Many credit union boards propose adding a collateral assignment split-dollar plan (CASD) as a desirable compensation benefit to help retain their top executives. At first glance, a CASD appears to perform similarly to a pension plan. However, this benefit is quite complex, and misunderstanding or making assumptions about a CASD could lead to more risks and challenges in the future.

A CASD offers a series of income payments during an executive’s career and retirement. What is unique about a CASD is that the credit union loans the executive premiums for a cash value life insurance policy, and the executive assigns a portion of the policy proceeds to the credit unions to repay the loan at death.  The details of these plans and how they operate may be unfamiliar to the average executive, so upfront work with a team of professionals specializing in these plans is critical to reducing risk to the executive and credit union.

To clarify the features of these plans and offer strategies to help mitigate risk, Doug welcomes Mike Downey, senior managing director at Newcleus Credit Union Advisors, to “C.U. on the Show.” For the last 15 years, he has helped credit unions design and implement effective CASDs that protect credit unions and executives and address anticipated and unexpected scenarios.

Mike explains what features credit union boards should consider and factors and risks executives should monitor before, during, and after the income payments start. For example, important components to review are how the plan and loan are structured, the vesting schedule, and how performance projections compare with actuals. In addition, Doug and Mike discuss:

  • How identifying your credit union’s goals, whether to retain or offer a retirement benefit can help determine if a CASD or 457(f) benefit is more suitable.
  • What executives and credit unions should review during the design phase to anticipate and reduce future challenges. For example, what occurs when an executive leaves their credit union or if the insurance carrier loses financial strength?
  • Why longevity and age play a role in if your credit union should offer this type of benefit to every executive.
  • The importance of working with professionals specializing in CASDs to clarify legal language, distributions, vesting features, and more.
  • Which factors may put more financial pressure on a credit union and its CASD policy agreement.

Stream the entire podcast to hear more from Mike in this area of his expertise, so you can be prepared if you’re considering a CASD.

Stream the episode now.

Doug (00:00):

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 today is Mike Downey, senior managing director at Newcleus Credit Union Advisors. Mike has over 29 years experience helping organizations with insurance and investment strategies. For the last 15 years, his attention and expertise have been focused on helping credit unions retaining and rewarding key executives, in addition to providing institutional investments to help offset employee benefit costs.

Doug (00:54):

In today’s episode, we’re going to talk about collateral assignments, split-dollar plans, and the risks in those plans in working with the credit union executives the split-dollar income stream is looked at like a pension. Seems like  most credit union executives look at it, like here’s the illustrated series of income payments. Is there going to be this dollar amount they’re going to come in this time and they’re going to come in for this link. We both know those income payments are illustrated and they may turn out to be better or worse than projected. Mike, tell us about the risks in these split-dollar programs and what we should be thinking about and looking for in the design and optimization of split dollar?

Mike (01:46):

Absolutely. Doug, thanks for the opportunity. Yeah. So with the split-dollar plan, let’s break it down into the three components if we could. So the first one is the plan design. So the plan design would be okay, let’s talk about vesting. When can the executive actually have true ownership of the policy and access to some of the values? That’s one part of the plan design. Another part of the design is how is the loan, because these plans are loans to the executive. How is the loan structured? Is it a recourse or non-recourse? And that’s important because that determines how the loan may be repaid back to the credit union. And then another part of that loan would be, is it a term loan or a demand loan, because some of them could be callable by the credit union. So it really depends on how that loan is designed. So I think the first part of looking at risk and a plan design of a loan regime split-dollar is the loan structure itself, because not all of them are designed the exact same way.

Doug (03:01):

What’s most common? Is there a dominant form out there?

Mike (03:04):

I would say yes. Earlier on, when these plans were first introduced to Credit Unions, because of where interest rates were at the time, over the last, I would say at least 10 to 12, probably about for 10 years now, we see the most predominant design is a term loan, which means the interest rate on that loan is locked in for the life of the loan. And that’s because of the IRS table. It’s very favorable and has been favorable for a very long time.

