Racing inflation: TIAA-CREF developed the variable annuity to help its pensioners when high inflation and low interest rates followed World War II.

In the Roaring '20s, stocks and the economy were hot in the United States. So was inflation, which eroded the value of fixed pensions. Teachers Insurance and Annuity Association (TIAA), formed in 1918, was in its early years, but leaders of the New York-based nonprofit understood that pensions funded in fixed-dollar investments couldn't keep up with inflation.

The market crash of 1929 and the Great Depression that followed shelved any plans for inflation-fighting products, hut the high inflation and low interest rates following World War II sparked new action. Relying on a study he conducted that found a correlation between the stock market and inflation, TIAA's William Greenough changed annuities forever. The doctor of philosophy in economics led a team of actuaries and attorneys to develop a new payout mechanism, one measured in units rather than dollars, with the value of the units based on their underlying investments. By 1951, Greenough and his team had invented the variable annuity.

By virtue of a system tied to units, annuitants' payouts could be adjusted annually, depending on investment performance and the assumed investment rate at the beginning of the payout stream. Greenough's team included Robert Duncan, a fellow of the Society of Actuaries, who developed the mathematics. His model is still in use today, except that annuitants may now choose payouts that change monthly instead of annually.

TIAA's variable annuity became live in July 1952, according to Gene Strum, vice president of pension product actuarial and a 35-year employee of TIAA and its companion organization, College Retirement Equities Fund (CREF). But before the product became official, TIAA needed the help of the New York State Legislature because life insurance companies in 1952 could not offer products that provided no guarantees. In a special act, the Legislature provided for creation of CREF as a sui generis company, Latin for one of a kind, for the sole purpose of funding variable annuities. Strum said CREF was a membership corporation organized under New York's not-for-profit law.

Several other conditions were right in 1951-52 for introduction of a variable product. TIAA-CREF already had substantial ties to colleges and universities, where it sold its fixed-annuity portable pensions. Because of its clientele, and due to its unique not-for-profit status, TIAA-CREF had more room for the development of new product ideas, said Strum. "Certainly the New York Insurance Department and Legislature were more inclined to allow this type of experimental organization," he said of CREF.

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TIAA-CREF also had the assurances of college and university leaders that they would accept use of stocks in pension plans and would amend those plans so participants could invest in variable annuities. At the time, the schools paid an amount equivalent to up to 10% of a participant's gross income into TIAA's annuity pensions. With the introduction of CREF's new product, participants were allowed to designate up to half of that into the sole variable-annuity stock subaccount, said Strum. The new plans also restricted an individual from frequently trading into and out of the variable and fixed accounts. Strum said beginning in 1968, participants could designate up to -75% of contributions into the variable account, and in 1972 the restriction was removed altogether.

Another condition that favored development of the variable annuity was the state of corporate America in the 1950s. At the time, workers often joined a company early in their careers and stayed for a lifetime. In return, the companies offered a defined-benefit pension. But colleges and universities encouraged teachers to move to different schools, which accounted for the origins of TIAA, said Strum. "It was considered a positive thing to provide portability to college educators," he said. "So TIAA-CREF became the funding mechanism for the pension plans of teachers at many schools. And once they were part of the pension system, they had to stay in whenever they changed jobs." Otherwise, educators who worked at six different colleges would find they had no money to support themselves when they retired, he said.

From One to Nine

TIAA-CREF did not offer another investment option to go with its CREF stock fund until 1988, when it introduced a money-market account. It now has nine variable-annuity investment options, including a TIAA option that owns real estate outright and one of the first Treasury inflation-protected securities funds, which came on the scene in 1997. "The pace is accelerating," said Strum. "We want to provide institutions a menu they're happy with. We've opened up avenues in which employees can invest in TIAA-CREF mutual funds or other mutual funds with us as the record-keeper." He said the company may develop more VA funds in the future, but only when they achieve enough of a participation to provide economies of scale.

TIAA-CREF was also a leader in the development of annuities used to fund 403(b) plans, which became part of the Tax Code in 1958.403(b) plans are offered as retirement plans for employees of nonprofit institutions, such as private universities, schools, foundations and hospitals, as well as public schools and universities.

As of November, TIAA-CREF had about $320 billion in assets, about half of which was in CREF variable annuities, according to the company.

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TIAA-CREF

A.M. Best Company # 07112

Headquarters: New York

Lines of Business: Annuities, life insurance, investment products

2003 Net Gain From Operations (TIAA only): $1.3 billion

Distribution: Direct

For ratings and other financial strength information about this company, visit www.ambest.com.

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