Thursday, November 9, 2017

No. 240: TIAA-CREF Under the Microscope

On October 22, 2017, The New York Times carried a long article about Teachers Insurance and Annuity Association of America (TIAA) and its affiliates, including College Retirement Equities Fund (CREF). Gretchen Morgenson, who received a Pulitzer Prize in 2002 for "trenchant and incisive coverage of Wall Street," wrote the article. It is entitled "Finger-Pointing at TIAA," and examines TIAA's reputation as a "selfless steward of its clients' assets for almost a century." Here I discuss some matters Morgenson mentioned in her excellent article, and some matters she did not mention.

TIAA long specialized in serving faculty members and senior administrators of colleges and universities, as well as officials of other nonprofit organizations. Indiana University, where I was an active faculty member for 31 years, was and remains a TIAA client. I have a CREF retirement account with the organization.

The Hiring of Allison
Morgenson pointed out in her article that in 1997 Congress revoked TIAA's nonprofit status because that status supposedly gave TIAA an unfair advantage over other companies. What she did not mention in her article was that TIAA had a long tradition of promoting from within its ranks. Thus new chief executive officers always had been deeply immersed in the organization's nonprofit and client-oriented culture.

The tradition ended in 2002, when the board of directors hired Herbert M. Allison, a former Merrill Lynch executive, as chief executive officer. Allison served until 2008, when he retired. Roger W. Ferguson, Jr., who also had not been associated with TIAA, succeeded Allison.

The Accounting Fiasco
Allison decided to revamp the accounting system, which inside staff had developed and maintained over many years. He fired all the TIAA employees connected with the existing system and hired an outside consulting firm to set up the new system. The result was a disaster. Among other problems were widespread reports of clients having to endure long delays in completing transactions.

I was affected, although I never engaged in anything other than simple and routine transactions. I have been taking systematic monthly withdrawals to meet the minimum distribution requirements imposed by the Internal Revenue Service. One month I received two payments instead of one. In another instance, every dollar figure in my quarterly financial statement had all the decimal points off by one place.

The accounting problems prompted a long front-page article in The Wall Street Journal on April 24, 2006. Tom Lauricella wrote the article, which was entitled "College Try: A Wall Streeter Aims to Revive Handler of University Pensions." Participants filed at least two lawsuits after publication of Lauricella's article.

The Rink Case
In October 2007 Richard Donald Rink filed in state court a class action lawsuit against CREF. A CREF account's value derives from the CREF-managed common stock of prominent public companies. Rink alleged that, when a CREF client requested a withdrawal or transfer of funds, CREF would assign an effective date but often would delay completing the transaction. To the extent the account value increased during the delay, CREF rather than the client received the benefit of the increased value.

In December 2010 the judge certified a class and scheduled trial for December 2012. The class consisted of:
All persons who at any time during the class period (October 1, 2005 to March 1, 2008) had one or more contracts with CREF and experienced a delay of more than seven days in the processing of a distribution or transfer request related to a fund governed by a CREF contract.
In May 2012, after extensive negotiations, the parties agreed to settle the case. The judge preliminarily approved the settlement and later granted final approval.

Under the settlement, 26,188 class members were entitled to about $18 million plus $4.4 million of interest at 4 percent per annum. The judge awarded the plaintiffs' attorneys $7.5 million of fees and up to $150,000 for expenses, both of which were on top of the amounts paid to class members, as well as up to $20,000 for Rink as class representative. (See Rink v. CREF, Circuit Court, Jefferson County, Kentucky, Division Six, Case No. 07-CI-10761.)

The Bauer-Ramazani Case
In August 2009 Norman Walker, Christine Bauer-Ramazani, and Carolyn Duffy filed in federal court a class action lawsuit against TIAA-CREF. They were faculty members with TIAA-CREF accounts subject to the Employee Retirement Income Security Act (ERISA). They endured long delays in completing transaction requests. Walker later dropped out and the case was continued by the other two plaintiffs, who filed a fourth amended complaint in October 2012. They alleged three counts: (1) ERISA breach of fiduciary duty of loyalty, (2) ERISA breach of fiduciary duty of impartiality, and (3) ERISA prohibited transactions. In May 2013 the judge certified the following class:
All persons who, between August 17, 2003 and May 9, 2013, requested a transfer or distribution of funds invested in a CREF or TIAA variable annuity account covered by ERISA whose funds were not transferred or distributed within seven days of the date the account was valued and who were not paid the investment gains, if any, during the delay period.
In October 2013 the judge set the trial for January 2014. In November 2013 he dismissed the second and third counts of the complaint. In December 2013 the parties reached a settlement. In February 2014 the judge preliminarily approved the settlement, and in September 2014 he granted final approval.

