Nittany_Lion wrote: ↑
Tue Oct 22, 2019 1:20 pm
OP here. Thanks for posting this very interesting paper.
My thinking on TIAA Traditional is that it might be something of a free lunch if yields continue to drop and one is invested through a liquid GSRA account. Suppose yields continue to fall such that the yield on the weighted combination of VG bonds you considered drops to say 2.00%. If one believes yield is the best predictor of total return going forward, then TIAA would be offering a quality and duration matched product with a superior expected return, no volatility, and no liquidity restrictions for SRA and GSRA products.
In that scenario, the big issue becomes the viability of the 3% guarantee going forward. As you noted, such a situation cannot be sustainable indefinitely, but it seems as though there could be a period of time when one could scoop up this "yield premium," especially if the general account reserves provide a means of meeting the guarantee in low-rate environments. The key would be figuring out when to exit based on the yield disparity and the size of reserves relative to liabilities.
This is less pie-in-the-sky than it seems in that the TIAA real estate account was successfully gamed by many back in 2008 due to the fact that the account's assets were only marked to market once a quarter or so, whereas REITs were crashing and burning (and, indeed, the TIAA real estate account ultimately fell by roughly as much, but with a long and exploitable lag).
The scenario you sketch is quite similar to the one conjectured by dodecahedron in a post above:
dodecahedron wrote: ↑
Sun Oct 20, 2019 8:34 am
[...] my impression is that TIAA is also quite concerned about the sustainability of their products with 3% minimum guarantees (on both RA and SRA products) and that it has been responding by heavily pushing its client institutions to switch away from RA and SRA product lines to other lines with lower guarantees (e.g., RC and RCP with 1% guarantees). If we stay in a low interest rate environment, RA and SRA contract holders with legacy 3% guarantees may end up in the future being a relatively small minority cross-subsidized by other products earning lower rates of return and with different term structures.
While I do not think Traditional provided a free lunch during the time period I studied, the future could be different from the past in just the way that you and dodecahedron suggest. In other words, the "Traditional with a 3% guarantee" could offer a free lunch in the future, especially if the general level of interest rates becomes very low, and TIAA would probably respond by restricting access to it and TIAA would have to subsidize it.
Nittany_Lion wrote: ↑
Tue Oct 22, 2019 1:20 pm
I came across a white paper awhile back (link below) that describes what would get them in trouble, albeit in the vague terms you have grown accustomed to. In a nutshell, they will begin to have problems if the ten-year treasury falls below 1.50% for a "significant amount of time" and the spread on corporate bonds (I guess at similar maturities?) falls below 1.48%. They note that historically when the ten-year risk-free rate has fallen, the spread with corporate bonds has tended to rise which, I presume, is what allowed them to meet the guarantee when treasury rates were super low after the financial crisis. This is described in the section near the end titled, "Impact of interest rate fluctuations." [...] https://www.tiaa.org/public/pdf/complia ... -paper.pdf
The white paper you cite, "TIAA Traditional Annuity: Adding safety and stability to retirement portfolios," has been annually updated since at least 2013. In the version dated 8/13, the passages you refer to read as follows:
"We used 23 years of data (1990–2012
), the “measurement period,” to determine the blended return on TIAA Traditional Annuity contracts for the participant population. [...] The mean spread over 10-year Treasuries for the observed measurement period is 131
basis points. [...]
"[...] we believe that the long-term risk-free rate would have to remain at 2.5%
or less for a significant amount of time for the value of the guaranteed rates on typical retirement annuity contracts, to be worth more than the risk-free rate plus the TIAA credit spread. During periods of low interest rates, we have observed a significant increase in the credit spread. As a result, the potential impact of the prolonged low interest rates has not impacted the valuation of the TIAA Traditional Annuity.
As of December 31, 2012
, 10-year Treasuries were yielding approximately 1.76%
. While the 3% guarantee rate exists as a term within the TIAA Traditional Annuity contract, the term does not appear to provide any meaningful value to owners of the contract given the term structure of interest rates and the nature of the yield curve."
Here is the way the numbers given in red above have changed in some of the more recent versions of this document.
4/15 version: 1990--2014; 136; 2.0%; 2014; 2.17%
9/16 version: 1991--2015; 141; 1.5%; 2015; 2.27%
4/17 version: 1992--2016; 148; 1.5%; 2016; 2.45%
3/18 version: 1993--2017; 150; 1.5%; 2017; 2.40%
3/19 version: 1994--2018; 148; 1.5%; 2018; 2.69%.
TIAA has changed its opinion of how low the 10-year Treasury yield would have to go in order for the 3% guarantee to have "meaningful value." In 2013, TIAA said this level was 2.5% (higher than the actual 10-year Treasury yield on 12/31/12); in 2015, it said this level was 2.0%; and in the years 2016 and later, it said the level was 1.5%. During this time, the backward-looking spread of Traditional over the 10-year Treasury only varied between 131 and 150 basis points, that is, it varied by 19 basis points. If one subtracts 131 or 150 basis points from the 3% guarantee one obtains 1.50% or 1.69%, so those would seem to be the approximate critical yield for the 10-year Treasury below which the 3% guarantee would have to be subsidized by TIAA. This supports TIAA's more recent 1.5% figure. Since April 1953, the 10-year Treasury yield has only fallen below 1.5% briefly during the summer of 2012, briefly during the summer of 2016, and briefly this past summer. It is about 1.8% now.
If, for each of these reports, one sums the 10-year Treasury yield of the preceding Dec. 31 and the reported backward-looking spread of Traditional over the 10-year Treasury, one obtains: 3.07%, 3.53%, 3.68%, 3.93%, 3.90%, and 4.17%. With the possible exception of 2012, this tends to support TIAA's assertion that the 3% guarantee was not meaningful in the past. The future may be different, or not.
None of the Vanguard mutual fund combinations suggested in Table 3 of the paper have a current yield now of over 3%.
I think this exhausts my insight on this matter; going further would require speculating about the future of interest rates, which is hard to do with much accuracy.