Collateral assignment split-dollar plans are a powerful executive benefit with favorable tax treatment that can incentivize retention and offer credit union leaders a long-term income stream in retirement. However, while many credit unions have collateral assignment split-dollar plans as part of their executive benefits mix, it is no secret that these tools are more complex to construct than other benefits. 

On the show, Doug welcomes Dan Balogh, an executive benefits advisor at SWBC. For over 30 years, Dan has helped credit union boards and management teams develop executive retention and succession plans. Dan and Doug discuss the critical factors credit unions should consider when designing a new split-dollar plan or evaluating an existing one—and why overlooking these factors could cause negative implications and undue burden to the organization and its executives.

Factors to Consider When Designing a Split-Dollar Plan

When designing and implementing a successful plan, credit unions must perform a preliminary and ongoing evaluation of several factors to help reduce the risks they and their executives may assume. For example, common risks may be related to an early separation between the organization and executive, rising interest rates, or unrealistic assumptions about a plan’s projections. 

Dan explains what credit unions should consider to help avoid some of these risks, which may be virtually unknown until a scenario presents itself, such as:

  • Term Loan or Demand Loan? A split-dollar plan is an agreement between an executive and their credit union to share the cost and benefits of a life insurance policy, which is purchased through a loan the credit union issues to the executive. When developing this loan, credit unions choose between term loans and demand loans, which feature different tax treatments and interest rates that could affect the accumulated value and the executive’s future income needs, among other factors.
  • Recourse or Non-Recourse? There may be situations in which an executive prematurely separates from a credit union due to termination or other reasons, a contingency that credit unions should consider when building a split-dollar plan. It’s important to understand the differences between recourse and non-recourse plans, who assumes the responsibility of paying the resulting loan deficiency when this occurs, and how it can be a significant financial strain and surprise to the credit union, executive, or both when it’s not strategically designed. 
  • Whole Life or Indexed Universal Life Insurance? Credit unions must evaluate such factors as cost, long-term fulfillment of the loan, and the guarantees associated with traditional whole life and indexed universal life insurance policies. 

Doug and Dan take a deep dive into these topics and provide credit union boards and management teams valuable food for thought when designing a split-dollar plan. Stream the full episode to learn more from Dan and how your credit union can develop a mutually beneficial split-dollar plan, plus:

  • The importance of stress-testing a plan annually to ensure projections are realistic and sustainable
  • Why credit unions should think about confidentiality and expertise when developing a CUSO to offer these products
  • Why Doug recommends consulting with a third-party accounting auditor and design specialist before putting a plan in place
  • How model regulations and commissions come into play and the consumer implications
  • Why credit unions should evaluate all retention tools available to them beyond a split-dollar plan

Listen now.


Dan Balogh and SWBC are not affiliated with or endorsed by ACT Advisors, LLC.


Audio Transcription (pulled from the podcast)

Doug  00:00

My guest on today’s podcast is Dan Balogh, an executive benefits advisor at Southwest Benefits Corporation. Dan works with credit union boards and management teams to develop executive retention and succession plans. In this episode, we take a deep dive into collateral assignment split-dollar plans, including what your credit union should consider when designing a new plan or evaluating an existing policy. Welcome to the show, Dan Balogh. Glad to have you join us this morning

Dan 00:29

Good morning. Thank you.

Doug  00:30

So tell me, how did you get started working with credit unions?

Dan 00:34

Well, I started in the business 43 years ago, and very shortly after I went in, we were the endorsed vendor for the Florida Independent Bankers’ pension trusts. I ran around Florida doing pension plans and deferred comp plans for community banks. And in the mid- to late ‘80s, all of a sudden Pac Man showed up and started gobbling up all my little community banks, and I had to discover another source of business and found credit unions. I’ve been working with them for over 30 years.

Doug  01:10 

Well, 43 years in the business, Dan, that’s pretty good.

Dan 01:15 

I started when I was 10. Yeah.

Doug  01:17 

I figured that’s what we needed to say next. So I know you work in executive benefits. And as you know, with the financial planning work we do for credit union leaders, I love to see a collateral assignment plan as a part of the mix in their executive benefits. And the reason is, it makes a bigger impact on the financial success of the executive than anything else I’ve ever seen, because it’s a long-term income stream not particularly related to the stock market that is tax-free. And when it’s tax-free, we can do all kinds of amazing additional financial planning strategies. But it’s also pretty complicated, right? There’s a lot to it. And it’s a long-term commitment for the credit union and the executive. So with your 43 years’ experience, talk to us a little bit about collateral assignments and some things a credit union should think about in that area.

