What is a Tontine?
According to the Oxford English Dictionary a “tontine” is: “A financial scheme by which the subscribers to a loan or common fund receive each an annuity during his life, which increases as their number is diminished by death, till the last survivor enjoys the whole income; also applied to the share or right of each subscriber.”1
In simpler terms tontine is an investment scheme in which so called shareholders create a common investment pool and derive some form of profit or benefit (usually financial) while they are alive. After the death of the shareholder his/her share gets split between the surviving shareholders in the pool and is not subject to inheritance rights. Tontine investment comes to an end when the number of surviving shareholders in the pool reaches a previously agreed on, small number.
As an example, imagine if 10 people were to put $1,000 each into a tontine pool, with a 6% annual “dividend.”
- Total contribution equals $10,000
- Annual dividend 6% of $10,000 = $600
If all 10 shareholders in the pool are alive each one of them will annually receive 1/10 of $600 = $60 (which is also equal to 6% payout of their original $1,000 investment). As the number of surviving shareholders in the pool decreases, the amount of dividend per shareholder increases. If, for example, 5 out of 10 shareholders in the pool are alive annual $600 dividend is now split between 5 of them instead of the original 10. Now each one of the 5 surviving shareholders gets $120 annually (which is equal to 12% payout of their original $1,000 investment).
First “tontine” was proposed in 1653 by Italian political exile and financial consultant to the French crown, Lorenzo de Tonti, whose last name also gave tontine its name. Back in 1600s Kings needed money to finance war and support their military, to raise funds they increased taxes and issued bonds. Bonds were expensive and taxes can only be raised to a certain point, before a riot starts. The goal of the tontine proposal was to provide King Louis XIV with an alternative way to borrow money to finance war.2
According to Tonti’s plan, which is the basis for all tontine schemes developed ever since, French government will issue shares, with 20 million principal, at the price of 300 livre per share with a 5% initial annual interest (15 livres per share).3 Investors/shareholders could choose either their life, or the life of a third party (nominee) as the life in interest for their stake in the tontine. Participation was structured in groups of equal sizes (classes) according to age of the nominee, 0-7, 8-14 etc. all the way through the age of 63. The rate of interest increased with the age of the nominee. If nominee, their share, or the share of the shareholder who chose the nominee became null, his/her payments will get redistributed among the surviving investors in that class. On the death of the last investor, the capital would revert to the government.4
Tonti did not just propose the financial aspect of the plan, he also made guidelines for administrative matters, such as fraudulent behavior on the part of the investors. For example, whistleblower that uncovered fraudulent behavior (for example, substitution of the initial investor by his/her heir) was entitled to 1/3 of the ten thousand livre fine.5 The Royal Edict featuring the plan also talked about other benefits, besides financial, that shareholders can extract via purchasing a tontine, which will help market it to the public. For example, Tonti talked about how owning a tontine dependent on your own life would encourage people around you to take better care of you, so they can get benefit from your tontine payments. He also talks about how purchasing tontine for your children will allow them to not worry about education etc., because tontine payments will ensure that that your children will not need a job to support themselves.6
Lorenzo de Tonti’s proposal did not take off, the first operating tontine was established in 1670 in Holland. In France the first national tontine was created only in 1689, five years after the death of the Lorenzo de Tonti and almost forty years after Tonti’s original proposal.7
There are some historians who suggest that Tonti’s idea was not original, that he got the idea for tontine from the charitable bridal scheme called montes pietatis, very popular in Italy and Germany. According to this scheme, when a daughter was born, her parents invested a certain amount of money with a bank (monte), in her name. Monte invested and managed said money for eighteen years, after which the money was given to the named daughter as a dowry. What made this arrangement different from the regular investment account is that, if the girl 1) married before the age of eighteen or 2) died before the age of eighteen, the investment was transferred to a younger daughter. If there was no younger daughter, the money went back to montes fund and was redistributed to other survivors.8
Today, tontine like arrangements are still used in France, especially for estate planning. “TontineTrust”, a company based in Gibraltar is creating tontine products using blockchain and smart contract technologies to prevent fraud and maximize payouts.9
Types of Tontine
Although the original purpose of tontine was to provide an alternative way for the government to borrow money, it later evolved and was used for other different purposes.
- Project Finance Tontine and Tontine Clubs
Tontine was used all over the world for project finance, specifically municipal improvements including both public and private buildings and what is now known as urban renewal. The structure of this tontine was very similar to the basic tontine structure explained above, shareholders would invest in a common pool, used to build a certain property or properties, and they will be entitled to rents and any other income generated by the property. Following the classic tontine structure shareholders would also pick a nominee, whose life will be the basis for receiving their tontine payments.
