Summary
- Even before the COVID-19 pandemic, the global economy was experiencing a slowdown. One important reason behind this slowdown has been the aging of the world population.
- Seniors tend to be savers. Therefore, as seniors become a larger part of the global population, this puts downward pressure on global consumer spending.
- Tontines are financial plans that combine elements of retirement annuities and lotteries. The longer a tontine member lives, the greater is the potential for an outsized return on his or her initial investment.
- By definition, individuals cannot outlive their initial contribution to a tontine.
- One possible advantage of tontines is that they could stimulate spending among seniors.
The problem
Even before the COVID-19 pandemic, the global economy was experiencing a slowdown. One important reason behind this downward economic trend has been the aging of the world population. (
). There have been increasingly more seniors as a percentage of the population of most countries, particularly in developed countries.
Seniors tend to be savers. Therefore, as seniors become a larger part of the global population, this puts downward pressure on worldwide consumer spending. And consumer spending drives the global economy. Adding to this is the fact that, with fixed income returns going down, the economic environment is increasingly hostile to savers. Returns are depressed, which can lead to a propensity to save even more.
What are tontines?
Tontines are financial plans that combine elements of retirement annuities and lotteries. They were popular in the 1700s and 1800s. Many different variations are possible (
), with various contribution and distribution rules. The following items give an idea of what a tontine could look like from a financial perspective:
- Each of a group of seniors makes an initial contribution to the tontine.
- The tontine members start receiving distributions.
- As tontine members die, their distributions are made to the surviving members.
- A small number of survivors receive a final lump-sum payment.
The longer a tontine member lives, the greater is the potential for an outsized (or asymmetric) return on his or her initial investment. In the basic simulation below, one could receive payments for a number of years, and nevertheless end up with a lump-sum payment that is 10 times the person’s initial investment.
A basic simulation
Let us assume that we have a tontine with 1,000 members, each contributing 100 thousand dollars by the time they reach age 65 (see table below). When they reach that age, they start receiving 4% yearly dividends. The total assets under management here would then be 100 million dollars.
We are assuming that the tontine would be managed by an organization that would be able to pay the 4% in dividends to the tontine members and still make a profit. This organization would have to not only manage the funds but also make sure that no fraud is committed. For example, deaths would have to be properly logged.
Also, we are assuming in this simulation a bell-shaped (i.e., normal) life expectancy distribution centered at age 80, with a standard deviation of 10 years. This means that, of the initial 1,000 individuals, approximately 16% would have died after 5 years (age 70). And, approximately 50% would have died after 15 years (age 80).
Still consistently with a normal distribution, after 25 years (age 90), approximately 16% of the original tontine members would still be alive. Soon after that, when only 10% of the remaining tontine members were still alive, each would receive a lump-sum payment of 1 million dollars.
As you can see, the dividend received by each surviving tontine member goes up over time, growing exponentially over time. This is highlighted in the figure below. If the members of a tontine had slightly different ages, which is likely, their distributions could be adjusted accordingly without affecting this exponential growth.
Currently there are a number of legal obstacles to the establishment of tontines. Among them are insurance and gambling laws at the local and federal levels. It would probably take targeted legislation at the federal level to overcome all of the obstacles to nationwide tontines, which would probably be preferable to local tontines (e.g., tontines where all members are from the same city).
How can this help the economy?
One possible advantage of tontines is that they could stimulate spending among seniors. As noted earlier, the trend for the future is a growing percentage of seniors in the population of most countries, and seniors tend to be savers. Since consumer spending is a major component of most national economies, this spells trouble for most countries’ finances and the global economy.
Seniors tend to be savers in part because they fear outliving their savings – this is one of their main fears (
). That is, the prospect of living a long life is a major source of financial stress, which may shorten that life. With a tontine, the longer one lives the more income one gets, with a nice payout waiting for the oldest surviving members.
By definition, individuals cannot outlive their initial contribution to a typical tontine. As the world population ages, tontines could significantly increase consumer spending, even if that extra spending in restricted to the tontine’s annual distribution.