Dan 02:13

Well, collateral assignment split-dollar life insurance is often misunderstood to be a particular type of a life insurance policy. What it is is an agreement between an employer and an executive to share the cost and benefits of a life insurance policy. They agree to allow the executive to acquire a piece of property called life insurance through a loan. And under all of our property laws, life insurance is very good as it allows for an owner to use it as collateral, it has a determinable value, it can be transferred in an estate, it has very favorable tax treatment. As a piece of property, it is a wonderful asset class and should often be talked about in anybody’s financial plan. In terms of a credit union, there are three or four pretty significant things the credit union should decide about how to approach a collateral assignment split-dollar plan. Split-dollar plans these days in credit unions are done using what we refer to as loan regimes. A loan is made to the executive in order for them to have the money to purchase this cash value life insurance policy. Well, a loan can be one of two types, it can be a demand loan or it can be a term loan. The significant difference between the two of them is what interest rate does the IRS say you’re supposed to charge for interest on that type of loan. They get published monthly—in the case of a demand loan only once a year. And typically, demand loans would look less expensive in terms of the interest rate than a long-term loan would. But it’s still important for the credit union to consider whether they want to use a demand or a term loan. Almost all credit unions using demand loans forgive the interest. In other words, the IRS says you’re supposed to charge X amount of interest each year. But the credit union forgives the interest, therefore making that a taxable event to the executive. The executive pays the tax or gets a bonus to pay the tax. And that tax will exist until the loan is repaid, which in most cases is until death. So demand loans have a tax aspect to them that term loans do not. Term loans you make a term loan for the life of the loan, the term of the loan, which is the life of the individual typically. And then you charge interest based on the IRS rate. And that interest rate gets compounded. So the credit union is accruing interest on the loan in a term loan scenario, whereas they were forgiving interest in a demand loan scenario. The basic differences again, one more step, you need to know how much loan you’ve made in a term loan to fix the loan interest rate. If you’re making annual payments to a plan, every time you make a loan with a term loan you have a different interest rate that has to be used. And that could get quite complicated to administer. But it also might, if interest rates are on the rise, cause the policy not to be able to support long-term compounded interest when you don’t know what the interest rate is going to be for the entire life of the loan right upfront. So you really want one single loan in a term loan and fix the interest rate and not make annual payments using a term loan. A demand loan, you could make annual payments.

Doug  06:34

And I know from my side of things, when I see folks who have the demand loan, what I’m used to seeing is that when the credit union leader retires, the tax burden of the forgiven interest becomes a cost to them and an unknown cost, right, because the IRS tables change. So I try to illustrate what that looks like using some rate of increase for inflation. And of course, here we are in mid-2022, where inflation is achieving unbelievable increases. So I would assume those exposed to that variable could really have a substantial impact next year.

Dan 07:16

Due to what the Federal Reserve did during COVID, the interest rate for demand loans is the lowest it’s ever been in the history of that rate. It was 13 basis points for 2021. It’s so low that it might not even cause the issuance of a 1099 for forgiven interest because it has to be $600 or more for that to be issued on a 1099. So the long-term rate for demand loans, if you average them over the last 40 years, is right at 5%. If you take out the highest five years, you take out the lowest five years, it’s still pretty close to 5%. So if you’re building a demand loan split-dollar arrangement at a credit union, you’d want to build in sufficient future income for the executive to have enough money to pay the tax, as well as have enough money to put the income in their pocket they expected to get from the supplemental retirement benefit. An important design feature of a demand loan: you have to figure two separate forms of income in retirement.

Doug  08:33

Well, virtually every demand loan credit union I’ve seen seems to have converted to term loans in the last couple of years. Is that right?

Dan 08:42

There has been a lot of that, and the primary reason is because interest rates got so low that the policies that were designed eight or 10 years ago are able to, through illustrations, support long-term compounding of interest because the interest rates are low. Now, if you take that same scenario today, policies issued eight or 10 years ago might not have sufficient accumulation and death benefit capacity to pay today’s current long-term rate; the rate for this month in 2022 is 2.66%. Well, it only takes 30 years or so before the total loan is doubled through compound interest. You have to be very careful that the policy supports that long-term accrual of interest when you have interest rates that are on the rise.

Doug  09:36

Yeah, that trend change has got to have real consequences for credit unions because of the long-term nature of these instruments. What are some of the things credit unions should be paying attention to in the design and annual servicing of their collateral assignments? 

