Evaluating Executives’ 2020 Performance

Bank boards know that the world has shifted dramatically since January, when they drafted  individual executives’ performance expectations. Using those outdated evaluations now may be a fruitless exercise.

As the impact of the pandemic and the social justice movements continue to unfold across the United States, boards may not feel that they have much more clarity on performance expectations currently than they did back in March. At many banks, credit quality has replaced loan volume as the key operating priority. Unprecedented interest rate cuts have further deteriorated earnings power.

Many boards of directors are revisiting how to evaluate the executive team’s individual performance for fiscal year 2020, considering these new realities for their businesses. Individual performance evaluations are a tool for evaluating leadership behaviors and abilities; as such, it sends a clear indication of what the board values from their leaders. After a year like this, all stakeholders will be interested to know what the board prioritized for their bank’s leadership. 

Considerations for Updated Individual Performance Evaluations
This year has been defined by unprecedented developments that broadly and deeply impact all stakeholders. More than any other industry, banks have been called on to support the country using every tool in their toolkit. Reflecting this broad impact, bank boards may find it useful to establish a revised framework for evaluating leadership performance using six “Critical Cs” for 2020:

  • Continuity of Business: How quickly and effectively was the bank able to transition to a new operating model (including remote work arrangements, staffing essential workers in office or branch, etc.) and minimize business disruption?
  • Customer Satisfaction: How were customers impacted by the change in the operating model? If measured, how did the scores vary from a normal year?
  • Credit Quality: Where are the trends moving and how are executives responding? Did the institution face legacy issues that took some time to address and may be compounding current issues?
  • Capital Management: What balance sheet actions did executives take to strengthen the bank’s position for the future?
  • Coworker Wellbeing: What was the “tone at the top”? How did executives respond to the needs of employees? If measured, how did the bank’s engagement scores vary from other years?
  • Community Support: What did the bank do to lead in our communities? How effective was the bank in delivering government stimulus programs like the Small Business Administration’s Paycheck Protection Program?

For publicly-traded banks, the compensation discussion and analysis section of the proxy statement should provide a thorough description of the rationale and process used for realigning these criteria and the evaluation approach used to assess performance. Operating results are likely to be well below early-year expectations for most banks; as a result, shareholders will be keenly interested in how leadership responded to the current environment and how that informed pay decisions by the board.

This year has created an unprecedented opportunity to test the leadership abilities of the executive team. Using the six “Critical Cs” will help boards assess the performance of their leadership teams in crises, craft a descriptive rationale for compensation decisions for fiscal year 2020, as well as evaluate leadership abilities for the future.

A Deeper Dive Into Board Pay

How you pay your board may have a surprising effect on its total pay package, according to Bank Director’s 2020 Compensation Survey. This exclusive analysis has been created specifically for members of our Bank Services program.

Across asset sizes, banks paying an annual retainer generally award more total compensation to the board compared to their fee-only peers or those that award a mix of the two. This analysis focuses solely on cash compensation for the full board, in the form of meetings fees and retainers. Committee compensation is excluded due to variances in structure and meeting frequency, although 63% award committee fees.

Estimated Annual Pay, by Type and Asset Size

 >$10B$1B – $10B$500M – $1B$250M – $500M<$250MAll Banks
Annual Retainer Only$595,000$380,000$312,750$180,000$150,000$400,000
Meeting Fee Only$921,000$120,000$140,000$105,000$65,000$107,500
Both Retainer + Fees$225,000$118,000$90,000$85,400$77,500$105,000

*Estimated annual pay assumes 10 directors per board and 10 meetings per year, based on the 2020 Compensation Survey.

The low usage of meeting fees by banks above $10 billion in assets, and of annual retainers by banks below $500 million in assets, result in smaller data sets for those groups.

So, are retainer-only banks overpaying their boards? Are fee-only banks underpaying theirs?

Board responsibilities have risen greatly since the last financial crisis more than a decade ago. Regulators expect more from directors; while the buck stops with the CEO, that individual ultimately reports to the board. So, while it’s hard to say what’s right and what’s wrong when it comes to board pay, the gradual, increased use of annual retainers — from 61% five years ago to 70% today — reflects a realization by many boards that their members are spending more time outside of meetings on bank matters, whether that’s reviewing board packets or educating themselves on issues important to the oversight of the bank.

