Executive Compensation Strategic Design and Funding

Transcription

1 Executive Compensation Strategic Design and Funding Learning Objectives: Friday, January 15, :15-3:30 pm Haku Ballroom Understand how to focus executive attention on specific strategic objective through financial incentives. Understand how multiple benefit plan options can be combined into a single package to address various risks and desired outcomes. Understand the general characteristics of the funding options and when and how to pre-fund benefit obligations. Understand funding opportunities and limitations under NCUA regulation and expected (recently issued?) guidance. Presented By: Chris Burns-Fazzi, Principal Burns-Fazzi, Brock & Associates cfazzi@bfbbenefit.com x 201 James S. Patterson, Benefits Attorney Sherman & Patterson, Attorneys at Law jpatterson@splawfirm.net

2 Executive Compensation Strategic Design and Funding Executive Compensation - Strategic Design and Funding Chris Fazzi and Jim Patterson For more information visit bfbbenefit.com or splawfirm.net/vli Benefit Budget = Investment in Success 6216 CUs file call reports

3 1206 CUs (19%) invest to fund benefits 322 CUs attending VLI 223 CUs (69%) attending VLI invest to fund benefits

4 Strategic Plan Design Designing plans to achieve strategic goals through vesting and forfeiture provisions. Change of Control No-cause termination So You re fired?

5 Disability Good Reason Impact of Vesting 457(f) taxation & distribution Split Dollar vesting does not cause taxation, but determines access

6 Disability Death Involuntary w/o Cause Good Reason Change of Control Prevalence of entitlement events Death Disability Good Reason (constructive termination) Involuntary termination without cause Change of Control Voluntary (split dollar only) Voluntary Forfeiture Voluntary Termination (without Good Reason) Forfeiture For Cause termination

7 Focusing executive attention through financial incentives Significant and meaningful benefits Cash vs. fringe benefits, taxable vs. tax-free Life circumstances can affect the type of benefit plan Age or time horizon to payment event Long time horizon Hold out a carrot to keep executives focused. When and how to vest

8 Intermittent payouts How much, when? Benefits are forgotten once paid. Quiver of Five Key Plan Options Cash 457(b) 457(f) 83 Bonus Split Dollar

9 Plan Combinations Cash 457(b) 457(f) 83 Split Dollar Plan Combinations Combine 457(f) lump sump with 457(b) installments to spread taxes. 457(b) 457(f) Plan Combinations Further enhance with tax-free retirement loans from Split Dollar and tax-free death benefit. 457(b) 457(f) Split Dollar

10 Plan Combinations Combine with 83 Bonus to provide tax-free loans (smaller) and tax-free death benefit. 457(b) 457(f) 83 Plan Combinations Add fringe benefits (e.g., post-retirement medical coverage, supplemental LTD, financial/ estate planning assistance), if needed. 457(b) 457(f) 83 Fringe Benefits Tax risk vs. Performance risk

11 Strategic Funding Design Invest now, or working capital later Pre-funding Benefit Obligations Impact on credit union financials Pre-funding Benefit Obligations Legal promises in document

12 Individual vs. Aggregate Pre-funding Benefit Obligations Funding return Pre-funding Benefit Obligations Indexing Investment Alternatives Investment Alternatives Variable Investments Structured Products Fixed Investments

13 Structured Products Fixed Investments Fixed Investments Institutional Life Insurance & Group Annuity Contract (Short-Term) Death benefit liability projection (life) Contractual guarantees High credit quality No duration risk Predictable returns / monthly income Book value treatment Investments Structured Products Structured Products Principal protection (at maturity) Fixed maturity FDIC insured (up to $250,000) Variety of index options Held-to-maturity / available for sale Fixed Investments Variable Investments (Mutual Funds) Flexibility Transparency Exposure to other asset classes Variable Investments Structured Products

14 1206 CUs (19%) invest to fund benefit plans Securites Other Investments Split Dollar (C.A.) Line 20 investment percentages 29% 14% 12% Call Report - September 30, All CUs Securities $2,804,573,703 29% Other Investments $1,525,729,377 14% Split Dollar (C.A.) $1,162,047,738 12% Split Dollar (End.) $ 642,877,219 7% Other Insurance $3,614,105,258 36% Other Non-Ins. $ 233,397,087 2% Total $9,982,730, % Split Dollar (End.) 7% Other Insurance 36% Other Non-Ins. 2% Securites Other Investments Split Dollar (C.A.) Split Dollar (End.) Line 20 investment percentages 29% 21% 14% 25% 12% 10% 7% 5% Call Report - September 30, VLI CUs Securities $ 183,997,996 21% Other Investments $ 216,161,353 25% Split Dollar (C.A.) $ 90,328,995 10% Split Dollar (End.) $ 40,035,266 5% Other Insurance $ 325,015,217 37% Other Non-Ins. $ 19,919,060 2% Total $ 875,457, % Other Insurance 36% 37% Other Non-Ins. 2% 2% All CUs VLI