Dan 09:52

This comes down to an accounting issue, whether the loan should be recourse or non-recourse. If for some reason the executive terminates employment before they’re entitled to the benefit, they’re terminated for cause or other things happen, the life insurance contract needs to be surrendered. Is recourse against the policy or is it against the executive? In other words, if the cash accumulation in the policy is insufficient to repay the loan, where does the credit union go to get whole on that loan and interest? If you make the loan a recourse, they have recourse against both the policy and the executive. If it’s non-recourse, they only have recourse against the executive. And here’s the fallout from that if you have a policy that surrendered: if there isn’t sufficient cash value to pay the loan and the agreement was non-recourse, whatever amount of loan and interest is not paid off by the policy has to be reported as debt forgiveness to the executive on a 1099. So in the case of a non-recourse loan, where there’s a $300,000 difference in accumulated values and loan amounts, that executive is going to get a very big 1099 for debt forgiveness that they may or may not be able to pay. The larger sophisticated accounting firms are paying a great deal of attention to this for one reason, and one reason only: you’re only allowed to book the actual loan amount if the cash surrender value is equal to the loan amount. 

Doug  11:44

Now that one’s a little complicated for us, let’s go through that nice and slow, if you will. 

Dan 11:47 

It’s an accounting issue. If you make a split-dollar loan of $100,000, and the first-year cash surrender value of that policy is $30,000, GAAP accounting says you have to write that loan down by $70,000. It has to be equal to the cash surrender value. Except in the case where you made the loan a recourse loan, where the executive is on the hook to pay that deficiency. Then, you’re allowed to book the full value of the loan. Well, this comes into play for boards when they’re trying to design an executive benefit plan and all of a sudden, I’m on the hook now for a great big loan that I was unaware I really was going to be on the hook for. And so, using recourse loans to mitigate an accounting effect is very popular. It doesn’t affect the board much, but it does affect the executive. And there’s also some discussion among the large accounting firms as to whether or not some of these executives would even be able to pay the size of the deficiencies that may result from something like that occurring.

Doug  13:13

Dan, I know you’ve got more on this, but I just want to dig in. In your example, I think you said that there was a $300,000 loss in the example, right? A $300,000 loss of value. Was that the example?

Dan 13:25

Let’s say the loan was booked at a million dollars, and the cash surrender value at the time they had to separate from the plan was $700,000. There’s a $300,000 difference. 

Doug  13:39 

So the credit union is going to get $700,000 back and they have a million dollars in the policy. Is there a tax impact to the executive in this situation and what is that?

Dan 13:50

They’re going to report the forgiveness of debt to the executive in the amount of $300,000.

Doug  13:57

And the reason that risk would be taken by the executive A) may be they simply are unaware of it in the first place, and then B) is because it gives more favorable accounting treatment to the credit union, from the difference between the value in the policy and the amount they put in, is that right?

Dan 14:19 

Those are both true. My fear is the former may be the more predominant; they just don’t know that situation exists.

Doug  14:28

Is there any consequence for the previous income they’ve received, any tax consequence of that?

Dan 14:34

Almost always reducing values from the policy to produce an income is going to reduce the amount available to the credit union to repay a loan, so that differential may get larger over time as distributions occur.

Doug  14:50 

Understood. Does a rising interest rate environment play into this risk?

Dan 14:54

No. Not in this particular scenario, not where you have an insufficient amount of cash accumulation to repay a loan.

Doug  15:04 

So did I hear your right that you said the majority of credit unions are booking these as recourse loans because of the accounting treatment?

Dan 15:14

Yes, the ones I see are known as recourse loans.

Doug  15:17 

Is there a change? What would you guide our listeners to think about in that scenario?

Dan 15:23

Is there any alternative to me being on the hook? Cash surrender values are a function of compensation. Traditionally, life insurance contracts are paid compensation in a heaped upfront fashion. And part of the reason for that differential, you have a $100,000 premium and a $30,000 surrender value, a large portion of that was because of the heap upfront compensation. If product can be designed in such a way as to flatten that compensation, level it out over a period of time to bring that cash surrender value up in the early years of the plan, you could use a non-recourse loan and not put the executive in any significant jeopardy, especially in the early years of a plan. Some more exotic things have been used in credit union land where outside third-party agreements were entered into will increase the cash values in the early years of a plan. The vast majority of the accounting firms I talked with don’t really think that’s a valid offset; they make them take the write-downs on the loans even in the case where those exist.  

