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One of the most interesting tools for retirement and longevity planning to come about in decades – the tontine – has seen a significant re-emergence in Canada during the past two years.
This product is actually very old in concept, dating back more than 500 years, but have not been seen in over a century. The full details of its history can be found in the book King William’s Tontine: Why the Retirement Annuity of the Future Should Resemble its Past by Moshe Milvesky, the man primarily responsible for resurrecting the concept.
However, despite this new, yet old, innovation in the marketplace, there’s still some question about how to best use these products to meet their intended purpose – giving clients the best probability of not outliving their money.
A tontine is basically a life annuity without insurance. With an annuity, you’re giving a large sum of money to an insurance company in return for an income stream for life. The insurance company invests the money and takes on both the investment and longevity risk.
By contrast, a tontine doesn’t involve an insurance company or guaranteed payouts. It’s an arrangement in which investors in the tontine risk-sharing structure effectively make a deal. Investors who die over the life of the tontine lose either the return on their investment or their principle and return in the tontine, depending on the type of tontine. The funds they give up go to the benefit of the survivors.
These benefits going to the survivors of a pool are known as mortality credits, and to date, they have only been available to defined-benefit pension (DB) plan members and purchasers of annuities.
While the idea of benefiting from the death of others may seem unsavoury to many, keep in mind this is an arrangement and mortality credits are a key reason why DB pension plans like the Canada Pension Plan cost as little as they do.
The unique difference between tontines versus these other options is the exclusion of the insurance company in the arrangement, which eliminates their margins and commissions. Instead, it gives investors access to mortality credits for a relatively affordable management expense ratio of 0.6 per cent in exchange for accepting the market and longevity risk. Tontines also all offer some form of redemption value, typically limited to net invested assets.
Features of current products
Currently, there are three tontine products on the market from two suppliers with different approaches to the distribution of income and mortality credits.
The first to come to market was Purpose Investments Inc.’s Longevity Pension Fund, which looks like a conventional portfolio and sets distributions annually based on actuarial assessments of what a conservative sustainable payout rate would be, based on returns, and the number of investors who have died in the pool. That means investors will receive a combination of return on investment and mortality credits every year, with the latter increasing faster over time as fewer investors survive.
The second is Guardian Capital LP’s GuardPath Modern Tontine 2042 Trust. This product is designed to make a lump-sum payout of principal, return, and mortality credits to survivors in the pool in 20 years.
This approach is more of a “give you the benefit when longevity becomes an actual problem” solution. It represents a pure longevity hedge that allows advisors the flexibility to determine exactly how much exposure they want to have to this type of solution versus bundled options.
The last product is Guardian’s GuardPath Managed Decumulation – Hybrid Tontine, which combines the GuardPath Modern Tontine with a managed decumulation fund that targets full decumulation in 20 years, the time the tontine portion and mortality credits would kick in for the survivors.
By doing so, Guardian is providing investors with regular cash flow over 20 years and then giving them the mortality credits, again, when longevity becomes an actual problem.
All three products provide an interesting range of options – a lifetime payment fund, a pure longevity hedge and a limited payment fund with a pure longevity hedge.
Are mortality credits worth all the effort to create these products? Putting aside the need for longevity protection from an investment standpoint, simply put – yes. Mortality credits are a form of additional return unavailable to the consumer to the degree they are here in any other product, and should one live long enough, represent a rate of return that’s well beyond what a comparable risk portfolio would deliver.
How much should you allocate to tontines?
The only real question that needs answering is – what’s the optimal allocation to one of these products to reduce their longevity risk and ensure success?
That’s the problem. We don’t know. There isn’t an accepted academic methodology to answer this question as the study of tontine optimization is in its infancy.
So, what’s the best course of action for advisor to take?
For clients who are nowhere near hitting their retirement goals, a tontine won’t solve the problem, only increased savings and reduced spending will.
For those who have more money than they will ever spend, while there’s theoretically no need for this type of product, if their family has a history of longevity, some exposure to these products has merit from a return-on-investment standpoint.
The real question is for those clients for whom mortality credits could mean the difference between success and failure, how much exposure should they have? That’s the tough one to answer.
To date, the only real option is to use the projected payout on a tontine of choice and plug it into the financial plan of a client who is in danger of ruin, then modify the allocation between the tontine and conventional investments to see what the impact is on the outcome.
The problem is this is a completely manual process; not all software can handle the variable inputs. And given these products use dynamic zero-cost collars to hedge against big swings in the market, stress testing will be difficult, at best.
Despite these limitations, for those at risk who would benefit from this type of product, some is better than none. But the question of how much exactly is a question that must be answered.
Jason Pereira is a partner and senior financial consultant at Woodgate Financial Inc., a financial planning firm under the IPC Securities Corp. umbrella in Toronto, and president of the Financial Planning Association of Canada (FPAC).
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