Doug (03:36):

Yeah, And I saw a lot of credit unions that already had collateral assignment restructured their plans in the last 24 months to take advantage of that fixed low rate. Right Mike?

Mike (03:48):

Absolutely. And we still see some plans out there that are these early on demand loans without interest charge, which is shocking, because they’ve had an opportunity to basically restructure these loans, and refinancing these loans . Now, the key there is the ties into the policy itself, meaning we have to look at the policy and how the life insurance policy has performed over that period of time to really align it with restructuring the loan if you have to, because at the end of the day, that policy is collateral for the loan, but the policy also is providing the benefit of the promised benefit to the executive. So that performance of that policy is extremely important because it’s repaying the loan, but also providing a benefit. And depending on the circumstance, that can put a lot of pressure and strain on that particular policy, especially as dividend rates continue to decrease on those whole life policies that are the typical funding source of these split-dollar. 

Doug (05:00):

Yeah, And in looking at other insurance policies that were put in place 10, 15 years ago, I would often see an illustrated benefit to the person that was far out of whack with reality because interest rates have dropped. now  in credit unions with collateral assignment, they haven’t been around that many years, you know, most of the time, what, 10 years or less, Mike?

Mike (05:28):

Yeah. I mean, well, I would say we started introducing these in 2005, 2006. By the time you go through the education process, credit unions  like to know what other credit unions have implemented this. So really we didn’t see that huge kind of increase until like you said, in the last 10 years because of that process.

Doug (05:50):

So in the last 10 years, interest rates have still come way down. So if your collateral assignment program is built on interest rates, I have to think that your illustration versus your actual reality could be spread there. Right?

Mike (06:08):

Well, absolutely. And another thing to add to that is not every provider runs those illustrations the same, because what I mean by that is you could run it very skinny, very thin, or you could build in a cushion with anticipation that dividend rates could potentially decrease in the future. So that’s why that really the third component of the plan, the plan administration and service, is so key, because every single year that provider should be showing, getting some real illustrations, in-force illustrations, showing how that policy is actually performing. 

Doug (06:50)

You need to compare the projections versus the reality and it may not b…

Mike (06:52):

Absolutely, 100%.

Doug (06:53):

Talk to us then, obviously we can check in on these illustrations, make sure we’re on track, but how do we evaluate risk in the structure of collateral assignment and how do we reduce it? 

Mike (07:05):

Yeah. So, great question there. We talked about the plan design, how some of the risks can be done there. Another way risk can actually be in these plans is in the plan agreement itself. Not all of these plans are written by the same attorney. There’s a lot of different law firms and attorneys drafting these plans around the country. So a lot of the language in those particular documents could create risk. And let me give you an example, Doug, there’s some language in these documents that gives the credit union and/or the board authority to deny a distribution from the policy if they deem that to jeopardize the policy from securing the loan. And this is really overlooked, this is the big one, because I don’t think a lot of the executives that have these plans realize there could be that probability that a future board could deny a distribution.

Doug (08:08):

The future board can deny the distribution if the distribution is putting the policy at risk.

Mike (08:16):

That’s correct. And that depends on how that language is written in that split- dollar agreement.

Doug (08:23):

So the definition of what is putting the policy at risk is very important in your plan agreement.

Mike (08:33):

Bingo Yep.

Doug (08:34):

Interesting. I will attempt to get a law firm on this podcast and dig into that a little bit further.

Mike (08:41):

Okay. Yeah, because that once again, I think the risk in the loan regime split-dollar is, I think, the main obvious one we talked about as a policy risk, policy performance. There’s also longevity risks because this is a plan that really doesn’t end at retirement. You know, it’s something that you have ongoing communication between the credit union and the retired executive until that executive passes away. And some people are fortunate to live to the age 100, so you’re talking potentially 35 years post-retirement. So the longevity risk is there and what’s the makeup of the board going to look like and so forth. So there’s a lot of what I consider risks that are post-retirement risk. And unfortunately, Doug, it is not addressed now, while they’re employed. It’s more challenging to address those risks when they’re no longer working at the credit union.