15 Percent of VLI CUs with investments Securites 23% Other Investments 22% Call Report - September 30, VLI CUs Securities 21 Other Investments 20 Split Dollar (C.A.) 16 Split Dollar (End.) 7 Other Insurance 30 Other Non-Ins. 5 Split Dollar (C.A.) 17% Sample Size: 92 Split Dollar (End.) 8% Other Insurance 33% Other Non-Ins. 5% Securites Other Investments Split Dollar (C.A.) Split Dollar (End.) Percent of all CUs with investments 9% 23% 11% 22% 14% 17% 6% 8% Call Report - September 30, 2015 CU asset sizes $46,879,600 $7,760,200,000 Securities 202 Other Investments 260 Split Dollar (C.A.) 321 Split Dollar (End.) 130 Other Insurance 525 Other Non-Ins. 73 Sample Size: 2,320 Other Insurance 23% 33% Other Non-Ins. 3% 5% CUs $46M $7.7B VLI CUs Four product risks Transactional, interest rate, credit worthiness, & liquidity 7 Risks Three board of directors due diligence risks Reputation, compliance, strategic

16 Transactional Transactional Risk How does the purchase of the investment affect the bottom line of the credit union? Is the transaction simple enough that everyone understands it? Interest Rate Interest Rate Risk How do the changes in the market affect the credit union s earnings and capital? Credit worthiness Credit Worthiness Risk What is the credit rating of the carrier(s) the board is considering? What is the risk to earnings and capital when the product fails to perform as expected?

17 Liquidity Liquidity Risk What is the risk to earnings if the investment has to be liquidated? Funding Risk Table Transactional Risk Interest Rate Risk Credit Worthiness Risk Liquidity Risk Market Return (+ or ) T-Bill Low None Lowest Medium Low Institutional Insurance Structured Products Medium None Low None Medium Medium Low Low Medium High S&P 500 High High Medium High Highest Reputation Reputation Risk Does the board fully understand the risk to earnings and capital arising from negative publicity regarding the credit union s business practices?

18 Compliance Compliance Risk Is the purchase of the investment compliant with all laws, rules and regulations? Strategic Strategic Risk Does the structure of the investment align with the credit union s philosophy? This key section of NCUA s regulations allows federal credit unions to make otherwise impermissible investments to fund reasonable benefit plan obligations. Benefit Plan Investment for FCUs Otherwise impermissible Direct relationship test

19 Section does not currently address concentration levels, but credit unions need to determine the proper amount to invest. Concentration Interagency Statement on the Purchase and Risk Management of Life Insurance. (OCC ) In 2004 banking regulators gave the industry guidance on the purchase and risk management of life insurance. It gives helpful start-to-finish pre-purchase and post-purchase board due diligence procedures, and sets out a concentration level of 25% of capital for BOLI investments with board discretion to exceed. Expected Federal Guidance The NCUA is in the final stages of developing guidance for credit unions that we believe will be similar to the Interagency Statement, but broader to include more on benefits such as split dollar life insurance.

20 Parity The 47 states with state-chartered credit unions want to be on a level playing field with federal credit unions. Their parity statutes allow them in some capacity to invest in benefit plans according to federal standards. Automatic Follows NCUA Notification Advance approval States take different approaches to allowing parity, with some automatically allowing their credit unions to invest as federal credit unions invest, and others requiring advance notification or even advance approval before making the investment. Split Dollar? States treat split dollar and institutional insurance differently in regard to parity, so it is important to check in with the state regulators regarding the proper process to follow. Institutional Insurance?

21 Some states have issued guidance specifically addressing benefit plan investments.

22 Sherman&Patterson Attorneys at Law Benefit Plan Investment Policies Current Standards and Best Practices James S. Patterson * Originally published in the California/Nevada Credit Union League 2015 Summit Round Table Executive Compensation Survey. Reprinted with permission. Investment policies are an important part of a board s due diligence, as they set out key investment procedures and practices for credit union boards, subcommittees, and executives to follow. This article first explores the general provisions to include in investment policies for both federal credit unions and state-chartered credit unions located in California or Nevada. It then addresses how to tailor the investment policies when the credit union desires to fund investment obligations for the benefit plans it establishes. Federal Credit Unions For federal credit unions, the NCUA requires a written investment policy that establishes The purposes and objectives of the investment activities; Investment characteristics; How the credit union will manage interest rate, liquidity, credit and concentration risks; Who has the investment authority and the extent of that authority; Broker-dealers and safekeepers that the credit union may use; How the board will address investments that later fall outside of the policy; and How the credit union will conduct trading activities. 1 Beyond these general categories, investment policies for federal credit unions vary significantly in terms of specific provisions, detail, and direction to their boards and committees. State-Chartered Credit Unions in California and Nevada The California Credit Union Regulations state: The board of directors of a credit union shall adopt and review at least annually, and the credit union shall comply with, a 1 NCUA Regulations

