partially funded by the Pension Section of the American Society of Actuaries titled Renty versus tontine in the 21st centurystreet Age: A Canadian case study. (The other authors are Thomas Salisbury, Gabriela Gonzales and Hanna Jankowski). In it, they advocate for reintroducing retirement investment income tonnes (RIT) into the modern financial supermarket.
What exactly is tontine, you ask?
So first, a reminder about tontines. Tontines are mortality-linked investments that superficially resemble annuities (particularly the Single Premium Income Annuity, SPIA), but were actually quite popular in Europe in the 17th century.vol and 18vol century and later in America. But they fell into disrepute in the early 1920svol century, partly due to the seedy image they received, often popularized by novels and films such as Wrong box. The “longest-lived” winner takes the jackpot, so creative artists often use it as a skulduggery plot device.
READ: Future Pension Plan 1/2
In short, tontines pool capital and distribute all capital and investment gains to those who live the longest: those who are unlucky enough to die early lose their capital (i.e., their heirs lose it), while those who live the longest benefit from super profits. Milevsky says the easiest way to describe a tontine is as a very long-term, coupon-bearing bond purchased by a group of people who agree to share the coupons for as long as they live. The dead lose their property to the survivors. The article compared the returns on regular annuities to tontine annuities, and while it’s not a revelation, generally speaking, tontine annuities perform better for those who “win” the super-longevity risk. (“lottery for centenarians” by some cynics).
While both tontine annuities and conventional annuities offer lifetime income and longevity risk, the mechanisms, cash flows and costs to investors are completely different, the article claims. When insurance companies price annuities, they must include margin for error in the longevity model in case longevity improvements continue to occur in the future. The authors warn that in the future, annuity issuers may need to hold more capital and reserves against this aggregate longevity risk, which means, relatively speaking, annuities would become even more expensive for consumers.
By contrast, tontines are easier to administer, cleaner, and less capital-intensive, and can be expected to generate increasing streams of payments over time, at least for those who live long enough to benefit from the higher mortality credits they provide. In a classic tontine, payments are initially quite low – at best comparable to a bond’s risk-free rate – and “certainly lower than what an annuity would offer.” But as retirees die, tontines become more attractive to those who survive. The last few survivors could receive 10 times what they paid into the program.
We want Jared’s tontine. Not Lorenzo
Milevsky et al. they distinguish between the classic Lorenzo Tonti schemes (in which payments increase exponentially) and “natural” or (Jared) tontines; In the case of natural tontine, the payout to the pool falls in exact proportion to the expected probability of survival.
READ: Future 2/2 retirement plan
While a Tontine recovery could make sense anywhere in the world – retirement and longevity trends are almost universal – they make particular sense in Canada. The authors state that they “believe there is a lack of personal risk protection products in Canada compared to the U.S. market.” They know of no Canadian insurance company offering a true deferred income annuity (DIA or ALDA), or a variable income annuity or equity indexed annuity with life benefits: all available in the US. Segregated funds are the closest we come to, and they’re really not that great in terms of guaranteeing a lifetime income, Milevsky says.
Ironically, one of the reasons Canadians have far fewer choices in the retirement income financial supermarket is that DB pensions have been common for a long time: at least in government circles. Additionally, Canada is the country that first invented exchange-traded funds (ETFs), which are now replacing mutual funds. Why not continue the revolution in annuities and tontine-style retirement vehicles?
Milevsky et al. They are NOT advocating the resurrection of the Lorenzo investment tontine, but are exploring the possibility of flattening tontine payments over time by investing the initial funds in a portfolio of risk-free bonds whose coupons or maturity value decline naturally over time.
READ: Excerpt from Mosze Milewski’s book “King William’s Tontine”.
Of course, the entire article is over 40 pages long and raises many theoretical and practical issues that we cannot summarize here. The bibliography lists at least 10 different proposals or programs in this style, most of which use assets other than the conservative fixed income bonds cited in Milevsky’s article. They acknowledge that using these other assets as a primary investment vehicle would be a natural next step if 21street century-old tontine is revived and commercialized.
This is certainly something that governments and the pensions industry need to look at. As the authors note, the bottom line is that “as a result of tontine’s skewed returns, we find that tontine provides an additional advantage in hedging against risks (personal, retirement) that are difficult to insure otherwise.”
Sounds like a possible solution to retirement anxiety that many long-lived baby boomers without DB pensions have been looking for!
The founder of the company is Jonathan Chevreau Center for Financial IndependenceAuthor Independence Day and co-author of Victory Lap Retirement. He can be contacted at (email protected)
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