Doug (09:35):

That’s the interesting point. And it brings up a question I’ve often had when I see a collateral assignment benefit for an executive, they usually end in 20 years or 25 years. The benefit that is illustrated to the executive ends after  20 or 25 years, although the executive’s lifespan may continue significantly beyond that. Is there a reason for why they tend to end in that period of time?

Mike (10:02):

Because most of these are illustrated on the assumption that the executive retires at age 65 and through life expectancy to have access to this money. So a 20-year is pretty typical because it goes from age 65 to 85, but the plan doesn’t end, it just means their ability to take distributions from the policy are based off of that projection. They’re not forced to take the money. So they have a lot of flexibility if they choose not to take distributions and build up more cash value and take it in the future. But just for initial projections to design, the whole plan 20 years is typically used, or you’d get more specific. Some providers do the exact mortality, maybe 81 or 82, and they’ll do it for 17 years. But to your point, the reason 20 years has done is just to get them to that 85 range.

Doug (11:00):

Get them to life  expectancy got it. 

Mike (11:00) But the plan doesn’t end, that just means distributions. The plan ends upon the death of the executive. So even though they stopped taking distributions, they’re still own the policy. And the policy still has that collateral assignment, which in layman terms is a lien. It’s a lien against the policy until that lien is satisfied. They don’t have true 100% clear ownership of that policy, right?

Doug (11:25):

Yeah. There’s some risks there to that policy structure. 

So let’s talk about that. Let’s talk about the what I’m used to seeing in credit union land is a single policy where the credit union picks a provider and that provider goes out and gets one policy from one insurance company. And that is the entirety of the benefit. So what are the risks in the vast structure? What are the risks in the different types of insurance? Now let’s not go too deep and get lost in the distrust lexus, but talk to us about what’s the safest form, what’s the riskiest form. And how do you decide when to use one versus another?

Mike (12:04):

Yeah. I think let’s first address one of the risks and that’d be the credit risk of the carrier. Look at the financial strength of whatever insurance carrier is backing this policy. Now, the majority of that we see out there or a rated carrier very rarely do. I see a carrier that is not currently financially strong, but that can always change in the future. So monitoring that ongoing financial strength of the carrier is important. The second thing is the type of policy. Typically we see two types of policies. One is a whole life policy and the other is an index universal life policy. Whole life is the more conservative because it’s priced with guarantees embedded in it. And because there’s guarantees, the insurance companies giving back some of those guarantees that you’ve paid upfront in the form of a dividend, and then the dividend helps depending on how you do it, build cash value and so forth.

Mike (13:01):

The index UL is a little bit different because that’s based on an index and the most popular is the S&P 500. But the key here is the money’s not in the S&P 500. It’s just the crediting rate on that cash value is going to be based off of the S&P 500. So the money really isn’t at risk as far as from a market standpoint, with the volatility in the S&P. But the crediting rate on that cash value is to be based on that performance during a certain period of time, they call it the point, the point here.

Doug (13:36):

Yeah. I’m used to seeing credit union executives needing to select an index or a basket of indexes on an annual basis. And that, I assume that indicates the structure is an indexed universal life, right?

Mike (13:50):

So you asked what’s the more riskier, but it still comes down to how was that initially funded? How is it structured? We would think just off the top of our head, that index UL may be the most risky because there could be a period where you have, it’s not going to go negative, but you have a zero crediting rate. But if that’s structured, Doug, in a manner, that’s more of, you have multiple point the point periods. If you dollar cost average upfront, that way you have maybe 12 point to point periods rather than one.

Doug (14:23):

Okay, Mike, this is news to me. So in one policy, it’s also possible to have multiple indexing periods or is that multiple policies?

Mike (14:33):

Yeah. Multiple index periods . That’s if that is done upfront the proper way. So that is one way you minimize what I consider the timing risk of some of these policies, because imagine if you purchased the policy in March 2019 and March 2020 was your point to point We had one month that was pretty much down last year, significantly. So by spreading out that risk and having multiple point to point is one way you mitigate that.