Doug  16:46

Interesting. The spread between the cash value of the policy in the cost the credit union has into the policy is the risk the recourse or non-recourse loan is addressing. And what you’re suggesting is, the industry needs to look at creating a levelized comp stream within the policy so that spread is not as great, and therefore the need for a recourse loan would be reduced. Is that what you’re saying? 

Dan 17:16 

They already exist. 

Doug  17:18

They do? Well, tell me more about that.

Dan 17:20 

They just aren’t being used. In my case, having done this for a long time, and having seen as many crazy things happen as I have seen, I’ve never designed one in a credit union that didn’t approach it this way.

Doug  17:36 

Why is that?

Dan 17:37

I don’t want an executive benefit plan that I implemented to cause serious negative repercussions to an executive or a credit union. My practice is successful enough. I can do this; I can level this comp and make it reasonable. I can stay in the business, I can run the business, I can do everything I need to do. At the same time, putting the executive in a position where if the policy had to be surrendered or it’s a non-recourse loan, the repercussion to the credit union and the write-down of that loan is not material to their financials and wouldn’t radically affect the executive.

Doug  18:23

So it’s a design choice. The decision between recourse and non-recourse for the credit union has another level of decision to it. And that is in the structure of the comp for the executive benefit specialist. If a more level of comp structure is used, that spread is reduced for the credit union and therefore the need to be concerned about the accounting write-down for the spread between the cash value and what you put into it is also compressed. Is that correct? 

Dan 19:00 

Exactly right. 

Doug 19:01  

Interesting. Well, I’m learning something today, Dan. I hope the rest of our listeners are as well. So let’s continue on through the other things for credit unions to think about when they’re looking into a split-dollar plan. That bit on the recourse versus non-recourse is very interesting to me at least. What else you got?

Dan 19:18 

Well, let’s take the recourse, non-recourse one step further, of course, because it has a significant accounting effect on these plans. What sort of uses of recourse would advisors use in order to be favorable in some way? In the scenario, how and when and where can recourse be done? Recourse really means recourse; it doesn’t mean you can only get recourse on Tuesday, February the 30th. And the way the documents are written, there’s some gamesmanship with how recourse is being defined that doesn’t really meet the intent of a recourse loan. But by having a recourse loan, in effect, in some fashion they get away from this accounting treatment. I think that will catch up to people sooner or later. The CPAs will say, wait a minute, this isn’t really truly reflective of the credit union’s actual financials, and we think we should probably investigate. So it’s a question that has to be answered. And it should involve the external CPA auditing firm or the credit union in the design phase. We typically like to have conversations with the external auditors, make sure they agree with what we’re telling the credit union they’re able to do. And then get agreement from the external auditor before the plan is implemented. We don’t like surprises later.

Doug  20:56 

So that’s another good step in the examination and design of policy is to get an advance review from your auditors before you put a plan in place. Another interesting point. 

Dan 21:12

I’d say 98% of the success of a split-dollar life insurance policy is going to be the underlying life insurance contract itself. About 2% for design and administration, and so forth, but the base upon which everything sits is the life insurance contract. And all life insurance contracts weren’t created to be placed into an equity split-dollar arrangement. They weren’t built for that; they were built for other reasons. And so sometimes what we have are square pegs in round holes. Some products were specifically designed as a means of using them in a split-dollar arrangement. They’re built that way; they were constructed in such a way as to be favorable to the long-term effects of using a split-dollar arrangement as a benefit arrangement.

Doug  22:10 

What I’m used to seeing is two things, either whole life or indexed universal life. And I know you can talk to us about the strengths and weaknesses of the choice between those two, but is what you were just saying that within those categories, within let’s just say the category of whole life, there is a sort of subcategory of whole life policies designed specifically for split- dollar?

Dan 22:36

Well, first of all, whole life in contrast to the other type of product that’s been used in most other credit union split-dollar arrangements has very significant guarantees. It has a premium guarantee that says if you pay this premium, we guarantee the death benefit of the life insurance policy is also guaranteed. And the cash value accumulations are guaranteed. And if you have to surrender the policy or do other things with it, we give you guarantees in the contract. You know that it has very specific guarantees. Then you look at whether or not you want the policy itself to be fully paid up in a period of time, which makes the board comfortable with whatever commitment they’re making. So there are products that are paid up at age 65, paid up with 20 payments, paid up with 10 payments. Some have very high early cash values but aren’t paid up until age 100. And so you have a quiver full of whole life arrows that you pull one out that seems to work in this space and fulfills a lot of the security, safety, and soundness issues credit unions would have. We apply that product to solving the problem as opposed to any number of others that might not. Another consideration, Doug, is that thing I talked about before, compensation; limited payment products routinely have significantly lower compensation than other traditional life policies. And there again, we’re dealing with cash value and loan amount ratio. And the ones that do better at that are more appropriate in my mind to using in a loan regime in a credit union.

