The Gold Standard
The Gold Standard was a system under which nearly all countries fixed the value of their currencies in terms of a specified amount of gold or linked their currency to that of a country which did so. Domestic currencies were freely convertible into gold at the fixed price and there was no restriction on the import or export of gold. Gold coins circulated as domestic currency alongside coins of other metals and notes, with the composition varying by country. As each currency was fixed in terms of gold, exchange rates between participating currencies were also fixed.
Gold is no longer used in this way, though it’s still valuable, so the term has taken on a looser meaning. The gold standard of something is simply a great or excellent example. A gold standard is the best of the best.
A tontine is an annuity shared by subscribers to a loan or common fund, the shares increasing as subscribers die until the last survivor enjoys the whole income.
The simple idea behind the tontine is that an individual needs income for their lifetime and so investors in a tontine that die young forfeit income to the investors that live longer lives. So how is this different than an insured annuity? The main difference is that in a tontine, investors are insuring each other, and the ultimate payouts depend on the longevity of each investor. Further, if the tontine is invested in a non-guaranteed investment such as equities then not only do the payouts vary depending on longevity, but they also vary based upon investment returns.
In contrast, an insured annuity is guaranteed by an insurance company and future payments are not reliant on future investment performance and do not depend on the longevity of other insureds. The insurance company takes the risks and they are not shared by those that need to rely on a predictable income in retirement.
Am I wrong?
In my last blog on decumulation, I touted insured annuities as the best tool for a retiree to insure outliving their savings. I went so far as saying that insured annuities are the gold standard of retirement income.
Someone on LinkedIn commented that “the OECD differs from your views…favouring Tontines instead”. This was news to me and one of the problems with social media is people can say things that sound completely factual and very few of us have the time to do the homework and check the details. Lucky for you my readers, I have the time!
I went back and read some of the papers published by the OECD. One of the papers says four things: First, there is a spectrum of risk transfer in retirement income with DC at one end where the retiree keeps all the risk and the insured annuity at the other end where the insurance company takes all the risk. Second, the paper explains that higher retirement incomes and guaranteed retirement incomes are in opposition to each other – that is, the higher the guarantee in income you wish to have the lower the income you will receive. Third, the paper notes that there are solutions in the middle where risks are shared collectively that provide what some might consider to be a better blend of income levels and guarantees than either extreme. Finally, the paper goes on at length about the effort that program designers must go to in order to ensure ‘fairness’ which is an elusive concept at best. Just to make sure you are aren’t tempted to go read the whole paper – just enjoy this tidbit:
“Fairness could be defined as having no inter-cohort transfers, with each cohort bearing their own risk. Alternatively, fairness could be viewed through a lens of expected welfare improvements for all cohorts. In this case, fairness is best assessed from the inception of the arrangement (ex-ante), as after a funding shock (ex-post) there will always be value transfers that will affect cohorts differently depending on the source, direction and magnitude of the shock”.
The paper doesn’t say that insured annuities are sub-optimal for those that want an iron clad (gold standard) guarantee for their retirement income.
Are they doing it on purpose?
In my last blog on decumulation I also mentioned the Longevity Pension Fund which is a mutual fund being promoted by Purpose Investment Inc. I have done a little more digging and the only thing I can be sure of is the suggestion that the product is ‘easy to understand’ is a little optimistic.
The income for this product is initially set at 6.15% which is fantastic given that bond yields today are less than 2%. As a bonus, the model for this product predicts paying a living bonus starting around age 85 – presumably funded by the forgone accumulated investment gains for fund holders that die and are returned only their unpaid capital.
It is too early to say if this product works. I have questions around anti-selection and the underlying assumptions used to establish the 6.15% which can be adjusted downward. But these are questions for another day.
With 10+ years of experience with my mom’s home, I can almost guarantee that your retirement home won’t reduce your monthly rent. I wish my dad was here so I could discuss his model for providing for mom for the remainder of her lifetime – something he managed to pull off even though he has been gone for 22+ years. I am pretty sure that even if he predicted she would live as long as she has, he could not have predicted the cost of her care – with that said he probably couldn’t have predicted the price she would get for her home in Mississauga.
What I can tell you is that between CPP, OAS, and her survivor pension from dad’s DB plan, mom has had a regular monthly income to cover the basics each month. Because she had some DC savings that weren’t annuitized, she was able to spend a little more on travel in the early years and spend a little more on a premium retirement residence in the middle years. We are closing in on the final years and now she is spending her last bit of savings on her grandchildren. There was never a plan to help her kids after university and this modest contribution to her grandchildren is the necessary outcome when you have a risk averse husband and an actuary-son running things.
More than anything, her children are happy they still have her with them as she approaches 90 and appreciate that her financial affairs were setup so that she could be well cared for until the end. Having a guaranteed monthly income to cover necessary expenses has been the cornerstone of mom’s retirement plan and one that I don’t think should be dismissed as ‘expensive’. I am not saying that DC plan retirees should use 100% of their nest-egg for an insured annuity. I am saying a mix of annuities and market investments might be more optimal than one extreme or the other – which is the OECD conclusion and two distinct buckets might be easier to understand than a tontine product where outcomes are tied to the lives of others.
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