Doug (15:06):

Interesting, that is unique to Mike Downey. Thank you for that insight. Now, another thing I want to ask you philosophically, from my standpoint, when we’re building a financial plan and we have the collateral assignment income as part of the illustration, my objective is for the person to get what was illustrating.  non-transfer upside, not trying to hit a home run, collateral assignment. I’m trying to hit the target and we’ll take some risks and other portions of the person’s portfolio. So when I have the S&P 500, you know, just as an option versus a blended approach with some small caps and some international and some bonds, my inclination is if the policy has been illustrated at, let’s say 5 or 6%, I like to take the lower risk option. I like to suggest the executive take the lower risk option, perhaps the middle risk option, because I’m only trying to get the projected return. We get extra, may not have a big impact, but if we get less, it has a very big impact. What are your thoughts around the selection of the index?

Mike (16:23):

I think it comes down to education. As far as if the executive knows that particular index, we have one carrier out there that’s a predominant carrier. It doesn’t give those options. They use the one index, they keep it simple. There’s other carriers that are going to have maybe eight different indexes, you know, the Russell 2008 maybe. So the majority of what I see, they keep it simple and they keep with the S&P 500.

Doug (16:50):

So the S&P 500 is the only choice for the majority of the policies. 

Mike (16:54):

With one particular carrier. That’s correct. 

Doug (16:57):

All right. So if you are a credit union and you’re looking to say, you know, you’ve got plenty of collateral. You’re going to put this program in place for the executive, and you want the minimum risk in your policy design. You want the minimum risk, you can get there one of two ways. But what I think I’m hearing is you can buy a whole life policy where everything is contractually guaranteed, or you could buy an index universal life and fund it liberally and sort of create a similar risk environment by the funding design. Is that right?

Mike (17:38):

That’s right. But let me just make one small clarification there from a compliance standpoint. What I meant by guarantees. You know, there’s no guaranteed distributions, anything like that. What I meant by is that product is priced to endow at a  certain age. And it has  embedded guarantees there.  not taking distributions from the policy. That’s not guaranteed. Just wanted to clarify that.

Doug (18:06):

Are the interest rates in whole life guaranteed, like they used to be?

Mike (18:11):

Once again, I’m an insurance geek. So I’m going to have to say, not necessarily, because by definition, the dividend itself is not guaranteed to be paid. If the dividend is paid,  There’s some guaranteed interest component in that dividend. But once again, being an insurance geek going on 30 years, that dividend is not guaranteed.

Doug (18:34):

Well that’s  important to understand that even the whole life is not fully guaranteed. Everything you see is still an illustration of a dividend, and that dividend rate may be greater or less than illustrated. So in both cases, you need to be checking up on the policies every year.

Mike (18:54):

Well, that’s correct, because if we look back to why these policies were created 100+ years ago, was to provide a death benefit, would guarantee a death benefit. If a premium was paid, we’re not doing that in this scenario, we’re looking at more of the cash accumulation and using that for a benefit. So once again, some of those underlying guarantees, I should say, really applied to when you’re designing the product to pull cash out. That makes sense because there were more death benefits guaranteed than cash value accumulation.

Doug (19:30):

It does. So talk to me about the difference. If you’re a credit union and you have had a policy already in place for your executive team, and you have a change in your team, or you want to add an additional retention structure, weigh the differences between adding to the existing structure, if that’s even an option versus adding a new policy with the same carrier versus adding a new carrier. Why should I do one versus the other? How should I evaluate those choices?

Mike (20:01):

That’s a great question. And this came up yesterday, actually there was this philosophy that, hey, I have this plan. So I want my other executives to have the exact same thing that I have. Well, you have to take into consideration the age of those other executives. What if they’re in their early 40s? Now you’re talking about a plan that might be in place for 40, 45, 50 years. And depending on how that’s structured, is that going to be a retention or is it really geared toward retirement? So I think each situation, Doug, is, I guess, attorneys say this all the time: it depends. I think that particular situation we would have to look at the ages of the executive. What is the credit union trying to accomplish? Is it a retention to keep them around until the CEO retires or more of a succession plan? What’s really the purpose of the plan itself, because then that would determine the best design to you.