One of the most famous tontine buildings in the U.S. was the “Tontine Coffee House” in Manhattan, the first real home of what later became the New York Stock Exchange. The tontine was proposed in 1790 and completed 2 years later in 1972. 203 shares were sold at 200 per share, the young lives nominated were also tontine’s shareholders who were receiving the rents and any other income generated by the property. According to the terms of the tontine, the dissolution was triggered when only seven nominees remained alive. The shares also had tontine derivatives feature, meaning they could have been sold by the original nominee, but the status of the share remained dependent on their lives. The building was torn down and replaced in the middle of 1950s, when only 51 shareholders remained. After the triggering death in 1970s the property was sold at a court ordered auction for $138,550, much less than expected.10
Tontine was also used to structure clubs, like “Livingston Sportsmen’s Association”. This New York club was organized upon “tontine” principle, where 45 original members were entitled to enjoy members rights and privileges and could lose their tontine right by the reason of death, resignation or failure to pay dues and assessments. Members were also responsible for managing the club and making other major decision.11
- Estate Planning and Insurance
Tontine was and in come countries still is (ex. France) a very popular estate planning tool, created mostly as a way around rules against entitlement.12
An English will from 1871, gives an example of such use. A property known as a “Sandwich Farm” near Apsley, Tasmania was divided the following way: 2/3 was left in trust to two brothers residing in Melbourne, Australia and 1/3 was left to the last of 22 residual legatees, nieces and nephews of the testator. The residual legatees had to divide the income from the farm until only one of them was left.13
Last, all over the world, including the U.S. tontine was used as a form of social or retirement insurance. In France short term (5-20 years) tontine retirement insurance was called “banques de prevoyance” and was very popular among military men. Their thinking was that they do not need money if they die at the battle field, but if they do not, they will have a well provided retirement. In British Isles, tontines were used by Burial Societies, who provided burial insurance (e.g., provide a decent and religiously correct funeral for their members and their families).14 In the 19th century United States a tontine insurance, known as “deferred dividend” policies, was introduced by Henry B. Hyde, a founder of Equitable Life (now AXA). 15
Tontine in the U.S.
Tontine related insurance products, called “deferred dividend” policies flourished from 1868 until their demise in 1906.16 By the early 1900s nine million individuals in the United States owned tontine policies, the value of which amounted to 7.5% of the total national wealth at the time. Under these policies no dividends, return premium or surrender value was received by the beneficiary for a certain term, called the tontine period. The death benefit would be paid no matter when the death occurred, but dividends will not be paid until the end of the tontine period. The dividend amount was based not only on the income from the premium, but also included a share of the premiums of anyone in the pool who died during the tontine period or whose payments lapsed. 17
At the peak of tontine insurance’s popularity insurance companies started to accumulate an immense amount of cash during the tontine period, “a surplus”. They did not strictly account for this surplus, due to the fact that during the tontine period they did not have to pay dividends, only death benefits, and they did not have to keep a reserve against tontine liabilities until the tontine period lapsed.18 Additionally, with time, harsh forfeiture clauses became a source of a major controversy. Under these clauses, if an investor failed to make required payments, insurance company had the right to forfeit the tontine and the investor was left with nothing.19
In the early 1900s, another problem arose, after a long period of deflation, post 1873 depression, payouts on tontine were much lower than had been projected at the time of sale. Tontine investors started to bring actions in court, but unfortunately pre-consumer era courts sided with the insurance companies and declared that earnings projections were speculations and not an enforceable part of the contract, which gave more fuel to tontine critique’s argument.20
The first major attack on the tontine, came from Wisconsin’s progressive Governor Robert LaFolette and his Commissioner of Insurance, William Fricke. In 1902 the Commissioner published an influential report, “The Law and Distribution of Surplus of Life Insurance Companies,” where he criticized insurance companies for ignoring Wisconsin statutes banning any policy that deferred dividends beyond five years. The insurance companies interpreted the language of the statute to apply to the act of providing a dividend, not the choice of a dividend plan encompassing 1-5 years.21
Finally, in 1905 insurance industry started to lose people’s trust. Equitable Life was publicly accused of corruption and self-dealing by its competitors and the whole industry started to fall apart. In response to these events, an investigatory commission, known as “Armstrong Commission”, was created under the supervision of the New York State Legislature and chaired by Senator W.W. Armstrong. The Commission discovered accounting flaws related to the improper use by the insurance companies of the surplus they accumulated. This, combined with the barbarian forfeiture clauses and a presumption, among some people, that tontine is a gamble on other people’s lives, led to the New York State legislature forbidding deferred dividend insurance.22 In particular, the insurance companies were forced to account for dividends on an annual basis and were forced to provide some forfeiture value to their policyholders.23
