Part 703 Exempt Investments - GCUA · CREDIT UNION DIVISION. Part 703 Exempt Investments. 6. Federal - Section 701.19 exempts a Federal Credit Union from the investment restrictions

Credit Union Division

Part 703 Exempt InvestmentsHow to effectively use them to benefit your credit union

Meyer-Chatfield Credit Union Division

March 2018

Securities offered through J. Alden Associates, Inc. A Member Firm of FINRA/SIPC

CREDIT UNION DIVISIONCREDIT UNION DIVISION

Agenda

▪ Hot topics for 2018▪ What are 703 exempt investments?▪ How are they allowed by NCUA?▪ How much can you do?▪ How are they used in Executive Benefit plans?

▪ Loan regime split dollar plans▪ 457(f) plans

▪ Traditional plan design▪ Non-traditional plan design

▪ Charitable Donation Accounts (CDA)▪ What to look for in provider/plan administrator

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What’s hot for 2018

NCUA Examiners Guide ▪ addressing 25% of net worth for 701.19 (c)▪ 15% concentration limit with any one carrier

21% Excise tax on compensation over $1.0 million▪ Impacts 457(f) plan payouts

ASU 2016-01 – AFS classification change on equities, mutual funds, ETF’s▪ Fiscal years beginning after December 15, 2018

CECL – it’s coming and likely will impair earnings

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As employee benefits expenses continue to rise, the need to help finance these costs is more critical than ever.

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1 NCUA Data, 12/31/15 2 17th Kaiser/HRET Survey, 2015


Spread Compression – 10 Year Treasury Minus 2 Year Treasury

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http://fred.stlouisfed.org/graph/?g=j9gG


Part 703 Exempt Investments

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Federal

- Section 701.19 exempts a Federal Credit Union from the investment restrictions of the Federal Credit Union Act and NCUA rules when the Federal Credit Union invests under its authority to provide and fund employee benefit plans.

12 U.S.C. §1757(7), (8), (15), 12 U.S.C. §1761b(12), 12 C.F.R. §701.19 and 12 C.F.R. Parts 703 and 704

Georgia

– State Chartered Credit Unions and Federal Parity O.C.G.A. §7-1-61



Life Insurance (CUOLI/BOLI)▪ General account▪ Separate account – private placement▪ Indexed UL▪ Retail – 10 Pay Whole Life, Survivorship

Annuities▪ Fixed▪ Variable▪ Separate account - private placement

Separately managed accounts▪ Mutual funds, corporate bonds, equities, ETF’s

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# of credit unions nationwide currently own: 1,418 out of 5,765

# of credit unions nationwide over $50 million: 1,234 out of 2,331

# of credit unions nationwide with CDA’s: 80 out of 5,765

# of Georgia credit unions currently own: 32 out of 110

# of Georgia credit unions over $50 million: 27 out of 44

Who currently owns these types of investments?


703 Exempt on Call Report

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What are the limits to these investments?

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CREDIT UNION DIVISIONCREDIT UNION DIVISION11


Hot topic #1

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Updates to NCUA Examiners Guide for 703 exempt investments

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Executive Benefits

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Why the need for a plan?

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Key objectives may include:

▪ Attracting new talent

▪ Retaining the current talent

▪ Rewarding and motivating leadership team

▪ Enhancing a compensation and benefits package

▪ Supplementing benefits provided through qualified plans

▪ Funding for a management succession plan

▪ Implementing plans with the lowest cost and greatest impact

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CREDIT UNION DIVISION

ERISA limits creates inequities for executives

The higher the salary, the lower percentage of final pay is covered by retirement plans and social security.

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A properly designed plan should benefit both the credit union and the executive. Fair and balanced.

Credit Union• Affordable• Safety & Soundness• Retain, Retire, Recruit

Executive• Meaningful• Vesting• Commitment

Plans are designed to have minimal risk to the credit union. If executive decides to terminate employment prior to vesting oris terminated for cause.

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Executive Benefit Plan Options

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Limited options – like a buffet

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Loan Regime Split Dollar Life Insurance

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Loan Regime Split Dollar Life Insurance

▪ Provides tax efficiencies for executive, such as:

• Tax-free cash value accumulation• Tax-free access to cash value• Tax-free death benefit

How it works:

▪ The credit union loans money to executive to fund the policy.▪ The executive owns the policy, not the credit union (no 409A or excise tax)▪ The loan is secured via a collateral assignment (lien) to the credit union.▪ The loan can be interest bearing, therefore, income generating for the credit union.▪ Flexible vesting schedules.▪ Ownership transferred to credit union if terminated or leaves prior to vesting.▪ Credit union recovers it’s cash outlay.