Under the settlement, TIAA-CREF created an interest-bearing $19.5 million fund for the benefit of class members. Out of the fund, TIAA-CREF agreed to pay $7,500 to each of the two class representatives. In addition to the fund, TIAA-CREF agreed to pay $3.3 million of plaintiff attorney fees and expenses. (See Bauer-Ramazani v. TIAA-CREF, U.S. District Court, District of Vermont, Case No. 1:09-cv-190.)

The Long-Term Care Fiasco
In 2003 TIAA abandoned the long-term care (LTC) insurance line of business it had been offering for more than a decade. It sent a letter to its 46,000 LTC insurance policyholders saying it was transferring them to Metropolitan Life Insurance Company. The letter prompted a furious response from educators who had selected TIAA for LTC insurance because of the firm's stellar reputation for fair treatment of its policyholders. I wrote about the incident in the March/April 2004, December 2005, and June 2007 issues of The Insurance Forum.

The Life Annuity Fiasco
One of the first anti-TIAA lawsuits with which I had become familiar involved a college professor who retired at a time when she was suffering from advanced emphysema. She had a $1 million retirement account (virtually all of her estate) with TIAA. She exchanged the entire account for an immediate life annuity with no death benefit. TIAA allowed her to make that horrible choice. She died six months later. In 2003 her estate filed a lawsuit against TIAA, which fought the case bitterly. After ten years of legal wrangling in a federal district court and a federal appellate court, the lawsuit finally ended in a confidential settlement. I wrote about the case in the January 2010 issue of the Forum.

The Surplus Notes
A surplus note is a bizarre debt instrument. When an insurance company borrows by issuing a surplus note, the money the company receives increases its surplus. That happens because state surplus note laws say the company issuing the note does not have to establish a liability. A surplus note is subordinate to all the company's other obligations. A surplus note can be issued only with the prior approval of the insurance commissioner in the issuing company's state of domicile. Interest and principal payments on a surplus note can be made only with the commissioner's prior approval.

State surplus note laws date back more than a century. Their purpose was to provide a mechanism allowing mutual insurance companies in financial trouble to increase surplus. When a surplus note appeared in a company's financial statement, it was a sure sign the company was in financial trouble. All that changed in "the revolution of 1993," when Prudential Insurance Company of America, a financially strong company, issued $300 million of surplus notes to investors through a private offering. The offering was made for tax reasons because courts had ruled that interest payments on surplus notes are deductible for income tax purposes. Within a few years, most major insurance companies had issued large amounts of surplus notes.

TIAA was one of the few holdouts, but in 2009 it issued $2 billion of surplus notes to help finance the acquisition of Nuveen, a for-profit investment firm. I wrote about that event in the August 2010 issue of the Forum. Later TIAA issued more surplus notes to help finance the acquisition of EverBank, yet another for-profit investment firm. TIAA now has $5.05 billion of surplus notes outstanding, according to its latest (June 30, 2017) financial statement. I have not been tracking surplus note data in recent years, but TIAA's surplus notes may now exceed those of any other insurance company. TIAA's surplus notes are described in detail on two pages in the above mentioned financial statement.

General Observations
The Carnegie Foundation for the Advancement of Teaching created TIAA through a grant in 1918. The purpose was to make it possible for college and university professors to retire in dignity with adequate financial resources. TIAA created CREF in 1952 so that the organization could offer variable annuities supplementing TIAA's fixed annuities.

Morgenson questions the objectivity of the investment advice being given by TIAA's advisers, with compensation that includes bonuses for steering clients into more expensive TIAA products and services. I am saddened that, during the past 15 years, TIAA seems to have been moving in the direction of for-profit investment firms, and that there seems to be little or no chance of reversing the trend.

Available Material
I am offering an 86-page complimentary PDF consisting of the Rink settlement agreement (30 pages), the Bauer-Ramazani settlement agreement (27 pages), selected articles from the March/April 2004, December 2005, June 2007, January 2010, and August 2010 issues of The Insurance Forum (27 pages), and an excerpt from the latest TIAA financial statement (2 pages). Email and ask for the November 2017 package about TIAA-CREF.