Other states joined the New York State’s 1906 “ban”, but only Louisiana and South Carolina have actual statutes specifically outlawing tontines.24 Title 22 §445 of the Louisiana statute covering insurance states “the sale by an individual, company, partnership, corporation, non-profit corporation or insurance company of tontine funds whereby any part of the principal or interest earned on individual contributions is to be used for the benefit of other contributors is hereby prohibited.”25 South Carolina statute mentions tontine in the heading “Tontine policies prohibited” but does not actually use the term in the text itself. 26 Surprisingly, the same statute also has a section that provides “reserve requirements for tontine policies.”27
The majority of the scholars who have since written on the subject, including Jonathan Barry Forman, Kent McKeever, Moshe A. Milevsky and other, claim that tontine funds, tontine annuities, and tontine pensions are legal because the ban of 1906 did not specifically prohibit the sale of tontines; instead it just made it difficult for companies to defer payments beyond one year.28 However, there is no official guidance on the topic. Bloomberg Law tried contacting the IRS, on the question of the legality of the tontine, and the agency told them that they “‘only provides guidance on actual situation and transactions, not proposed or hypothetical ones.’ And a DOL spokesperson said, ‘At this time EBSA has no pending requests for guidance.’”29
At the same time, there are some examples of indirect forms of tontines that exist in practice today. For more than 60 years TIAA-CREF30(i.e., major issuer of annuities to teachers) has been offering a form of “participating” annuity with payouts that at least partially are adjusted for actual mortality of the participants.31
“CREF operates eight investment accounts that differ by objective: stocks, bind, money market, and so cial choice; and CREF keeps its costs for managing those accounts at between 0.395% and 0.465% of assets under management. CREF participants choose which fund to invest in; and later on, they choose from among a variety of distribution options, including one-life and two-life annuities. When a retiree selects a life annuity, the annuity payments will depend on both the investment experience of the chosen accounts and on the mortality experience of the other participants. Basically, within each investment account, CREF periodically adjusts the annuity payments so that the present value of the aggregate amount expected to be paid out over the participants’ remaining lifetimes matches the current value of the assets in the account. If participants in the fund ‘live longer… than expected, the amount payable to each will be less than if they as a group die sooner than expected.’ In short, like a tontine, the mortality risk falls on the annuitants and is not guaranteed by CREF (or TIAA).”32
Another example of the modern, functioning, tontine is a company based in Gibraltar, “Tontine Trust”. 33 The company is a legal, tontine trader that offers tontine investments secured and controlled through the Blockchain and smart contracting technology. The company’s goal is to create secure, low cost, transparent lifetime income solutions via tontines invested in a highly diversified set of exchange traded funds (ETFs). 34
All in all, the question of whether tontine is legal in the U.S., still remains open. As mentioned earlier, today, there are only two States in the U.S. (Louisiana and South Carolina) that specifically prohibit “tontine” in their statutes and, at the same time, TIAA-CREF has been offering tontine-like retirement plan for the past 60 years. So, one can argue that tontine-like investments are legal, so long as one doesn’t use the word “tontine” in their name or doesn’t offer them in Louisiana and South Carolina. This is not necessarily true; this issue is much broader than just the name. It is most likely that the question of tontine’s legality will turn more on the structure of the proposed investment (dividend structure, mortality credits, management, possible fraud etc.) rather than on its name. Unfortunately, there has been no state or federal guidance on this topic and there is no legal precedent that can shed some light on the situation either, so the question remains open, until the government or the court steps in and provides guidance on this issue.
[Last updated in April of 2019 by Krystyna Blokhina Gilkis]
- 1. The Oxford English Dictionary 231 (2d ed., vol. XVIII 1989).
- 2. Kent McKeever, A short History of Tontines, 15 Fordham J. Corp. & Fin. L. 491, 492 (2009).
- 3. Moshe A. Milevsky, King William's Tontine: Why the Retirement Annuity of the Future Should Resemble Its Past 43 (Cambridge Univ. Press 2015).
- 4. Kent McKeever, A short History of Tontines, 15 Fordham J. Corp. & Fin. L. 491, 492 (2009).
- 5. Moshe A. Milevsky, King William's Tontine: Why the Retirement Annuity of the Future Should Resemble Its Past at 45-46 (Cambridge Univ. Press 2015).
- 6. Moshe A. Milevsky, King William's Tontine: Why the Retirement Annuity of the Future Should Resemble Its Past 45 (Cambridge Univ. Press 2015).
- 7. Kent McKeever, A short History of Tontines, 15 Fordham J. Corp. & Fin. L. 491, 493 (2009).
