Book Review – Moshe A. Milevsky, in a life insurance industry – shot across the bow, makes yet another ground breaking appeal since his landmark 2004 white paper on Advanced Life Delayed Annuities (ALDAs) that set the tone for the deferred income annuity (DIA) products we have today. The book re-evaluates how we think about lifetime income and what might make sense when it comes to “sharing” longevity risk among the various age classes of our society. It delves into a rich annuity/finance history as the annuity story is really a finance story and concludes with new thinking regarding retirement income financing.
In his new book; “King William’s Tontine” Moshe A. Milevsky makes an argument for re-emergence of “tontine thinking”. A tontine is a pure longevity risk sharing arrangement between participants not dependent on current insurance carrier lifetime annuity pricing proclivities. In this more transparent arrangement, mortality credits are actually shared with participants only after they are earned. Because there are no guarantees or reserving, but just a private arrangement, a tontine does not fall under insurance company auspices. Theoretically, any financial services industry participant could establish a tontine type arrangement to share longevity risk.
Currently mortality based annuities advance mortality credits to all participants using an averaging method to level out/smooth payments and carriers hope their estimates are correct. This is one reason why carriers have to post reserves to make good on their guarantees and also by-the-way, get to have the longevity insurance market all to themselves. The States then look-out for consumers by regulating annuity companies and company guarantees. In recent years, these guarantees have become expensive for all parties. A by-product of this averaging method is an obfuscating of mortality based annuity pricing because consumers can’t reasonable determine the interest rates they receive vs. the mortality credits they earn. A Tontine arrangement can be more transparent in this regard and provide much higher annual incomes.
In this country and after the 1906 New York State Armstrong Committee hearings, tontines were not directly prohibited. After this time, carriers had to include non-forfeiture values for life insurance and annuity contracts. Prior to 1906, life insurance policies and annuity (tontines) were directly linked together. The Equitable Life Insurance Company via Henry Hyde’s legacy became the master of the universe of its day when they designed a novel approach of utilizing life insurance policy dividends to fund a tontine savings plan. These were hugely popular arrangements and by the late 1800s and early 1900s, over half of all U.S. households owned such policies and savings plans.
However, many people who couldn’t keep their policies in force over the required several decades ended up with discontinued coverage (lapse) for failure to pay all the required annual premiums and had nothing to show for the money they did pay. The states believed this to be inherently unfair and mandated policies have some residual value if life insurance or annuities lapsed and or were surrendered. This residual value or non-forfeiture value, now usually takes the form of a cash payment or some other replacement policy or contract that offers reduced benefits based on the paid premiums just prior to lapse. Given the current interest rate environment and longevity estimates that seem to constantly increase, the insurance industry is chafing under the weight of its non-forfeiture costs.
Look out life insurance industry! The “boys with cigars” behind closed doors are already discussing inexpensive and other mortality risk sharing arrangements. The re-emergence of a public and re-popularized tontine type arrangement might be the greatest retirement income financing mechanism come back since Lazarus! So, if you don’t want to lose your mortality risk sharing franchise to more nimble financial competitors you better get on it. Wearing your reputations around your belts isn’t smart business.