Credit unions across the country are currently facing a common challenge—how to create more yield and income. They traditionally rely on reinvesting money from lending products as one form of income. However, due to the increase in government stimulus payments and record-low loan growth, credit unions have had to find alternative income-generating sources to offset costs and a significant increase in member deposits.
On the show, Doug welcomes guest Mike Downey, who has worked exclusively within the credit union movement for the last 16 years. In addition to helping credit unions offset employee benefit liabilities and implement supplemental executive retirement plans, Mike also helps them fund charitable donation accounts (CDAs).
Mike explains how CDAs, which provide alternative investment options, can be a solution to help credit unions donate to their communities while also generating income. Mike discusses the details of this option, including how credit unions must contribute 51% of the yields to qualified charities every five years; the remaining 49% can be an income source. In addition to generating income, the investment vehicle poses fewer risks to credit unions and is liquid without any withdrawal penalties.
Additionally, he talks about credit union-owned life insurance (CUOLI) as a way to fund a CDA and how it’s gotten more accessible in recent years. A CUOLI offers conservative credit unions the predictability of minimum returns with low risk.
If your credit union has struggled to create more yields and income, stream the episode to hear Doug and Mike discuss:
- The impacts of investing in a state versus federal charter
- If a credit union should choose a CDA or develop its own foundation
- The risks to consider, including when an insurance carrier liquidates
- The net worth cap of a CDA’s aggregate value
- How various investments may affect the balance and income statement of credit unions differently
Listen to the entire conversation now.
Audio Transcription (pulled from the podcast)
Hello credit union executives. Welcome to C.U. on the Show, where we give you up-to-date information on how you can reduce risk, keep key talent, and take a strategic approach to your personal financial wellness. Hosted by me, Doug English, a CERTIFIED FINANCIAL PLANNER™ and former credit union insider with Act Advisors.
My guest on today’s podcast is Mike Downey. Mike helps credit unions fund charitable donation accounts to offset employee benefits and liabilities, and implement supplemental executive retirement plans for their leadership team. In this episode, we discuss if your credit union should consider a charitable donation account and the risks and benefits of credit union-owned life insurance. Mike, thanks for joining me on the show today. So as always, I’d like to hear how you got into working with credit unions.
Hey Doug, thanks for having me again. My path may be a little bit different. My background: I was a life insurance wholesaler and in 2005, I got a phone call from a recruiter to say, Hey Mike, I have an opportunity to talk to this insurance company that works exclusively with credit unions. And I didn’t hear of that insurance company ever before because they work exclusively with credit unions. But Doug, my second reply was what’s a credit union, because being in the DC area, if you’re not, at least my perception was that you weren’t one of the departments of the federal government. We didn’t have a community-chartered credit union in my area. So I really wasn’t familiar with credit unions, believe it or not. But I did join that firm in 2005. And what I experienced was fantastic because I was calling on traditional Wall Street firms and providing life insurance to their clients, to the advisors, but coming over and working with credit unions, it’s a completely different environment. In fact, it was refreshing, very down to earth, very humble people. And I think that’s consistent throughout the industry, but really focused on serving their members and it wasn’t about profit and share. It was a completely different environment. So since 2005, I’ve been working exclusively in the credit union movement.
Awesome. Now the credit union movement is a special place that we’re both delighted to get to serve. And of course these days it’s a special place with a lot of deposits, right? The government has been putting so much money out. Folks in credit unions are challenged to create yield on their deposits. Tell me what you’re seeing in that space, Mike.
Well, ideally credit unions want to loan money to help their members. But if that demand isn’t there, then they have this traditional fixed income. Call it a bucket where they could purchase different investments, but NCUA allows them to use two other buckets. And one of the buckets is where we’ve seen for the last 16 years where they can offset benefits like employee benefits or some kind of executive benefits, but where we’re seeing a real high demand and explosion is in this third bucket, which is a charitable donation account. And that allows a credit union to help their communities, both members and non-members, but using alternative investments and the returns off of those investments to help their communities because that first bucket, that traditional investment bucket, they’re very low yielding today. So you have these cash deposits and what they were traditionally doing. They’re not generating much income. Imagine if they can increase that yield twofold, threefold, and be able to use that to help members in their community.