Doug  24:40 

You were going through the whole life benefits and contractual guarantee, the word guaranteed, illustrations guaranteed. Is the paid-up status for these things an illustrated paid up or is it if you make these payments to this point in time, it’s contractually paid up? Which one is it?

Dan 25:01 

It’s a guaranteed contractually paid-up contract. As opposed to, again, an indexed universal life that might not be paid up until age 95 or age 120. They aren’t actually paid up until some future significant age. Which is why one of the comments often made is, well, indexed universal life should be used in a credit union split-dollar plan because it’s cheaper than whole life. Well, is it really? if you paid a 10-year mortgage versus a 30-year mortgage? Did you pay more for the 30-year mortgage or the 10-year mortgage? You’re very likely to pay more for the 30. And it’s a simple analogy and maybe too simple, but that’s the basis. It’s not really a true and accurate statement to say that it costs less. You’re getting certain things; guarantees cost more than things that aren’t. 

Doug  26:06

Yeah, that would be my intuition about it is that there is no free lunch, right? And if in whole life you get more guarantees, if the insurance companies are coming to the table and saying if you do this, I will do that, that’s probably going to cost you more per dollar of benefit than something where you have more of that risk. Because you’re taking on the risk. That would just be intuitive, is that right?

Dan 26:34 

Yeah, I always thought the purchase of insurance was an attempt to transfer risk. One of my bones of contention is that people aren’t understanding how much risk they’re actually assuming in these arrangements, whether it be recourse, non-recourse, forgiveness of debt, interest rate increases, all the other forms of risk they’re assuming in these arrangements. Why would they also want to assume a lot more risk related to the life insurance contract itself? They have enough risk in their 401(k), their real estate, their deferred comp plan. This type of asset, life insurance as an asset class, takes that risk away. Other forms do not; you’re assuming a good deal of risk.

Doug  27:29 

Yeah, I get that. In the whole life is even the dividend, is that also guaranteed or is that something that is variable?

Dan 27:36

No, it is the one non-guaranteed element in the plan. Again, it’s a selection issue. You want to look at a mutual life insurance company that has a long track record of paying dividends better than they actually illustrated.

Doug  27:55

Oh, better than. That’s an interesting thing. Where would you get the data? 

Dan 27:59

They all have histories.

Doug  28:01

What an interesting thing to look for. So you can tell, I mean, certainly you could get the dividend history. But how would you get the historical illustration accuracy? Is that data you can access?

Dan 28:21 

That’s available to the general public. So they would give you this as a policy purchased by a 40-year-old in 1980. And it’s a whole life product. This is the illustrated dividends we used when we sold the policy in 1980. These are the actual dividends that were paid on that policy for the last 42 years.

Doug  28:45

So is there a name for that, that you would ask for that? A listener would ask for? Is there a description that’s the appropriate way to say it?

Dan 28:53

Yeah. Can you show me the actual versus illustrated dividends on the policy?

Doug  28:58

Again, another interesting point I’d never heard before. Now, as our listeners probably know, the Treasury rates have just plummeted over the last 20 years; the curve is only going in one direction. Until now, right? It’s 20 years’ worth of down, down, down, down, down. So I would assume the illustrated rates of dividends, or rates of return, would be much higher than the actual in a past that has this great downslope to interest rates, is that not correct?

Dan 29:34

You’d be surprised at the result. There is tension on mutual insurance company dividends because they buy long-term fixed income investments to back up their long-term promises. And as you know, trying to invest in long-term fixed income investments is a difficult proposition in this interest rate environment. However, a mutual company that is diverse, that may own multiple other businesses, is—forgive the analogy—kind of like a mutual fund. You’ve got the mothership, the insurance company that owns all these other profitable businesses, funneling profits to the mothership to help support that long-term dividend that’s been paid by the mutual company. So it has a less dramatic effect on those companies that use those kinds of arrangements to help bolster the long-term viability of their dividends. Dividends are not guaranteed; past performance is no promise of future performance. 

Doug  30:41 

I’ve heard that somewhere, Dan, thank you. So going into the environment we have today, where we have extremely robust inflation and thoughts that interest rates may be in the generally upward moving direction for some time, how would that inform the discussion for insurance product choice?

