July 9, 2021

TO:    ALL WISCONSIN STATE-CHARTERED CREDIT UNIONS

RE:    FACTORS AFFECTING THE PERMISSIBILITY OF CERTAIN INVESTMENT INSTRUMENTS USED TO PROVIDE EMPLOYEE BENEFITS

Many credit unions, like other businesses, find that retirement and other employee benefits are integral for purposes of recruiting and retaining good executives, managers, and staff. For that reason, the Office of Credit Unions has long permitted credit unions to offer such benefits to employees under section 186.113(17) of the Wisconsin Statutes, which authorizes a credit union to “make contracts necessary and proper to meet its purpose and to conduct its business.” 

Some types of employee benefits, however, involve the acquisition of life insurance, annuities, or other investment instruments by the credit union. Unless those investments are included among the pre-authorized investments specified in section 186.11 of the Wisconsin Statutes or section DFI-CU 59 of the Wisconsin Administrative Code (entitled Miscellaneous Investments by Credit Unions), the credit union must seek and obtain approval of this Office before acquiring them. See Wis. Stat. § 186.11(1)(e). 

This guidance is intended to describe factors that the Office will consider when evaluating requests for credit union approval for certain investments used to pre-fund future benefit obligations or implement deferred compensation programs, including credit union-owned life insurance (CUOLI)¹ , collateral assignment split-dollar (CASD)² arrangements, and other investment products. 

General Factors 

The Office considers several general factors in evaluating any request for approval of such an investment. Those factors include: 

• Whether the investment conforms to the credit union’s written investment policies. By law, a credit union’s board of directors must maintain a current written policy governing its investment practices. Wis. Admin. Code § DFI-CU 68.04. The policy should address the investment risk tolerances, net worth and overall financial condition of the credit union, as well as the credit union’s procedures for reviewing, authorizing, and—where necessary—seeking this Office’s approval for such investments. 

• Whether the credit union has avoided potential conflicts of interest when considering the proposed benefit plan. Wisconsin law requires directors, officers, committee members and employees of credit unions to avoid “initiating or participating in any action that may present to that person a personal conflict of interest.” Wis. Stat. § 186.071(1)(e). To avoid potential conflicts of interest, the credit union’s board of directors (or compensation committee, if it has one) should be responsible for reviewing, evaluating, and approving or disapproving proposed benefit plans—not the officer or employee who will receive the contemplated benefits (or anyone subject to their supervision or control). The board should ensure that officers and employees are not in position to make decisions on behalf of the credit union concerning their own compensation or benefits, and it should adopt written policy to that effect. In addition, credit unions must obtain explicit consent from any employee that is being insured. 

• Whether the credit union has obtained the advice of independent legal counsel, accountants, or other advisers concerning the proposed benefit plan. CUOLI, CASD, and similar investments used for employment benefits are typically complex instruments, making it important for the board to obtain the assistance of experts who can provide an objective and thorough analysis of legal, financial, tax, and compliance-related risks associated with them. The Office expects the credit union to retain legal counsel to review the compensation policy, plan, documents and agreements and any amendments to these items, as well as an independent CPA or other qualified consultant to ensure the program is properly administered, valuated, and accounted for.³ 

• Whether the credit union has a clear understanding of the terms and conditions of the proposed benefit plan and possible alternatives. The board should have a clear, documented understanding of each proposed benefit plan or arrangement, including: eligibility criteria and vesting periods; the effects of early or involuntary termination of employment; responsibility for tax reporting and liabilities; and all other obligations and responsibilities of both the credit union and the employee, including identification of the person authorized to act on behalf of the credit union concerning the plan. The board should also compare the terms of the chosen plan to other available alternatives—including similar plans offered by different vendors and alternative investment and plan types designed to serve the same purposes—and maintain documentation explaining the credit union’s rationale for the chosen plan. 

• Whether the credit union has fully considered and documented the risks associated with the proposed benefit plan. The board is responsible for performing (or retaining qualified independent experts to perform) due diligence on the proposed investment, and for considering all associated risks to the credit union’s future earnings, net worth, and other safety and soundness concerns. These risks include:  

• ​Concentration risks. In evaluating concentration risk, the board must consider the size and risk profile of the credit union. For a well-capitalized and well-managed credit union, related investments should not exceed 25% of net worth. This includes the total cash outlay (including accrued interest) and unfunded commitments. Exposures to single non-governmental obligors must be limited to 15% of net worth or less. 

• ​Interest rate risks. The board must evaluate the risk that funds dedicated to the program will contribute a less than market rate of return over the term of the program and negatively impact earnings and net worth. 

• ​ Liquidity risks.  The board must evaluate the risk of reduced liquidity due to plans having a high amount of non-liquid, long term assets including unfunded commitments. 

