The Tontine Building on Wall Street in New York in 1797. Tontines have resurfaced recently in new investment products.ilbusca/iStockPhoto / Getty Images
This is the third article in a four-part series examining the decumulation product landscape in Canada and how advisors can explain the options to clients. Read Part 1 here and Part 2 here and Part 4 here.
Tontines date back to 1653, when they were invented by their namesake, Lorenzo de Tonti. But until recently, they hadn’t been seen for more than a century.
A tontine is a mortality risk-pooling arrangement. People enter into an agreement in which they forfeit all or part of the investment pool when they die. The survivors benefit by receiving a share at the end of a period or as part of an ongoing payment. This additional benefit beyond their return is known as mortality credits.
While many may take issue with the concept of benefiting financially from the death of others, this concept is at the core of what makes annuities and defined-benefit pension plans more affordable for members.
Anyone can access mortality credits through an annuity, but what makes a tontine different is that it doesn’t pay guaranteed amounts; instead, the payments are based on the performance of the underlying assets and the mortality results of the pool. And whereas with annuities the insurance company assumes that risk and charges for it, the risk is shared by the members of the tontine. That means there’s less certainty in payments, but there’s also more potential upside for the members because they retain the profit the insurance company would otherwise take.
Tontines became a reality in Canada in the spring of 2021 when Purpose Investments Inc. launched Purpose Longevity Fund. The following year Guardian Capital Group Ltd., with the aid of longtime tontine advocate Moshe Milevsky of York University, launched its Modern Tontine Trust.
While both products are tontines, they take very different approaches to using mortality credits.
The Purpose product is a fund designed to make monthly income distributions at a sustainable level determined by its committee. It’s based on actuarial assumptions about how long the people in the pool will live, market returns and volatility. While distributions would initially be made up largely of market returns and, if need be, return of capital, over time, more and more of the distributions will be made up of mortality credits. Should an investor pass away, they would be entitled to receive the lessor of the market value of the fund or net deposits.
The Guardian product, on the other hand, is a balloon payment. The fund will last for 20 years, and at the end of the 20 years, the survivors split the total value of the fund. Anyone who dies or cashes out before then will receive part of the value of their account, starting at 95 per cent in year one and dropping to 50 per cent in year 20. The idea is that as the pot grows, a lower percentage is needed to refund an amount close to the initial investment.
Guardian also offers a version of this product that combines it with a managed income portfolio that makes annual distributions during 20 years, with the idea being that in year 20, the managed income portion is eroded to near zero, just when the tontine pays out. By doing this, Guardian has allowed investors to select either a pure tontine or a hybrid that provides cash flow.
Using a tontine
Take a 65-year-old couple retiring today with full CPP and OAS benefits, combined RRSPs totalling $1.36-million and earning 5.22 per cent annually, who spend $100,000 a year adjusted for inflation. The couple bounces their first cheque in the year they turn 95.
So, how can a tontine help?
If the couple were to have invested $200,000 each in the Purpose fund on Jan. 1 of this year, they would again succeed in financing their retirement to 95. But in this case, they have an estimated estate of approximately $280,000. Also, if they lived beyond 95, they would continue to benefit from additional mortality credits.
In the case of Guardian, the same couple could invest approximately $100,000 each in the tontine. This amount is lower than in the Purpose fund as the investment in the tontine will not be available to fund retirement expenses for 20 years, and the remaining funds are needed to finance their retirement until then, (with a little extra to account for volatility). After 20 years, the couple would have a projected payout at 6 per cent rate of return of $456,636 each at 85, of which 30 per cent would be mortality credits. At age 95, their projected estate would be worth $153,000.
Overall, the result is about identical for the two products, with an estimated estate value per dollar invested of $1.40 for Purpose and $1.53 for Guardian over a 30-year period.
Unfortunately, it’s impossible to apply Monte Carlo analysis properly to these products with current financial planning software, but both products give investors access to something they can’t get in conventional portfolios: mortality credits. When it comes to hedging longevity risk, that’s exactly what investors need.
Next week, we finish the series by looking at the challenges advisors face when modelling decumulation products.
Jason Pereira is a senior partner and financial planner at Woodgate Financial Inc. in Toronto.