Doug (21:06):

Contrast those for me, if I’m looking at a retention plan versus a retirement plan, what path would that tend to lead me down each time?

Mike (21:15):

Yeah, I think then you have to kind of step back and look at the different plans that are available based off of what you’re trying to accomplish, because we’re talking about today, loan regime split-dollar, but there’s other plans that might be more suitable for a retention aspect as compared to geared toward retirement.

Doug (21:39):

Tell me more about that. So if we think we want to focus on retention because we’ve got this 42-year-old superstar running our credit union. Talk to me about how we might want to do it differently.

Mike (21:52):

Yeah. Could you set up a retention and retirement and everything with one plan like the loan regime split-dollar? You could, but is that the most optimal? So you may want to look at what about a 457(f) plan that might be more suitable to provide those incremental retention payouts. We call them carrot on a stick for simplicity, but maybe that has more suitability for those shorter duration benefits then using a vesting schedule and the loan regime that has partial vesting and gets kind of complicated.

Doug (22:29):

Now, Mike, that is really interesting because I’ve seen many a credit union that has a collateral assignment, a single collateral assignment program, and they’ll have lump sums come out to the executive at various times. Usually when the kids hit to college ages or when various periods of time have passed, totally it’s a golden handcuffs plan. Of course the executive loves it because when that money comes in, it’s tax free and they can take that and do what they please. So contrast that for us, please, the collateral assignment as the golden handcuffs for retention plan versus 457(f). How do I choose one versus the other?

Mike (23:15):

Yeah. So let’s say in that scenario, they would have used the 457(f) plan and that executive would receive that same dollar amount. Let’s say rather than taking a distribution from their collateral assignment, because you’re taking a distribution from that collateral assignment maybe early, when what happens when dividends reduce after that time, what kind of, once again, I’ll use the word pressure, what kind of pressure and stress would that distribution from the policy have? In  the long term on the backend. Whereas a 457(f) plan would have just given them that money that they could go ahead and use for college and so forth and leave that split-dollar policy intact without any additional strain on it. So I think it really, once again, we have multiple plans available and different designs in the industry that can be used based off of  what credit unions are trying to accomplish. So with a loan regime split-dollar, you could achieve very similar by doing vesting, right? Vesting doesn’t necessarily mean a distribution. It just means the percentage of the plan you have at any given time, if you decide to leave. So vesting in distributions can be completely different.

Doug (24:35):

Now that’s another interesting point. Let’s talk about vesting. So you’re a credit union CEO, and let’s say you vested 10% a year. What are you investing in at 10% a year? Are you vesting in an income stream? Are you vesting in a sum of cash, a death benefit? What am I investing in and how does that vary across them?

Mike (24:57):

I think if you asked an executive that probably 99.9% of them really don’t have any idea, it’s very vague. And it really comes down to how that document is drafted, that language in the document. That’s a great question. What are you actually vested in? Are you vested in that policy is the policy split into two policies? Is it that future benefit, meaning this plan continues as is, but you only get a percentage on the back end? That’s a big question mark though. There’s a lot of confusion out there.

Doug (25:31):

So is that often not even covered by the attorney. It just says you’re 10% vested per year, but it doesn’t say what specifically you’re vested in. And you figure that out only if you get into a situation. 

Mike (25:43):

I’ve seen some of these documents. It gets pretty detailed, but it still can get confusing, very confusing for the average person. I mean, it’s legal language and it’s confusing, but that’s a good question. That’s the million dollar question. What are you exactly vested in? What does that mean for you financially? Do you have access to that money now? What would that look like? Or is it a future access to that money? If I leave a credit union and I’m 20% vested, it might be 20% vested in the current cash value. Am I  20% vested in that future benefit. Maybe if I need the money now; how do I get that money? Now I’m 20% vested. What does that look like? You’re going to give me a reduced, paid up policy of 20% of that current value. Well there’s a lot of confusion out there and that’s where I think sometimes to simplify it and optimal, you use multiple plans, you diversify your plan offerings to avoid that kind of confusion, because if that kind of confusion comes up, guess what happens? You’re going to have to get attorneys involved to try to figure out what am I 20% vested in.

