| Abstract: |
A big challenge facing retirees is how to draw down their nest egg in
retirement. The main consideration is insuring against “longevity risk” – the
possibility of outliving one’s savings – without unduly restricting spending.
One solution is to buy an annuity, which converts wealth into an income stream
that is guaranteed until death. Common annuities include Social Security and
traditional employer pensions. However, Social Security is not intended to be
the sole source of retirement income and pensions in the private sector are
rapidly disappearing, so buying an additional annuity with savings is often a
good idea. Yet few people actually do. Many reasons exist for the lack of
annuitization. These include the complexity of the product and the fear of
giving up one’s wealth and then dying too soon to “break even.” A simpler
reason is price, since annuity prices include a premium to protect the insurer
selling the policy against longevity risk.1 Given the lack of interest in
annuities, some policy experts have begun advocating an alternative form of
longevity insurance – a “tontine” – which would require insurers to assume
less risk and, in turn, charge lower premiums. Tontines, which do not
currently exist in the marketplace, are the topic of this brief. The
discussion proceeds as follows. The first section describes a basic tontine
and how it differs from an annuity. The second section discusses the legal
status of tontines. The third section explores the central tradeoff of a
tontine: lower cost for less insurance. The fourth section describes a way to
eliminate a potential downside of the payout pattern of tontines. The final
section concludes that some of the enthusiasm for tontines is well placed but
drawbacks also exist. |