Let’s drill in and let’s just focus on the charitable exercises of credit unions. So the credit union can obviously simply give money directly to the entities, the end users of the charity. They can go to a community foundation and give the money there. And that foundation can then hand it out. The big guys I see create their own endowments or foundations and have a staff and kind of have a legacy intent there. And then there’s some ideas that you’re talking about. So help me understand who might do this, why to do it, and what the strengths and weaknesses are of each of those options.
That’s a very good point. The majority of the credit unions, you can look at their annual report and they’re already giving to different charities within their communities. And that’s the direct approach that you’re talking about. And then with the foundations, the foundations are a little bit more complex because like you said, you have to staff them, there are certain rules that they have to follow, they do fundraising and so forth. What I’m talking about is a charitable donation account. And that falls under section 7721 of the code. And that is where a credit union can invest a federal charter, that will vary depending on their state. So we got to put that caveat out there, but allow them to use these excess yields, excess returns. So the CDA really, it’s a very simplistic way to leverage some of those dollars and provide charitable giving in the community.
First, let’s go further in the details. What exactly is a CDA?
Okay, it’s a charitable donation account and from about 2013, the NCUA said that a credit union can invest in these, what I call alternative investments. You know, they fall outside those permissible, but 5% of net worth is where a credit union can invest. And it is set up and the earnings, at least 51% of the earnings, have to be donated to a charity at a minimum of every five years. Doug, what that means is the other 49% can be general income for the credit union. So a CDA allows to help not only the community, but it can also help the bottom line of the credit union. Because if we’re getting, let’s say hypothetically, anywhere for between two and a half to let’s say 5%, depending on the type of investment, those excess returns can generate income, but also help with charitable giving.
Let’s go further, in the CDA, take out 5% of net worth. What is the actual account composed of? Are there a variety of investment choices or what sort of vehicle is it that the credit union owns?
That’s a great question. So typically what we see you can do mutual funds. You can do direct stocks, investment grade, but we really have to consider the accounting impact of those types of investments. How does that impact the credit unions? Not only the balance sheet, but also the income statement , because there was an accounting classification change that came about back in 2016 when it was announced, but it’s fully enforced now, that any volatility in those accounts can flow through the income statement. So that may or may not be a good thing for the credit union. So we also see credit unions by nature are somewhat conservative. So it’s not uncommon to see them use some kind of institutional life insurance, it’s called credit union-owned life insurance or CUOLI. People go with CUOLI, but that’s where principles protect it. The returns are somewhat stable, but still they exceed traditional investment returns typically between a hundred to 150 basis points at any given time. So there’s a mix of different types of investments that can go into a CDA. A separate managed account is another one where you have someone overseeing a pool of investments. So there’s a lot of different choices. A credit union can do that, where they can invest inside of a CDA.
So if you’re a conservative credit union, you’re trying to say, I want the simplest least risky approach to pick up another couple percent in returns. Where are you going to end up?
Yeah. Well, once again, we would have to look at how that particular investment is structured. So let me give you an example on the retail side, we know fixed annuities guarantee a principal guaranteed return, but they come with surrender charges, penalties if you cash out during a certain period. Well, if a credit union owns that, by an accounting standpoint, they have to basically mark the cash value. So that may not be suitable just cause they’re taking a hit to the principal almost immediately. So that’s a perfect example where something on the retail side where a member might purchase may not work in an institutional type of setting. So what we see is credit unions look at once again, CUOLI, because of, it’s not only predictability, but safety of principal, it has minimum returns. So they know they’re going to at least earn something. So I think for the very conservative credit unions, that is where we are seeing those types of risk tolerance go towards.
Who do you insure in that structure?
That’d be a good question. Yeah, I was going to lead to that. So typically it is by definition, someone in management and an executive; it could be C-suite EVP, VP, and so forth. So it’s a classification, or Doug, what’s happened recently, which has been great, especially for those smaller credit unions, because traditionally this is life insurance and insurance companies say you need at least 10 lives in order to avoid everybody getting a medical exam, it’s called guaranteed issue. So a lot of credit unions needed to gather up 10 lives or 10 executives. It’s just, they couldn’t do it, maybe because of their size or complexity. These days, insurance carriers will actually insure one person. And if it’s designed in a certain way without a medical exam,
In my experience looking at insurance, usually the higher the insurance cost. And I mean the mortality portion of insurance costs the lower the return of the instrument to the entity.