• ​Transaction risks. The board must evaluate risks related to the purchase, implementation and monitoring of the program. Consideration must be given to following GAAP, having sound internal and dual controls over the program, and assurance that authorized individuals are managing the program in an appropriate manner. 

• ​Vendor risks. The vendor may be an agent of an insurance company or an independent broker who has relationships with many insurers or other parties. The board must consider the vendor’s reputation, experience, financial capability, knowledge of the product, and the services provided. The nature of the review should be commensurate with the size and complexity of the compensation program and products.⁴ 

• ​Compliance risks. The board must evaluate risks and establish safeguards to ensure compliance with state and federal rules and regulations, tax and accounting requirements, and other applicable law.

• ​Credit risks. The board must evaluate the underlying investments and monitor risk exposure. For certain life insurance products, this includes risks relating to the insurance carrier’s contractual obligation to pay claims (and, if applicable, the cash surrender value less any applicable surrender charges) upon surrender of the policy.  

• ​Exit risks. The board should consider exit strategies from these programs and plans and the related costs. 

• ​Strategic risks. The board must consider these programs in relation to budgeting, ALM analyses, the credit union’s overall employee compensation program, and its long-term strategic planning. 

• ​Reputation risk. Potential perceptions associated with a credit union’s compensation to senior executives and potential earnings shocks resulting from financial statement restatements could elevate reputation risk. 

These risks are discussed in greater detail in the Interagency Statement on the Purchase and Risk Management of Life Insurance dated December 7, 2004. The board should maintain written documentation of its analysis of each of these risks, including its assessment of the financial costs and potential impact on the credit union’s earnings and net worth. This documentation must be sufficient to demonstrate that the board has performed thorough due diligence concerning the investment and has a clear understanding of the investment characteristics, terms, and risks. 

• Whether the credit union has taken documented steps to ensure proper accounting for the plan. The credit union must comply with all IRS provisions and work with an independent CPA regarding the accounting, financial statement reporting, and consideration of any changes of circumstance related to the plan. Related assets and liabilities should be reconciled quarterly. Valuations must be ongoing and any identified shortfalls must be funded in a timely manner. The credit union must follow generally accepted accounting principles (GAAP) and adhere to 5300 Call Report instructions, and it should consider whether and how future changes in GAAP and/or changes to tax laws may affect the credit union’s ability to properly account for the plan. 

• ​Whether the board has adopted a policy to ensure ongoing assessment and compliance. The board should have a written compensation policy that addresses ongoing monitoring and periodic review of employee benefit plans. The policy should address ongoing regulatory, accounting, and tax compliance; the engagement of independent attorneys, accountants, or other consultants who report directly to the board concerning the plans and other matters concerning compensation; and the periodic review of the plans and underlying investments by the board. Such reviews should occur at least annually and must include an assessment of the investment performance, the cost of the plan/arrangement (individually and in the aggregate), any modifications or changes to the plan or the associated risks, and any threats it poses to current or future earnings, net worth, or the safety and soundness of the credit union. If modifications are necessary or advisable, the board should promptly ensure their implementation. 

In evaluating requests for make investments for the purpose of pre-funded benefits, this Office further assesses whether those investments meet the same standards that the NCUA applies when evaluating such investments by federal credit unions. Those standards are: 

     (1) whether the investment is used to fund an employee benefit obligation;

     (2) whether the investment is directly related to the funding obligation under an employee benefit plan; and 

     (3) whether the investment will only be held for as long as the credit union has an obligation under the employee benefit plan. 

See 12 C.F.R. § 701.19(c) (entitled Benefits for employees of Federal credit unions). The board should document adherence to these criteria at least annually during the periodic review process described above.

Examiners will review board minutes; audit reports; investment schedules and reports; financial statements and other documentation to ensure these investments are compliant and being actively managed and monitored. It is imperative that the board of directors has completed and document appropriate due diligence to demonstrate that the investment and/or arrangement will protect the credit union in the short and long term. 

Specific Considerations Relating to CUOLI 

CUOLI can be structured in various ways, which can create challenges for ongoing risk monitoring. Because of the complexity of many of the CUOLI policies and group programs, and the fact that life insurance is a form of long term financial commitment with various components of risk, credit unions and their boards of directors should take appropriate steps to assure they are making informed decisions about purchasing this insurance, consistent with safety and soundness principles. 

A resource for additional information on CUOLI is the Interagency Statement on the Purchase and Risk Management of Life Insurance dated December 7, 2004.

