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February 15, 2008

Mutually-assured-destruction fund

This would combine the benefits of old-age insurance, mutual funds, and Russian roulette

The problem: even if average retirement savings were adequate, a few long-lived individuals would outlive their savings.

Insurance seems a logical solution, at first, because only a few people will live much longer than average. Insurance works well to spread current risks, such as home fires, where it’s easy to audit reserves, payouts, etc. But it’s hard to audit a promise that benefits will be available decades in the future, especially if governments are more concerned with the next election than with oversight. So pension programs (essentially old-age insurance) turn into pyramid schemes, which may fall apart as more people start collecting benefits. Government pension programs can keep making payments by raising taxes or by printing money. However, either “solution? can hurt the overall economy, e.g., by increasing inflation.

Mutual funds with stocks and bonds have the potential to keep ahead of inflation. But to supply enough income indefinitely, you need to invest a lot more money than if you were able to use it up during your lifetime. The problem, of course, is that you don’t know how long you’ll live.

A possible solution would be a mutual fund where, when one member died (presumably of natural causes), his shares would be distributed among all members older than he was. You wouldn’t need to invest enough money to last to age 100, say, because the longer you lived, the more shares you would inherit from shorter-lived cohorts. This is essentially an inverted pyramid scheme, so it would complement conventional pension programs, which tend to pay less, or perhaps nothing, as one ages. Earnings would be distributed, but principal could not be withdrawn. Heirs would lose the chance of inheriting money from a conventional mutual fund, but wouldn’t have to worry about supporting an unexpectedly long-lived parent. Furthermore, ensuring life-long financial security at a relatively modest cost might free up assets that could be invested more aggressively and inherited by heirs.

The reason shares would only be distributed among those older than the deceased is to allow people of any age to join, without diluting the wealth of older members. Want to wait until you’re 90 to join? No problem. You’ll probably collect from some younger members, but your shares will probably be recycled soon. Undisclosed health problems? Welcome!