Annual retainers can better demonstrate the amount of the work directors put in. 

What’s more, technology has expanded how the board can meet. Some boards already offered phone and video conferencing options to more-remote members, like snowbirds who head south for the winter. The Covid-19 pandemic forced entire boards to adopt these measures, so they could become a more permanent feature for some. Should those attending virtually be compensated differently?

Annual Cash Compensation Per Director, by Type and Asset Size

 >$10B$1B – $10B$500M – $1B$250M – $500M<$250MAll Banks
Annual Retainer Only$59,500$38,000$31,275$18,000$15,000$40,000
Meeting Fee Only$92,100$12,000$14,000$10,500$6,500$10,750
Both Retainer + Fees$45,000$28,000$22,500$17,900$14,500$24,000

*Estimated annual pay per director assumes 10 meetings per year, based on the 2020 Compensation Survey. The low usage of meeting fees by banks above $10 billion in assets, and of annual retainers by banks below $500 million in assets, result in smaller data sets for those groups.

Getting the compensation mix right is vital to attracting the new talent a board needs to oversee the bank. Boards are often seeking someone younger. They may be looking to add gender or ethnic diversity. Or they may be looking for new skills.

While the 2017 Compensation Survey indicated that directors serve for loftier reasons than a supplemental paycheck — 62% cited personal growth as the top reason they serve — new, younger directors could be balancing an already high-pressure career with family obligations. And other organizations could be seeking their valuable time. Your bank likely isn’t the only one in its community on the hunt for board talent.

“It’s difficult to fully compensate someone for their time as a director,” says Flynt Gallagher, president of Compensation Advisors. “If you’re going to pay them for the time they put in, the skills they bring to the board — they’d be unaffordable.”

But boards still need to make it worthwhile to serve. Simultaneously, they may feel pressure to maintain current pay levels during the economic downturn.

Compensation committees could consider awarding equity compensation, which wasn’t factored into this analysis. Equity provides a way to pay directors more — and gives them additional skin in the game — without having an outsized effect on total compensation. Roughly half of survey respondents, primarily at public banks, awarded equity to outside directors in fiscal year 2019, at a median fair market value of $30,000. 

Bank Director’s 2020 Compensation Survey, sponsored by Compensation Advisors, surveyed 265 independent directors, CEOs, human resources officers and other senior executives of U.S. banks to understand trends around the acquisition of talent, CEO performance and pay, and director compensation. The survey was conducted in March and April 2020. Compensation data for directors and CEOs for fiscal year 2019 was also collected from the proxy statements of 98 publicly traded banks. Fifty-three percent of the total data represent financial institutions above $1 billion in assets; 59% are public.

Several units in Bank Director’s Online Training Series focus on compensation matters. You can also learn more about finding new talent for the board by reading “Cast a Wider Net for Your Next Director” and “How to Recruit Younger Directors.” If you’re considering virtual meetings, read “Best Practices for Virtual Board Meetings” to learn more about navigating that shift.

Designing a Pandemic-Proof Compensation Plan

The ability to pivot and adapt to a changing landscape is critical to the success of an organization.

The coronavirus pandemic has created a unique challenge for banks in particular. Government stimulus through the Paycheck Protection Program tasked banks with processing loans at an unheard-of rate, turning bankers working 20-hour days into economic first responders. Simultaneously, the altered landscape forced businesses to adopt a remote work environment, virtual meetings and increase flexibility — amplifying the need for safe and reliable technology platforms, enhanced data security measures and appropriate cyber insurance programs as standard operating procedure.

Prior to Covid-19, a major driver of change was the demographic shift in the workforce as baby boomers retire and Generation X and millennials take over management and leadership positions. Many businesses were focused on ways to attract and retain these workers by adapting their cultures and policies to offer them meaningful rewards. The pandemic will likely make this demographic shift more relevant, as the workforce continues adapting to the impending change. 

Gen X and millennial employees are more likely than previous generations to value flexibility in when and where they work. They may seek greater  alignment in their career and life, according to Gallup. The pandemic has forced businesses to either adapt — or risk the economic consequences of losing their top performers to competitors.