Actually, it’s the complete opposite, because these policies are designed once again for institutions and what’s attractive about a credit union being a non-taxable entity. Then there are certain features we can use in these products, for the majority of the deposit is going into the annuity portion, let’s say that doesn’t have those costs of insurance and we can actually, Doug, drive the cost of insurance down significantly. And that’s why there’s no medical exam required.
You need 10 lives to do that.
We use one life. So that’s been the game changer over the last year and a half. So those credit unions no longer have to have 10 lives in order to get insured. We can do CUOLI only on one person without a medical exam, the way we designed it with a very low cost of insurance, because there’s no need for the death benefit; this is to accumulate yield. So what the insurance carrier basically does is they look at databases, driving record, prescription drug, the MIB, which is an insurance type of database. So what it does, Doug, it streamlines the implementation process. And I know it’s a cliche, but has been a huge game changer in the industry because prior to that, if we were an insurer, anybody less than 10 lives, one or two people, three people maybe, we’d have to go through that whole full underwriting.
I’m kind of imagining you’re looking through your executive suite and you’re looking for the youngest non-smoking person you can find. And you’re saying, okay, we’re going to insure you so that we get the lowest cost or insurance. What I’m hearing you say is that’s not necessarily the case at all.
That is not necessarily the case at all. And in fact, I think I’m going to say out an insurance named, Gerber Life, where it’s like, you know, guaranteeing you buy these policies. Well, the reason is because the cost of insurance is so low, you’re buying like a $20,000 policy. We design these to have that kind of low death benefit on these where the central focus is on cash accumulation. So what it does, there’s not a lot of risk on the insurance carrier if someone passes. So honestly, I’m a 55-year-old male versus a 35-year-old female in a traditional life insurance setting, huge discrepancy and cost of insurance. It’s not that way when we design a certain policy for CDA.
Awesome. So let’s pretend that we’re a big credit union. We’re in the billion plus club and we’re talking about a substantial ongoing charitable activity that we want to fund this year. Am I going to look at the CUOLI as the only solution versus the private foundation? Contrast those things for me, obviously the private foundation has more control. It has the ongoing nature of the entity, maybe some marketing power. Help me to contrast those two options in a scale players situation.
Absolutely. The beauty of the CDA is a credit union can fund its own foundation from the returns.
So it doesn’t have to be an either/or;
It doesn’t have to be either or at all. And then for the larger credit unions they have because of their size, they actually have access to more of a menu of institutional products, where some of the smaller credit unions won’t have access just because of the minimum requirements. There are some investments out there where the minimum requirement is $20 million to get in. Well, if 5% of net worth is your maximum, that just excluded a lot of credit unions. So what we see with the larger credit unions is they have more investment options. And so maybe CUOLI is not a fit because of the ability to really get into something that’s more, I would say, exotic, sophisticated, where they can have access to things like a sub-debt and some of these other types of instruments out there. And we can wrap it in a manner that really protects the income statement. So the larger credit unions have access to things that other credit unions may not have just due to size.
Yeah, because it’s a smaller portion of their larger amount of assets. So going back to a CUOLI, and when that should and shouldn’t be used, when does it go bad? When do these things not work? When should they not have been done?
Wow, that’s a great question. Within the credit union industry, there’s not a lot of insurance companies, believe it or not, that will allow a credit union to own their policies because it’s too much risk on the insurance carrier because these policies don’t have surrender charges. So in a way they’re liquid and credit unions just don’t pay tax. Whereas let’s say they’re a for-profit bank, they pay taxes. So if you’re looking in, let’s say the banking industry, there might be 45 insurance carriers doing BOLI and the credit union movement, maybe less than a handful. But what we saw earlier on were insurance carriers saying, you know what, we’ll get into this, but we’ll put a limit to how much premium deposits and what we saw, Doug, as they viewed that as too much of a risk. And they would drop their interest rates, wanting to have the policies basically surrender.
So what we’ve seen over the years, really, where did these things go bad? There’s not a lot of risk to the credit union because they can get out without any penalty. And where they really have gone bad is basically the yields have gone down. And if the carrier is no longer issuing new policies in the credit union movement, then we see those types of policies, those carriers being liquidated. But the one thing I definitely have to put out there is even though these are liquid and yes, a credit union can cash them out, there may be some challenges if they want to get back in because the insurance carriers don’t want credit unions chasing yield. So if for some reason, a credit union cashes out, they may or may not get back in to another CUOLI product or carrier.
So this is an institutional structure on the big side, like you mentioned, with the $20 million premium, I would assume that there is no form of insurance backing other than the strength of the company you invest in.