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CU loans premium

Exec pays policy premium

Tax-FreeRetirement

Income

Death Benefit(less loans due to CU)

Executive ReceivesCredit Union Receives

Cash Value(equal to total loans due)

Death Benefit(equal to total loans due)

Life Insurance Policy

Credit Union Executive

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457(f) SERP

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Traditional 457(f) SERP

▪ An unfunded promise to pay in the future

▪ Typically funded with a one-time contribution

▪ Executive not vested until sometime in the future

▪ If leave prior to vesting, forfeit the benefit

▪ Plan can be used to recruit new executive

▪ Entire benefit is taxed to executive at vesting

▪ Potentially subject to 21% excise tax to credit union

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Case Studies for Loan Regime Split Dollar

▪ Affordable plan for smaller credit unions▪ Affordable plan for older executives▪ Alternative to 457(f) plan

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Case Study #1

Collateral Assignment Split Dollar Life InsuranceLoan Regime

Can be used for any size credit union

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Case Study #1

▪ Credit Union under $20 million in assets▪ CEO is a 37 year old female▪ Board agreed to loan $40,000 per year to fund policy▪ Utilize present value discount to loan upfront

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Case Study #1

How it works:

▪ The credit union loans Cindy $366,801 to fund a cash value life insurance policy

▪ Cindy is owner of the policy, not the credit union, therefore:- Cash build up is tax-free- Death benefit is tax-free- Distributions from policy are tax-free

▪ The loan is secured via a collateral assignment (lien) to the credit union.

▪ The loan can be interest bearing, therefore, income generating for the credit union

▪ At retirement, Cindy can take $53,000 per year from policy income tax-free.*

▪ If Cindy is terminated or leaves prior to vesting, she forfeits benefit.

▪ Credit union recovers it’s cash outlay, and total loan due.

* Based on current projections and assuming distributions for 20 years.

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Cindy

Tax-free incomeNumber of payoutsTotal tax-free income

Survivor BenefitInitialAge 65Age 85

$53,000 per year20

$1,060,000

$877,754$1,627,040

$694,891

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Case Study #1


Community Credit Union- Summary

Loan to CindyLoan interest rate (locked in for life of loan)

Loan Interest Income Recorded by Credit Union1st year5 year total

10 year total

Key Executive Coverage for Credit Union1st year5 years

10 years

$366,8012.66%

$9,757$51,450

$110,116

$376,558$418,251$476,918

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Case Study #1


Credit Union Cash Outlay

Cash Investments Proposed Plan

Yield 1.20% 1.10% 1.71%*

1st Year Income $4,401 $4,034 $6,272

Executive Retention None None Incentive to finish career at credit union

Retirement Benefit None None Tax-free retirement income

Key Executive Coverage None None Total recovery of cash outlay and accrued interest income

Survivor Benefit None None Yes

Opportunity cost of the money$366,801

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Case Study #1

* Net of plan document and administration fees


Case Study #2


Can be used for older executives – not just young executives

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Case Study #2

▪ Credit Union $160 million in assets▪ C-Suite executive is 60 year old male▪ Retirement age 65 – (5 years until retirement)▪ Use loan interest income to provide bonus at age 65

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Case Study #2

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457(f) Payout: $900,000Estimated Taxes (45%): $405,000

Net to Executive: $495,000

- Executive can choose to spend or reinvest the $495,000.- Future income depended upon investment performance.

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Hot topic #2

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457(f) Payout: $900,000Base Salary: $200,000Bonuses: $50,000

$1,150,000

21% Excise Tax on $150,000 = $31,500 tax to credit union

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Case Study #3


Rescue existing 457(f) plans

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Case Study # 3

▪ Credit Union $386 million in assets▪ C-Suite executive is 53 year old female▪ Retirement age 65 – (12 years until retirement)▪ Utilize vesting to reward executive for years of service▪ Accrued 457(f) liability - $189,045

▪ $1.0 million targeted 457(f) payout

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Case Study # 3

What happens to accrued 457(f) liability - $189,045?

