How the guaranteed rate is determined

Last updated: 9/30/2008 2:39:18 PM

Each year the announcement of the guaranteed rate prompts questions from participants such as who decides the rate, how is it calculated, and does the Federal Reserve (Fed) rate influence the decision? Below are answers to these questions and more. We hope they are helpful.

Who decides on the rate?

The Board of Trustees has the final say on the guaranteed rate. They base their decision on the analysis and reports provided by Member Benefits professional staff and investment managers from Prudential Financial, Inc. Prudential manages the Guaranteed Investment for the WEA TSA Trust and WEAC IRA programs.

How is the guaranteed rate determined?

Many factors contribute to the calculation of the guaranteed rate, but because the contributions made to the guaranteed account are invested solely in the bond market, managers pay close attention to factors that influence the price of bonds.

To determine a rate of return for the next twelve months, investment managers need to analyze what happened last year, what's happening today, and what’s likely to happen in the next 12 months.

Evaluating last year

First, they look at the return on the money currently invested. The bonds currently held have a host of unique traits, including purchase prices, maturity dates, and rates of return. To determine what existing investments returned in earnings over the last twelve months, a manager must calculate a combined return—an averaging of sorts.

The current situation

Next, managers look at maturing bonds and anticipate how that money will be re-invested and how much it might earn. Managers analyze the bond market offerings today and make assumptions about future rates based on what the Fed might do with interest rates.

Anticipating the next twelve months

Finally, managers need to consider new contributions such as how much new money will be available for investment, where it will be invested, and the anticipated rate of return.

When the analysis is complete, the managers at Prudential provide us with a recommended rate of return. We then present it to the Board of Trustees for its consideration and approval.

What is the role of the Fed?

The Fed controls interest rates that member banks charge each other to borrow money. The Fed adjusts the rate to stimulate economic growth or slow the economy in order to control inflation. When the rate goes down, you will enjoy lower interest rates on loans to finance a home or a car. This is good news when you need to borrow money.

Why is there a difference between the rate I pay for a loan and what I receive in a savings account?

Every coin has a flip side. While low rates make it more economical to borrow, they don’t look so good when you consider the yield on your savings accounts, certificates of deposit (CDs), or money market investments. For instance, a local Madison bank is paying 0.4% APY on a savings account and 3.06% APY on a 36-month CD (minimum $5,000 deposit). Banks make money by paying out less interest than they earn on loans and other investments.

How does the Fed rate affect investments in stocks, bonds, and the guaranteed rate?

The stock market responds quickly to interest rate changes by the Fed. Bonds are also sensitive to interest rates. Bond prices move opposite interest rates, rising when rates fall and falling when rates rise. However, this has greatest impact on bonds traded on the open market. We do not trade bonds on the open market. In our case, bonds are bought and held until maturity to provide the stability needed to guarantee a rate of return.

What is the difference between compound interest and simple interest?

An account paying simple interest pays interest only on principal, whereas an account that pays compounded interest pays interest on the principal plus accumulated interest earnings. Interest is compounded daily in the TSA Guaranteed Investment and WEAC IRA Guaranteed Accounts.

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