Tontine

Tontine refers to a system wherein a group of people contributes to a common fund to receive regular income for the rest of their lives. However, if a contributor dies, his/her share gets distributed amongst the remaining members instead of the deceased’s family. This way, whoever lived the longest made the highest profit by overtaking the shares of the deceased.

If a member of the group passes away, a new member is not added, the funds are divided among the remaining members. In the 1800s, tontine trusts were a vastly popular means for retirement planning, insurance policies, construction, and war funding. However, death benefits and certain corrupt functionalities led to their downfall.

• Tontine used to be a popular investment scheme of the 19th century. Like an annuity scheme, in tontines, a group of people gave money towards a common fund to receive an annuity or dividend for the rest of their lives.
• However, if any member passed away, it would bring in profit to the remaining members as his/her share of income would get divided amongst them. This way, their income would keep going up with each death.
• The scheme was considered irrevocable, i.e. once a member had subscribed, the share could not be withdrawn.
• Tontines were preferred to fund major government projects, hotels, roads and cafes. For example, The First Freemasons’ Hall, London and The Tontine Coffee House in New York City were an outcome of such funds.
• The scheme became popular in the US in the 1800s and became unpopular in the 1900s leading to its banning in several states, especially in the US.

Tontine is an insurance-like product, popular in the 19^th century where a group of individuals would pay to a common pool which would disburse dividend-like payments to the members until their death. If a member of the group passes away, a new member is not inducted in their place. Instead, the funds are divided among the remaining members. Since there was no established protocol or governance, there had been several cases of fraud and mismanagement of funds which led its downfall.

One must have heard of annuity schemes in insurance. Usually, an insured contributes a lump sum or fixed payments over time towards the scheme. It is then further invested for increased earnings. In return, the insured gets insurance coverage, usually for life. Tontines worked with a similar principle, so let us understand their definition in detail.

Certain people came together and created a pool of funds in which each member contributed. The common fund was put to further investment to fetch higher profits. In return, every member received a dividend for the rest of their lives. However, the main difference in the definition of tontine and other traditional investment came through the idea of making profits out of the death of the members.

As explained, the contributed capital of the dying members did not get passed on to their family members. Instead, it was divided amongst the living members of the group. This share is also called mortality credit for the same reason. This way, the last living member got all the returns on the entire investment by overtaking the shares of the deceased members.

It is pretty evident that if the share of the dying member is divided amongst the living members equally, it will be unfair since the members from different age groups will have different longevity.

To make it more suitable, actuarial tables started gaining prominence. They showed the probability of death. It helped investors figure out the longevity of the group members. The gathered information also paved the way for modern-day mortality tables. The mortality table is a logarithmic table showing different annuity yields by age.

In the early days, many tontine will and schemes involved assigning a nominee or getting the fund in someone else’s name, such as one’s child. Such schemes were segregated by age. Higher the age, higher the rate of interest they would attract.

Tontine, as a word, got its derivation from Lorenzo de Tonti, who had proposed this arrangement to the French in the 1650s to raise revenue in the war-affected France. The idea gained momentum in the UK and the US for some years.

The examples of a tontine trust majorly come from the UK, where massive projects were funded by it. Some examples include the Tontine Hotel in Ironbridge, Glasgow Coffee House, Peebles Hotel, Assembly Rooms in Bristol, etc. Another example is Freemasons Hall in London, built in 1775.

Example #1

Consider ten people who come together to form a group. Each contributes $200 and then agrees that the dividend is 5% per annum paid annually.

The total investment becomes $2000. The dividend is $100, which is to be divided amongst ten members. Consequently, the dividend per head comes to be $10. (5% * $2000 = 100, 100/10 = $10.)

Now, consider that two members have passed away. As we’ve learned above, the share of dying members is shared amongst the living members.

The annual dividend of $100 shall be distributed among the living members. So, the dividend received now shall be $12.5. (5%*$2000 = 100, 100/8 = $12.5.)

Example #2

Tontine Coffee House, NYC, the renowned Manhattan Project was proposed in 1790. The members of the group were supposed to receive rent for the rest of their lives. The entire investment was divided into 203 shares, and each share was sold for $200.

As a method for estate planning and insurance, tontines became so popular that at one time, studies suggested that they were holding around 7.5 percent of the national wealth in the US. In the early 1900s, it was estimated that there were 9 million such policies.

The idea of profits being directly proportional to the number of members passing away made the process problematic. It contributed as one of the major reasons for the unpopularity of tontines. Members of some groups were believed to have hoped for the demise of other members to increase their share, resulting in many fiction writers taking such stories to the silver screen.

Moreover, the accusations of rampant corruption in the insurance industry resulted in an investigation by the New York State Legislature. It was known as the Armstrong Commission. Consequently, in 1906, New York state legislation banned tontine-related products. They are banned in most of the United States. Although, only Louisiana and South Carolina are believed to have specifically outlined clauses in their insurance laws to prohibit their use.

Some prevalent investment schemes have certain tontines-like traits such as Wisconsin Pension Plan and CREF variable annuity as per a study. The study further lists some countries that have come up with a particular investment scheme sharing similar traits. Examples include Sweden, France, Australia, South Africa, and Canada. Canada expressed a proposal in 2019 to have a retirement scheme that has similar features as a tontine will investment scheme.

Moreover, economic thinkers have reiterated through various studies how certain tontine hybrid investment plans could prove more profitable. This is because they could work better in terms of annual yield if allowed within the legal boundaries.

This has been a guide to Tontine and its meaning. Here we discuss how tontine investments work, whether is it legal along with examples and mortality tables. You can learn more about from the following articles –

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