That’s a great point. What I was talking about earlier was not really the $20 million, it was pretty generic of all sizes, but it really depends on the product structure, because some are backed by the credit risk. Let’s say of the insurance carrier, like more of a general account, or maybe what we call even an index product, the insurance carriers backing that, right? So credit risk and the credit worthiness of that carrier are very important. But some of these that are more separate accounts or variable, where you can access funds, from let’s say Fidelity or Vanguard, then the risk is not from the carrier backing; it’s in the underlying investment. So is credit risk as important? Well, you want someone with a good reputation from a servicing standpoint, but it’s a lot different because it’s more of a, let’s say it’s a pass-through than it is where the carriers are backing any kind of guarantees or promises.
In these institution forms of the CUOLI Is it a single insurance company that’s behind the product? Or is it a pooled approach to the risk-sharing instrument?
There’s a couple of different carriers out there. Because once again, this is a really a niche marketplace, but oftentimes it’s wise and prudent to diversify because you never know what a carrier may or may not do. They may say, you know what, we’re going to get out of this market and sell that book of business to another carrier and so forth. But also I think from the regulator standpoint, they like the diversification. Yeah. So within a charitable donation account, once again, it does vary depending on if it’s state chartered. And that’s extremely important to make sure that the regulations in that particular state and additionally, what NCUA came back with on the CDA is the credit union necessarily does not have to access the funds in the CDA to make the charitable gift, they can use let’s say out of cash reserves or some other asset at the credit union to make that. This is really offsetting those costs because here’s why, Doug, you take out a 51% pay out to charities, but you can do 5% of net worth. They’re gonna turn around and take that same amount of dollars to put right back into the CDA, kind of silly. So you do not have to tap into that particular investment to actually make that payout.
You’re going to distribute the lowest yielding instruments. Then keep the higher yield on i think.
Still gauging that 51%-49% limit.
Okay. We go through this process, we put some funds into it. So now we have a policy that’s sitting on the balance sheet that we can access if we want to. I leave it alone. If we don’t want to be subject to the limits, then it’s a liquid asset. So at any point in time, someone wants to take the money out. They can take the money out and that structure, right?
So that gives them the ability to decide what we’re going to be able to react to and whatever way they want to. A lot of times what I’m seeing these days is credit unions kind of combining, right? There’s a lot of M&A activity in the credit union industry. What happens when that occurs? What have you seen go along with these products when an acquisition occurred?
Nothing really changes. I mean, it’s just acquired roles often. I mean, we’ve seen that we’ve had credit union clients be acquired. We’ve had those that acquire, and it’s just more of education, educating the other credit union, what it is, what’s the purpose and so forth.
How about you picked a group of executives to insure and now one of them isn’t there anymore.
Yeah, we see that often. And so these policies have what we call a change of insured. So you can just swap in another person. You don’t have to liquidate and get a whole new policy. We say they have change of insured features to them. So it makes it very easy.
So the benefit here is strictly to the credit union. This isn’t a form of executive benefits or retention or anything like that. This is strictly an investment choice to potentially earn more yield for the institution.
That’s correct. If they choose life insurance as one of the funding options that they can do in the CDA. It has nothing to do with the other bucket we were talking about that would be where you’re using life insurance as an executive benefit, completely separate. And it is a separate 5%. So it does not have an impact on what you can do in that other bucket with regards to some of those limitations; it’s completely separate.
Very good. Well, excellent. Mike has been a very interesting discussion. Any further thoughts for our credit union leaders?
I’ve just enjoyed working in the credit union movement for the last 16 years; it was nice to come to an industry where you saw the collaboration among credit unions. And it was like I said before, Doug, it was just very, very refreshing, because in other industries, you don’t have the same vibe. You don’t have the same desire to serve, so to speak. So I’d love to see that continue, that desire to serve not only members, but also non-members in their community.
That’s part of what we’re trying to do in this podcast is to give the credit union leaders the information they need to make the best decisions, do it objectively and try to help the movement be successful. So thank you for your time.Thank you for your part in that, Mike.
Doug. Thank you. It was great talking with you today.
That’s all the insider credit union knowledge we have for this episode. Are you enjoying the conversation? Be sure to subscribe and share your thoughts with other credit union leaders by leaving us a review. See you next time on C.U. on the Show.
Speaker 3: (23:37)
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