Doug (26:51):

So you might want to make sure that’s very clear in the beginning, what you were getting vested in, and that if you end up leaving the credit union, for whatever reason, that vested benefit doesn’t blow up and become highly undesirable. It’s a policy that’s still with your old employer where you may not have a great relationship. And now you have to go through them to get an income stream. Is there a way around that? Is there a way around that if you leave the credit union and you know, this is why you were headhunted away. You leave the credit union for, not on bad terms, but you went somewhere else to run a bigger credit union.. And so you’ve got this 50% vested plan at your old credit union. And I assume what you would have to do is interact with that credit union when it comes time to start getting your benefits. is there a way any other way around?

Mike (27:51):

Yeah. I mean, you could pay off the lien , pay off the note, own the policy outright. And your new employer could do that. If you negotiated that coming over, that they satisfy that loan as part of the negotiation of employment. So there are some things you can do to have that ownership a hundred percent outright, Then it comes back to 50% of what? So is it 50% of that current cash value? projected benefit? And that’s where once again, it oftentimes depends on that split-dollar agreement, how it’s written; if it’s vague, then it’s what exactly it is.

Doug (28:29):

That’s why you need both the executive benefits specialist, Like you, as well as the attorney, you need a deep specialist in this world that has seen these contracts over and over again, to bring up the things that you’re not going to think about in the design of the collateral assignment program to make sure that all the stuff that might happen is clear. What that means and  all parties agree.

Mike (28:58):

And I think that’s extremely important, Doug, because really, if we look at the number of providers that are the predominant providers that do these for credit unions in the industry, I mean, I don’t know off the top of my head, I’m going to say maybe six, but they know what they’re doing. And they work. They know these plans. Where we really see some of these that fall apart is where someone knows an insurance agent and someone knows I’m an attorney and they try to put these together. And this is really not their area of specialty. So, not only, cause There’s a lot involved. Like we talked about, you have the loan, you have the policy, you have the agreement that is a very highly specialized area. So to your point, it’s very important to work with a provider that does this in the space because they can really help get a plan. That’s not going to have some of these big complications because of the rep. The insurance guy really didn’t know this. And the attorney really didn’t know how to draft these. And we do see that as a one-off.

Doug (30:01):

Yeah. I’ve heard nightmare stories about those one-offs and that sounds like something that is not a good decision,

Mike (30:11):

Because they’re not always easy to unwind. So even if they’re not done correctly, where is the policy as far as funding, is it still under water? Is it above water? Meaning is there cash value exceeding premium? So if they restructure these, if they’re not done correctly, it’s not always that easy. It can be done, but it’s not always as simple. So it is important. What you said earlier to get a lot of this done upfront, understand what you’re getting into, understand what the potential risks are going to be in the future and design it and fund it to help mitigate those risks.

Doug (30:49):

Excellent. So earlier in this podcast, we brought up the 457(f), which is another SERP structure that is not an insurance policy. It’s another form of investment vehicle. And I think there’s a significant amount of complexity and  interest in the 457(f) as a vehicle. So we’re going to record another episode and really drill in on the 457(f) strengths and weaknesses and funding and different issues there. So thanks again, Mike Downey. We appreciate you greatly.

Mike (31:24):

Anytime. Thanks Doug.

Doug (31:28):

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 (31:47):

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. Economic forecasts set forth may not develop as predicted. All performance references are historical and are no guarantee of future results. Indexes are unmanaged and cannot be invested into directly.

Mike Downey and Newcleus Credit Union Advisors are not affiliated with or endorsed by ACT Advisors, LLC.

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