Dan 31:06

Well, understanding two distinctly different types of life insurance, legal reserve whole life insurance versus an indexed universal life insurance contract. At the core of an indexed universal life insurance contract, it’s an options contract. The insurance company has to buy options to hedge the indices so they can credit interest. Well, market volatility increases the cost of options. And there’s a lot of people chasing options because the product itself, indexed universal life, is a popular form of life insurance. So now there are a lot of people trying to buy options at a time when market volatility is high and option costs go up. Well, in order to be able to look at what is being illustrated in an indexed universal life contract, you have to rely on the regulations. State insurance commissioners, the NIC, National Association of Insurance Commissioners, create model rules for how policies can be illustrated. This product is only about 10 years old, it’s only been around 10 or 12 years.

Doug  32:30

When you say this product, you mean indexed universal life? 

Dan 32:33

Indexed universal life. So model regulations are relatively new. The first one was AG 49. So it says this is how you should be able to illustrate this type of product. Insurers found some vulnerabilities in that. And they were able to show reasonably significantly higher illustrated incomes than was the intent of the rule. The commissioners discovered that and they came out with AG 49 A, which tried to tamper down that overexuberance and illustrating incomes that were not very realistic. Well, insurers found some other vulnerabilities in AG 49 A. So now AG 49 B is being created to try to fix the things that are being used to illustrate what are not really sustainable long-term income streams coming from these policies. So in a very short period of time, the commissioners have had to produce three separate rules on how to illustrate this particular product. Because it’s one, brand new, and two, back in the ‘80s we all went through what we call the illustration wars. Illustrate a life insurance policy to look like it could pay for itself in five or six years. And 25 years later, we’re still paying for them. And that’s what we’re trying to prevent. The industry needs to not tell consumers to expect unrealistic things when they purchase insurance. They’re trying to mitigate risk, not assume it.

Doug  34:28

Exactly, especially as you said earlier, generally when you’re purchasing insurance, you’re looking to transfer the risk to the insurance company. So simply undergoing the exercise of understanding the risks you’re taking is no small exercise. Some of the things you’re talking about, I wonder how many credit union boards and executives even appreciate these details.

Dan 34:55

I’ve never heard a presentation in-depth about how one of them works. In fact, I can pretty much bet there are a lot of things that are unknown to purchasers of that. It’s kind of like if you did every single disclosure you should ever do on a mutual fund. Nobody’s going to buy a mutual fund. Hope compliance isn’t listening. But it’s kind of like that, in front of a board of directors talking about an executive benefit plan and you take hours to get into the weeds of how a life insurance contract works, you’re going to lose the audience. But what’s the takeaway from us today to boards? It’s that they have to be wary of what it is they’re buying and know there are alternatives to what they may be considering. And they should consider alternatives.

Doug  35:55

You know, what would be really interesting is some sort of a checklist, some resource for the for boards to use, because there’s really two alternatives is what I’m hearing you say, right? There’s indexed universal life or there’s whole life, and there’s recourse, there’s non-recourse, and then the strengths and weaknesses of each one, or at least things to understand and weigh in your decision for each one would be a really useful tool for the credit union movement. Is there anything like that out there?

Dan 36:27

We have such a checklist. 

Doug  36:28

All right, well, I will attempt to twist your arm and see if I can get that posted along with this podcast so the credit union members can take a look at that and see if that can be of help. What are other things boards should continue to think about, especially in regard to existing policies? I know with the larger credit unions we tend to work for a lot, they already have split- dollar plans. I think the industry ratio is somewhere around 35 to 40% of the larger credit unions have a split-dollar plan. Is that your impression of the statistics?

Dan 37:08

The survey data will tell you it’s probably higher. 

Doug  37:10

Higher than that. Okay. So there may be a large number of credit unions that have existing policies. How should they go about properly understanding what they have and evaluating them and making sure they’re keeping up-to-date for the potential consequences of recourse versus non-recourse, or tax implications, or what have you?

Dan 37:34

In the case of NCUA and federal institutions and those that are insured by the NCUA, the examiners really do want the boards of directors to have their hands on the plan on an annual basis. So when the board gathers to do the annual split-dollar review, there are a number of things they’re going to want to investigate. Where did we start out, what did the illustrated values and the incomes it was going to produce look like, five years ago, eight years ago, and what does that look like today? And the interest rate caps that are allowed to be applied in indexed universal life insurance contracts have dropped rather significantly. I mean, they were 13%. They’re 5.71 in some cases. So what effect is that going to have on the long term of that policy being able to produce the income that executive expects to get and because they’re still paying the costs of expense and mortality and so forth? Is there enough erosion that the death benefit ultimately comes into some jeopardy?