23 Sherman&Patterson Attorneys at Law written investment policy which sets out the goals of the credit union s investment portfolio with respect to the yield, maturity, liquidity and diversification of its investments. 2 Beyond these basic requirements, many California credit unions also address some or all of the additional policy provisions set out above required for federal credit unions. Nevada does not have a statute that specifically requires credit union boards to establish investment policies, but the use of investment policies in Nevada is still the best practice. Benefit Plan Investments When credit unions invest to fund their benefit plan obligations, they need to update their investment policies to specifically address the investments that can be purchased in connection with the plans, and how the board will manage the investments going forward. 3 When life insurance is involved, one of the best resources for credit union boards actually came from the banking regulators in Interagency Statement For investments in life insurance, the Interagency Statement on the Purchase and Risk Management of Life Insurance 4 issued by banking regulators in 2004 provides helpful standards for purchasing and managing the life insurance. Some key concepts from the Interagency 2 California Credit Union Regulations Section (a). 3 Some regulators prefer to see the benefit plan investment policy set out separately from the general policy. 4 OCC In Opinion Letter , the NCUA responded to a request to provide guidance similar to that contained in the Interagency Statement by stating our practice is not to review and approve materials such as you provided but recognized the thrust of the guidelines in OCC may be useful to FCUs We understand the NCUA has established a steering committee to create similar guidance for credit unions, and plans to issue the guidance soon. 2

24 Sherman&Patterson Attorneys at Law Statement to consider addressing in the investment policy when life insurance is involved are: Effective oversight by senior management and the board, with the board remaining ultimately responsible. An ongoing system of risk assessment management, monitoring, and internal control processes. Adequate pre-purchase analysis, such as identifying the need for the insurance, the appropriate type and amount of insurance, vendor qualifications, credit worthiness of carrier, and evaluation of alternatives. Internal policies for investment concentrations. Annual review of investment, including items such as carrier financial strength, risk assessment, death benefit amounts, mortality performance, investment performance, impact on income, audit results, and compliance with laws and regulations. Analysis of the seven institutional insurance risks (i.e., liquidity, transactional, reputation, credit worthiness, interest rate, compliance and strategic) used by credit unions and their regulators. Additional Direction Some regulators have suggested that boards consider additional questions (some relevant to insurance-based investments and others generally relevant) as they establish their benefit plan investment policies: What types of reports will the benefits consultant provide? How would the board monitor the insurance carriers directly if the benefits consultant does not provide sufficient assistance? How do the insurance policies work, including policy types, terms and surrender charges? How often can the carriers change their crediting rates? What actions will the board take if an insurance carrier suffers an economic downturn? How can the board mitigate the risk inherent in the benefit plan investments? How will the board account for the plan? 3

25 Sherman&Patterson Attorneys at Law What stress testing can the board perform on the expected investment returns to help it develop a plan of action if investment performance lags expectations? What is the board s exit strategy for the investments if it desires to get out early? Board Due Diligence Regulators recognize that credit unions often use benefits consultants to assist in designing, funding, and administering benefit plans and their investments. However, regulators require independent board action and review as part of the board s due diligence. Consultants may assist with suggested language for the boards to consider adding to their investment policies, but regulators will look for board minutes or other documentation showing that the board has sufficient understanding of the new investments and resulting investment policy provisions. Conclusion Investment policies provide the road map for boards to follow to make sure their investments are both legally compliant and safe and sound for the credit union. Credit unions should update their investment policies to include new benefit plan investments, and carefully oversee the investments going forward. * Jim is a partner with Sherman & Patterson, Ltd., a law firm focusing on executive compensation in credit unions and other tax-exempt entities. Jim frequently interacts with the NCUA and state credit union regulators regarding the implementation and funding of executive and director benefits, keeping clients compliant with applicable regulations. 4

26 Benefits Pyramid Foundational Analysis Guidepost: Concentration Limits Seven risks Liquidity Transactional Credit worthiness Interest rate Reputation Compliance Strategic Benefit plan investments Proper risk management Prudent investments Board due diligence Fair& reasonable compensation Attract and retain key employees Sherman&Patterson Attorneys at Law

27 EXECUTIVE BENEFIT PLANS OFFERED FOR CEO By Type and Asset Size Credit Union Executive Compensation / Benefits Survey - CUES (2015) Percent Offering for CEO Plan Type Asset Size $25M - $75M $75M - $150M $150M - $400M $400M - $1B $1B - $5B+ 457(b) 25% 31% 33% 54% 81% 457(f) 17% 19% 37% 48% 55% Split Dollar * 6% 2% 7% 13% Credit Union National Association - CUNA (2015) Percent Offering for CEO Plan Type Asset Size $100M - $200M $200M - $500M $500M - $1B $1B - $3B $3B+ 457(b) 59% 73% 76% 97% * 457(f) 62% 51% 41% 42% * Split Dollar 1 5% 17% 7% 18% * National Association of Federal Credit Unions & Burns-Fazzi, Brock - NAFCU / BFB Survey (2015) Percent Offering for CEO Plan Type Asset Size $40M - < $75M $75M - < $150M $150M - <$400M $400M - <$1B $1B - < $6B 457(b) 11% 13% 42% 33% 67% 457(f) 11% 17% 32% 46% 43% Split Dollar 6% 10% 20% 15% 21% *Not Available