Specific Considerations Relating to CASD 

CASD plans generally involve the credit union making loans to employees (see footnote 2), and credit unions must adhere to safe and sound lending principles when making such loans. The Office has identified the following additional factors for consideration when evaluating the safety and soundness of proposed CASD plans: 

• Loans under CASD plans may only be made to a credit union employee. CASD loans where the borrower/employee is not the insured are not safe or sound and will not be approved. 
• Assignments must be fully executed with acknowledgement by the collateral issuer and acknowledged of the credit union’s superior interest in the collateral must be obtained. The agreement must ensure that the owner/borrower cannot borrow against the policy without approval of the board. 
• The board is responsible to maintain documentation of the underwriting decision if the arrangement requires the employee to repay the credit union irrespective of the collateral assigned. When determining if the loan is collectible, the ability to repay must include evaluating the borrower’s obligations under varying employment scenarios; the borrower’s verified repayment capacity from earnings and/or unencumbered assets pledged; and the presence or absence of a structured repayment plan. Collateral shortfalls on full recourse CASD accounts must be identified and analyzed. The board must establish and monitor reasonable limits for these shortfalls. As an example, the Wisconsin member business loan rule limits unsecured loans to members to 1% of net worth. 
• ​The credit union must recognize and measure an asset based on the nature and substance of the CASD arrangement and document compliance with the criteria outlined in GAAP. Credit unions should consult with a qualified CPA to determine the proper balance sheet recognition of the asset based on the plan structure on an ongoing basis. A CPA should also be used for accounting guidance and a credit union should periodically engage for a review of the agreement and accounting as part of their annual audit or a separate audit. 
• In considering liquidity and other general risks identified above, the board should bear in mind that the credit union is not the owner of the policy and does not control liquidation. 
• CASD collateral assignments must be clearly documented, valued and have controls in place to ensure independent monitoring and risk management throughout the duration of the loan. It is expected that the Board of Directors engage a qualified CPA firm to do a complete review of the CASD including any amendments to the original agreements; valuation; accounting and identification of any financial or other risks to the credit union.

Specific Considerations for Other Investments^​5 

Other investments used to fund employee benefit plans may include investment in an institutional managed account program that includes mutual funds, debt and/or equity securities, exchange traded funds, annuities, etc. Other investments used to fund employee benefits must be of investment grade as defined by NCUA Rules and Regulations Part 703.2 and have a predictable contractual return over a time horizon that matches benefit obligation cost. In general, investing primarily in equity and commodity type investments is not suitable for employee benefit purposes because the historical return performance is not a reliable indicator of future returns. These investments would only be appropriate if the benefit obligations performed on the same basis as the investment used. 

Summary 

When seeking approval of these programs, credit unions must provide documentation to the OCU quantifying their investment and addressing the general factors and specific considerations described in this letter. Examiners and management will review and evaluate these programs and related investments to ensure that adequate due diligence has been done, the products are reasonable, the program is properly set up and monitored and has been approved by the board.  

If a credit union does not obtain the required approval or the investment presents safety and soundness concerns, the Office of Credit Unions has the authority to order divesture of the investment. 

If you have questions, please contact the Office of Credit Unions at 608-261-9543 or dfi-ocu@dfi.wisconsin.gov

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​¹In a CUOLI program, a credit union purchases life insurance policies on the lives of its employees. The credit union pays the premiums, owns the cash value, and is the designated beneficiary. 

²In a CASD program, the credit union agrees to lend an employee money to pay premiums on a life insurance policy that the employee owns and controls. The employee signs an agreement and collaterally assigns the policy to the credit union to secure the loan covering the premium payments. The employee uses the value of the policy to supplement retirement costs while the policy is active, while the credit union and the employee share the rights to the policy’s cash surrender value and death benefits. 

³The credit union must also ensure compliance with applicable audit requirements under  title 12, part 715 of the Code of Federal Regulations, entitled Supervisory Committee Audits and Verifications.  

^​4The NCUA has published several letters on evaluating third-party relationships, which boards should reference when evaluating vendors and consultants. See Letter No. 01-CU-20, Due Diligence over Third Party Service Providers; Letter No. 07-CU-13 and Supervisory Letter No. 07-01, Evaluating Third Party Relationships; Letter No. 08-CU-09 and attachment, Evaluating Third Party Relationships Questionnaire.  

^​5These investments may not always have a defined “maturity date” and are likely to carry higher levels of credit, market and interest-rate risk than permissible investments. Assigning an estimated weighted average life (WAL) for interest-rate and liquidity risk analysis may prove challenging. The credit union must develop supportable estimates of key attributes to measure and monitor the risks of holding the investments over the life of the employee benefit plans. Reasonable and supportable assumptions and estimates can be developed by looking at the terms and conditions of both the investment and the benefit plan being funded to identify the holding period, maturity, and asset amortization to calculate the WAL and valuation of the investment(s).