Doug  38:54

All right, Dan, that would be very consequential for the executives and the credit unions. What exactly would they do to find out that there’s a problem coming? Where would they see that snowball? What series of steps would they go through to see that? 

Dan 39:11

They have to use different assumptions that are available to them to put stress on the policy internally, to be able to say if this happens, this is the outcome. And not just some pie in the sky, everything is fine, the policy is doing exactly what we wanted to sort of a message. You really do have to stress those policies. And do that in such a way that it’s meaningful to tell you there’s a problem coming down the road. 

Doug  39:46

So with whole life, if everything’s guaranteed, what do you have to illustrate? 

Dan 39:50

Reduce the dividend. 

 Doug  39:52

Reduce the dividend because that’s the only thing that’s not guaranteed

Dan 39:55

And increase the internal policy loan rate. We press the policy from both ends. Let’s bump up the loan interest rate and lower the dividend. So you’re crunching it from both sides.

Doug  40:12

Those must be two things that are not in the long-term guarantees—the internal loan rate, as you said, is a variable rate. And then the dividend is illustrated, right? So you increase the loan rates, so therefore its higher expense leaving the policy and you decrease the dividend rates, there’s less money coming in. Okay, so that’s what you should do to stress test a whole life policy. And I assume you would have to do that by illustration software from that same company? Is that right? Okay. Thank you for that. How do we stress test an indexed universal life policy?

Dan 40:48

When you increase the internal costs, the product is a current assumption product, they make current assumptions about what they need to charge for mortality and expenses up to a guaranteed maximum number. If you want to really stress it, you run it at the guaranteed maximum number. And it very likely lapses at some reasonable point in the future.

Doug  41:14

Yeah, that’s going to be an unpleasant experience if you go to that high level, right?

Dan 41:18

Yes, then you’re making it look more like whole life.

Doug  41:21

Right. So I guess that’s going to be one of the things as you increase the cost to what? Some percentage increase, I assume, would be reasonable.

Dan 41:30

Yes. And you decrease the yield. You would change the caps. And the participation rate in that cap.

Doug  41:44

So again, the way you can do that is from software from the insurance company you’re already working with, right? 

Dan 41:52

That’s correct. 

Doug  41:53

There isn’t a third party that has software that can illustrate these things; you are dependent on the insurance company you have the product from. 

Dan 42:01

Yeah, but that’s a primary responsibility of the insurance company. Even though they aren’t a party to a split-dollar agreement, they have an obligation to illustrate for the insured how the policy is performing or will perform under various scenarios. And the insurance commissioners are not going to like an insurance company that is not responsive to that. And you shouldn’t have any difficulty getting those from any major insurance company. That’s a routine request.

Doug  42:34  

If you are a credit union that does not have a collateral assignment policy and you’re trying to figure these things out, I imagine you’re talking to different executive benefit specialists and sort of seeing what they provide. Is it normal that each executive benefits firm would offer both universal life or whole life or does it tend to be each firm has their way and they’re consistent in their product selection?

Dan 43:04 

I can’t speak for everybody. But we talk about all of the things that a credit union can do. Not only split-dollar, but other forms of deferred compensation. And it’s not a foregone conclusion that the only way to try to retain talent is to use split-dollar arrangements; they can do other things. And a board, beginning to end, our case is 12 to 18 months. And most of that is because of educating the board and working with committees and telling them all of the things they can do and trying to prepare them to make decisions that they can live with long term. And so we do it that way. We talk about we have the capability of using all forms of life insurance. Whether they choose to go in the direction they go in is a decision they make and they understand why they made it. I shouldn’t make a decision for them. They should be given an opportunity to understand that other things are available. I don’t know if that’s been done universally. I suspect it isn’t. Compensation has something to do with that. Not to pick on my brothers in the business, but money does talk sometimes. And if this product, a 90% commission, and this one pays me a 30% commission, I might think this one’s better. 

Doug  44:36 

That’s something we’ve never talked about on this podcast. So to the degree that you can shed light on that—again, I have no transparency into that space—is generally there a higher compensation in universal life than there is in whole life for the executive benefits specialist?

Dan 44:54

In the way that we design it? Yes. Dramatic.

Doug  44:57 

Dramatically higher. Interesting. And if it’s a limited pay product, either one of them? Is universal life higher compensation than whole life?

