The Tontine Annuity

The Tontine Annuity

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This article was first posted January 1, 2020.

MBAs may recognize him as the creator of the Sharpe ratio, but Professor William F. Sharpe has now turned his attention to helping middle-class workers with their retirement income.

Nobel Prize-Winning Economist on How to Solve the "Nastiest, Hardest Problem" in Retirement

So, there are lots and lots of possible future scenarios. You can cut down the investment uncertainty by just basically having Social Security and an inflation-indexed-based annuity. But, even then, you've got to make choices about whether it will be a joint annuity, for how much, and when you'll buy it. It's a tough, tough, tough problem.

Is this something people can do on their own?

I don't think so. Maybe if you were a physicist, but most people have a really hard time internalizing uncertainty.


Professor Sharpe provides a free 730 page e-book "Retirement Income Analysis with scenario matrices" you can download at the link below where he details his methods.

Perhaps the most interesting idea he presents is the need for some kind of longevity insurance product that provides the investment returns of the equity market to the retiree -- the "Tontine Annuity" (page 282).

Enter the idea of a Tontine Annuity, shown in the diagram below. Here the insurer guarantees the total amounts to be paid in each year, shown in the diagram in the upper left. These are designed so that if the number of recipients alive in each year corresponds to the estimates in current mortality tables, the amount received by each annuitant (per dollar of coverage) will be constant from year to year. But if the number of recipients differs from that forecast, the variation will be reflected entirely in the annual amounts paid, as shown by the arrows. In effect, all the mortality table risk is borne by the annuitants. Hence the name, since the contract combines elements of a Tontine with those of a traditional annuity.

A tontine is a financial instrument where each participant pays an agreed sum into the fund, and thereafter receives an annuity. As members die, their shares devolve to the remaining participants, and so the value of each annuity increases. On the death of the second to last member, the remaining value of the tontine is paid out to the last surviving member and the books are closed.

I've long criticized Single Premium Life Annuities because of the 15% to 20% of the premium paid that's lost to the insurer's various fee, expenses and costs. (See link: The high cost of a no-fee, no-commission Single Premium Immediate Annuity (SPIA). Since the mortality table and investment risk is retained by the annuitants in the Tontine Annuity, costs should be much lower -- perhaps approaching what you'd see in a low-fee index fund given sufficient economies of scale.

Resources for additional information.

Nobel Prize-Winning Economist on How to Solve the ‘Nastiest, Hardest Problem’ in Retirement, Barron's Nov 16, 2019

Retirement Income Analysis with scenario matrices, William F. Sharpe, Stanford University (730 page e-book)

Tontine, Wikipedia


Social Security Administration website

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