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Innovative Plan Design & Funding

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▪ A lower cost alternative to traditional 457(f) plan designs.

▪ Provides lifetime benefit to retired executive, with a joint payout option available.

▪ The benefit is a contractual guarantee from the issuing insurance company, not based on investment performance. Credit risk of insurance company remains.

▪ No market investment risk. At retirement, the executive will control the policy. Credit union does not have concern over additional funding requirements for targeted benefit, like a traditional defined payout design.

▪ Can complement a loan regime split dollar plan and provide a strategy to get the plan off the credit union’s books at or near retirement.

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Credit Union Owned Life Insurance(CUOLI)

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Types of CUOLI

General Account

• Invested in the general account of the insurance carrier

• Ability to invest in regulatory eligible securities

• Strong guarantees

• “Black box”; no disclosures

Separate Account

• Invested in a bankruptcy remote separate account

• Many eligible investment options

• Full disclosure on all policy changes & credits

• Stable Value Protection available

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Product is proven• Developed in the 1990’s for use in banks

Transaction approved• NCUA, OCC, FDIC, SEC, IRS and all state banking insurance commissioners

General Account CUOLI - Product provides predictable interest earnings• Floats with other conservative market instruments

Separate Account CUOLI – Product has numerous investment options• Reallocate amongst asset classes

Guaranteed floor crediting rate• Up to 2%

10 year interest earnings history• The net return on CUOLI has averaged 150 to 275 basis points better than credit union permissible investments

Financial strength• Product backed by financially strong insurance carriers A+/AA/AAA

Liquidity• Product can be surrendered on demand without surrender charges

Non-interest income• Creates monthly income immediately accretive to earnings

CUOLI

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Plan Comparison

457(f) LINQS+ CASD

Accrued liability Yes Yes No

Taxes due at vesting Yes Yes No

Annual retirement income

% of estimated pay % of estimated pay % of estimated pay

Duration of income Flexible Contractually guaranteed for life

Flexible

Plan ends at retirement Yes Yes No

Insurability required No No Yes

Plan cost recovery Yes* Yes* Yes

Income generating for CU

Maybe* Maybe* Yes

Key executive coverage Yes* Yes* Yes

Survivor benefit for exec

Yes* Yes* Yes

* If CUOLI is on the participant

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Hot topic #3

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ASU 2016-01 – Mark-to-Market

If you own mutual funds, ETF’s, variable annuities/life insurance, separate managed accounts▪ You will be impacted. Any movement of account balance, flows through income.

What to do:

▪ Do nothing. Live with volatility and unpredictability to income.

▪ Re-allocate. Give up potential return for low volatility to income.

▪ Cash out.

▪ Move to an indexed insurance product. Floor and ceiling.

▪ Replicate or increase equity position, using Stable Value Protection (SVP)

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Stable Value Protection (SVP)

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Stable Value Protection

▪ Allows the credit union to have equity exposure and the potential for equity returns without the volatility to the income statement

▪ Addresses ASU 2016-01 – AFS to Mark to Market

▪ The stable-value protection is an accounting mechanism which amortizes the gains and/or lossesover an extended period.

▪ Offered institutional insurance or non-insurance

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Stable Value Protection


Guaranteed Investment Contract (GIC)

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Guaranteed Investment Contract (GIC)

A GIC offers a guaranteed rate of return over a fixed period of time, issued by insurance carrier.Principal risk is if insurance carrier defaults.


Trust Certificate Gestational Repo

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Trust Certificate Gestation Repo

As of March 19, 2018, Annualized Yield = 2.82%


Charitable Donation Account(CDA)

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Credit Union Challenges

▪ Credit unions are philanthropic by nature

▪ Many investments are impermissible to credit unions

▪ Return on Investment (ROI) from traditional investments for credit unions have been low

▪ Limited in how a credit union can recognize board of directors

How much does your credit union contribute each year to 501(c)(3) charitable organizations?


501(c)(3) Organizations

▪ Not-for-profits in your community

▪ Your State Credit Union League Foundation

▪ National Credit Union Foundation

▪ Credit Union Foundation


What is a Charitable Donation Account (CDA)

▪ Allows a credit union to generate income through Non-703 investments for donations to 501(c)(3) charities.