Dan 45:08

Almost always. Yeah. Here’s a key also for boards that’s on our checklist. Why would a company license itself in all 49 states except New York? 

Doug  45:19

New York is a pain in the rear end. I grew up there.

Dan 45:22

My parents grew up there. But there’s a reason. The State Department and State Insurance Department of the state of New York says if you do business in the state of New York, you have to do business the same way in all the other 49 states, and they have a strict New York Life Insurance Commission Schedule. And so if I want to pay more commissions to my agents selling these products, what do I not do? I don’t license myself in the state of New York.

Doug  45:53

Interesting. So New York controls the rate of commission you can pay for agents throughout the whole country if you’re licensed in New York. Wow, New York reaching over the whole country. 

Dan 46:04

In practical terms, I think it’s an appropriate thing. I do. I’m not much for one state controlling all the other states, but when you think about it, there are too many games that can be played with a consumer’s pocketbook that somebody ought to look out for. The state of New York took that on themselves. And they created model regulation that the other states buy into. ABC Life Insurance Company could be licensed in 49 states, and then it could license itself in New York, as ABC Life of New York. And they pay commissions based on their licensing of that particular entity in New York, but in the other 49 states, not so much. They don’t do it. And so you’ll see that happen a fair amount, but look at the big old line mutual insurance companies and the ones you know, the Metropolitans and Prudentials of the world, they’re all licensed in New York.

Doug  47:09 

It’s a big market to skip for sure. There’s a lot of huge credit unions there among a lot of other consumers. Well, one of the things I wanted to ask about—we obviously have gone a little long on this—but I think because the information is really important, and again, completely untouched in anything I’ve ever done. I’m seeing some activity in credit unions, creating CUSOs that actually sell executive benefits or I’m not sure what level of detail they’re getting into it. But we’re going to talk about that at some point on this podcast. What is your take on that initiative? 

Dan 47:46

I can relate that question to another thing that occurred. Larger credit unions have insurance agencies, they might have financial services, people who are licensed to sell insurance and securities embedded somewhere within the credit union. And some of them have created CUSOs to house and support those organizations. And so the sale of a mutual fund to a member in Dallas to the benefit of the CUSO, which then helps the credit union. Inherently nothing is wrong with that. Some credit unions, before the Department of Labor came out with its initial rules regarding qualified retirement plans, were going to use that organization to support their 401(k) plan. It’s a clear problem from a fiduciary perspective from the Department of Labor’s viewpoint. In this particular case, where a CUSO is formed to do executive benefits my statement to that would be, I’m a capitalist. I believe in a big pie, everybody getting a share of the pie. But you should put people in there whose education, training, and experience allows them to offer the kinds of services, knowledge, and advice they would get from a really experienced person who’s been doing it for a long period of time. Nothing helps a split-dollar plan than an advisor who’s been through all kinds of economic ups and downs, because they can embed that in the legal documents and help the board understand, why are we planning for this contingency? Well, here’s how that manifested itself in a case years ago. So the education, training, and experience of the people who are working in that CUSO should be very carefully selected, carefully screened, they should have the right credentials to do that. And then if they’re successful, have at it. I’m happy to compete with them. Just like I’ll compete with anyone else.

Doug  49:56

Yeah, it’s interesting credit unions do that kind of thing, right? They create an indirect program for a large credit union in a market and then some of the other smaller credit unions get together and benefit from their scale. I’ll be interested to see how that develops or doesn’t develop in this area.

Dan 50:15 

There’s one final thing in that regard. Typically, executives are going to be reluctant to have too many people in the organization know about their executive benefit arrangements. It’s a private matter that deals with their personal assets, that deals with their health history. Having a third-party, well-credentialed advisor who knows how to keep their mouth shut and doesn’t have any sharing or responsibilities to anyone else in the credit union provides a level of personal security executives are looking for. And in the CUSO arrangement, somebody’s working for somebody who’s working for somebody who might not provide that same level of detachment a lot of these executives are looking for.

Doug  51:05 

I can see that would definitely get an executive’s attention. Yeah, that makes sense. Well, Dan, you’ve provided a huge amount of content and value for our listeners today. Thank you very much for that. Do you have any final thoughts for our listeners?

Dan 51:20 

I would encourage you to send out the checklist and I’ll send that to you. And please invite me back on another podcast in the future. I always enjoy talking to you. Awesome job.

Doug  51:30

Thanks so much.

Dan 51:32 

Thank you.

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