- 8. Moshe A. Milevsky, King William's Tontine: Why the Retirement Annuity of the Future Should Resemble Its Past 46 (Cambridge Univ. Press 2015).
- 9. Jasmin Ye Ham, Tontine Meets Blockchain: Something Old Could Be New Again, Bloomberg News (December 8, 2017), https://www.bna.com/tontines-meet-blockchain-n73014473005.
- 10. Kent McKeever, A short History of Tontines, 15 Fordham J. Corp. & Fin. L. 491, 498 (2009).
- 11. Kent McKeever, A short History of Tontines, 15 Fordham J. Corp. & Fin. L. 491, 502-503 (2009).
- 12. Jasmin Ye Ham, Tontine Meets Blockchain: Something Old Could Be New Again, Bloomberg News (December 8, 2017), https://www.bna.com/tontines-meet-blockchain-n73014473005.
- 13. Kent McKeever, A short History of Tontines, 15 Fordham J. Corp. & Fin. L. 491, 504 (2009).
- 14. Kent McKeever, A short History of Tontines, 15 Fordham J. Corp. & Fin. L. 491, 506 (2009).
- 15. Michael Kitces, Could a Tontine be Superior to Today’s Lifetime Annuity Income Products, Nerds Eye View at Kitces.com (February 3, 2016, 07:01 AM), https://www.kitces.com/blog/tontine-agreement-instead-of-annuity-lifetim....
- 16. Kent McKeever, A short History of Tontines, 15 Fordham J. Corp. & Fin. L. 491, 509 (2009).
- 17. Michael Kitces, Could a Tontine be Superior to Today’s Lifetime Annuity Income Products, Nerds Eye View at Kitces.com (February 3, 2016, 07:01 AM), https://www.kitces.com/blog/tontine-agreement-instead-of-annuity-lifetim....
- 18. Kent McKeever, A short History of Tontines, 15 Fordham J. Corp. & Fin. L. 491, 509-510 (2009).
- 19. Moshe A. Milevsky, King William's Tontine: Why the Retirement Annuity of the Future Should Resemble Its Past 120 (Cambridge Univ. Press 2015).
- 20. Kent McKeever, A short History of Tontines, 15 Fordham J. Corp. & Fin. L. 491, 509-510 (2009).
- 21. Kent McKeever, A short History of Tontines, 15 Fordham J. Corp. & Fin. L. 491, 510 (2009).
- 22. Kent McKeever, A short History of Tontines, 15 Fordham J. Corp. & Fin. L. 491, at 510-511 (2009).
- 23. Moshe A. Milevsky, King William's Tontine: Why the Retirement Annuity of the Future Should Resemble Its Past 130 (Cambridge Univ. Press 2015).
- 24. Kent McKeever, A short History of Tontines, 15 Fordham J. Corp. & Fin. L. 491, 514 (2009).
- 25. La. Rev. Stat. Ann. §22:445 (2008).
- 26. S.C. Code Ann. §38-55-90 (2006). “No life insurer, mutual aid association, or fraternal benefit association…is permitted to issue policies, certificates, or contracts to policyholders or members providing for the establishment of its policyholders or members into divisions and classes for the purpose of providing for the payment of benefits from special funds created for that purpose to the oldest member of the division and class or to the member of the division and class whose policy has been in force the longest period of time upon the death of a member in the division in class.”
- 27. S.C. Code Ann. §38-55-110 (2006).
- 28. Moshe A. Milevsky, King William's Tontine: Why the Retirement Annuity of the Future Should Resemble Its Past 130 (Cambridge Univ. Press 2015).
- 29. Jasmin Ye Ham, Tontine Meets Blockchain: Something Old Could Be New Again, Bloomberg News (December 8, 2017), https://www.bna.com/tontines-meet-blockchain-n73014473005.
- 30. TIAA-CREF website at: https://www.tiaa.org/public/retire/financial-products/annuities
- 31. Michael Kitces, Could a Tontine be Superior to Today’s Lifetime Annuity Income Products, Nerds Eye View at Kitces.com (February 3, 2016, 07:01 AM), https://www.kitces.com/blog/tontine-agreement-instead-of-annuity-lifetim....
- 32. Jonathan Barry Forman and Michael J. Sabin, Tontine Pensions, 163 U. Pa. L. Rev. 755, 798 (2015)
- 33. Tontine Trust, company’s website: https://tontinetrust.com
- 34. Richard Fullmer, Fintech’s Answer to the Global Retirement Crisis, Forbes (Jan. 30, 2018, 09:48 AM), https://www.forbes.com/sites/pensionresearchcouncil/2018/01/30/fintechs-....