▪ December 2013- NCUA established §721.3(b)(2) for Federally-chartered credit unions


CDA Federal Guidelines

▪ Invest up to 5% of a credit union’s net worth

▪ Minimum 51% of earnings must be donated

▪ Distributions at a minimum of every 5 years

▪ Remaining 49% of earnings used as credit union chooses

▪ CDA must remain at or below 5% of net worth

▪ Funding held in custodial account or trust

▪ Document named charities

▪ Document program or plan policy statement


Why establish a CDA

▪ May help generate additional donation funds to make an impact locally, in your state or across the country.

▪ Variety of potentially higher-yielding investments, otherwise restricted under 703.

▪ Remaining earnings retained by credit union.

▪ New way to recognize board members.


Sample Case #4

$10,000 Planned Giving by Credit Union

$1.0 million permissible investment

earning 1%

$1.0 million CDA investment

earning 5%

$10,000 donation generatedNothing additional for credit union

$50,000 of earnings$25,500 donation generated (51%)

$24,500 income to credit union (49%)


$25,500 = New Total Charitable Contribution (51% of return)

$10,000 Original Planned Giving

$15,500Contribution in Director’s Name

$15,500 Additional Charitable Donation

Option 1 Option 2

Sample Case #4


Investment/Funding Options

Separate Account CUOLI

Managed * Money

GIC

Institutional Annuities


Plan Administration

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The plan administer should work closely with the executives, and/or directors, to identify the objectives for the plan and review accordingly. The process should include:

▪ Legal Documents

▪ Financial Modeling & Accounting Support

▪ Record Keeping

▪ Regulatory Due Diligence

▪ Participant Communication

▪ Board Education, Reviews and Reports

REVIEW SCHEDULE SHOULD INCLUDE

– annual visits, daily online support and ongoing due diligence on plan funding.

What you should expect from plan administrator

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Ensuring safety and soundness

What makes a plan administrator superior:

▪ Reporting standards and internal controls are SSAE 18 audit certified

▪ Relationship with multiple insurance carriers.

▪ Monthly asset value reports

▪ Death claim processing, which includes reprojection of cash values and accounting entries

▪ Daily Social Security sweep in the event an insured participant passing, credit union is notifiedimmediately

▪ Annual 101J report (IRS 8925 form)

▪ Insurance carrier credit risk reports

▪ Annual face to face compliance reviews

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Recap

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Flattened yield curve presents earnings pressure▪ The potential for higher returns helps bottom line

Increase cost in employee benefits, especially health insurance▪ The potential for higher returns helps bottom line

Existing executive benefit plan ▪ Restructure to help bottom line

No executive benefit plan▪ Implement to help bottom line

CDA – get more bang for your buck▪ Helping charities, help your bottom line

CECL, Increases in delinquencies & charge offs▪ Potential for higher returns helps the bottom line


MEYER CHATFIELD GROUP

▪ Industry leaders in BOLI and executive benefits, offering customized products and services to credit unions and community banks.

ADMINISTRATIVE SERVICES

▪ Independent service provider and record keeper for BOLI and executive benefit plans. SSAE 18 Type II audited.

COMPENSATION ADVISORS

▪ Executive and director compensation consulting services, providing innovative compensation solutions including the patent pending LINQS+ retirement plan strategy.

Meyer Chatfield

Meyer Chatfield

Administrative Services

Compensation

Advisors

Meyer Chatfield Group3 Independent Companies…

working individually or together for the Credit Union

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Mike has over 27 years of experience helping corporations with insurance and investment strategies. For the last 13 years, Mike’s attention and expertise focused on helping credit unions with retaining and rewarding key executives in addition to providing institutional investments to help offset employee benefit costs. He has won numerous industry awards and has been a speaker at industry conferences.

Mike is responsible for engaging new clients and assuring existing customers are provided with the best cutting-edge solutions. He works with financial institutions to enhance the firm’s earnings and/or to reduce their risk by offering Meyer-Chatfield suite of insurance and executive compensation–based products.

He is a graduate of the University of Maryland and holds the Chartered Life Underwriter (CLU) designation. Additionally, he is Series 6, 63, 65, 7 and life and health licensed.

Mike and his wife Linda have a beautiful blended family with 7 children. He is active in his church, leading the men’s ministry.

Mike Downey, Managing Director

7675 Lake Shore Drive Owings, MD 20736

[email protected]

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Securities offered through J. Alden Associates, Inc.

A Member Firm of FINRA/SIPC

Disclaimer

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