Many employees find they are more productive when working remotely compared to the traditional office setting, which could translate into increased employee engagement. In fact, the Gallup’s “State of the American Workplace” study finds that employees who spend 60% to  80% of their time working remotely reported the highest engagement. Engagement relates to the level of involvement and the relationship an employee has with their position and employer. Gallup finds that engaged employees are more productive because they have increased autonomy, job satisfaction and desire to make a difference. Simply put, increase engagement and performance will rise.

The demographic shift and a force-placed virtual office culture means that designing programs to attract and retain today’s workers require a well thought out combination of strategies. An inexpensive — though not necessarily simple — method of employee retention includes providing recognition when appropriate and deserved. Recognition is a critical aspect in employee engagement, regardless of demographic. Employees who feel recognized are more likely to be retained, satisfied and highly engaged. Without appropriate recognition, employee turnover could increase, which contributes to decreased morale and reduced productivity.

In addition to showing appreciation and recognizing employees who perform well, compensating them appropriately is fundamental to attracting and retaining the best. The flexibility of a non-qualified deferred compensation program allows employers to customize the design to respond to changing needs.

Though still relevant, the traditional Supplemental Executive Retirement Plan has been used to attract and retain leadership positions. It is an unsecured promise to pay a future benefit in retirement, with a vesting schedule structured to promote retention. Because Gen X and millennials may have 25 years or more until retirement, the value of a benefit starting at age 65 or later could miss the mark; they may find a more near-term, personally focused, approach to be more meaningful.

Taking into consideration what a younger employee in a leadership, management, or production position values is the guide to developing an effective plan. Does the employee have young children, student loan debt or other current expenses? Using personalized criteria, the employer can structure a deferred compensation program to customize payments timed to coincide with tuition or student loan debt repayment assistance. Importantly, the employer is in control of how these programs vest, can include forfeiture provision features and require the employee perform to earn the benefits.

These benefits are designed to be mutually beneficial. The rewards must be meaningful to the recipient while providing value to the sponsoring employer. The employer attracts and retains top talent while increasing productivity, and the employee is engaged and compensated appropriately. Banks can increase their potential success and avoid the financial consequences of turnover.

Ultimately, the pandemic could be the catalyst that brings the workplace of tomorrow to the present day. Nimbleness as we face the new reality of a virtual office, flexibility, and reliance on technology will holistically increase our ability to navigate uncertainty.

Covid-19, Compensation and Corporate Performance

Covid-19 has created a literal life-and-death struggle for many; the resultant economic slowdown has imperiled businesses, employees and shareholders. A few lessons have already emerged from the pandemic’s fallout.

How companies manage employment and compensation through the Covid-19 crisis is already under intense scrutiny; positive and negative case studies will undoubtedly emerge offering insight into best (and worst) practices when it comes to human capital and non-financial risk management. 

Human capital is an intangible company asset, often thought of as the economic value of an employee’s experience and skills. Already, investors focused on environmental, social and governance issues, commonly known as ESG, are tracking how companies address human capital issues in light of the pandemic and economic shutdown. 

Aon and McLagan have tracked corporate reactions to Covid-19 since the start of the crisis, recording a wide array of pandemic responses through May 2020 from 66% of companies in the Russell 3000. 

We found that firms had already taken steps to curtail executive (14.7%) and board (9.5%) compensation, work hours (2.1%), hiring (2%), and dividend payouts (3.9%), while others have gone further and closed locations (12.1%) and furloughed (6.2%) or terminated (1.9%) employees. 

By May, 387 diversified financial services firms reported making executive compensation changes; however, none were community banks, which have mostly taken a wait-and-see approach.  

Because human capital is a major driver of corporate profits in any industry, how companies manage workforce issues during a crisis and on a daily basis is important. In the banking and financial services industry, however, human capital is even more critical. 

Human capital issues rank in the top material ESG risks that commercial banks should proactively manage, along with data security, business ethics, systemic risk management and product-related considerations such as access and design. And that was before Covid-19. In a post-pandemic world, several urgent human capital issues have taken center stage at banks and financial institutions. 

Customer Access, Workplace Safety 
Financial institutions are considered essential businesses and must simultaneously balance remaining open to maintain market liquidity with workplace safety for front-line staff. While organizations should do all they can to maintain strict social distancing and cleaning regimes, some have gone further by offering hazard pay to customer-facing employees. When evaluating hazard pay options, it is also important to weigh one-time versus ongoing pay adjustments, or whether to include this compensation in hourly wage figures. While one-time or periodic bonuses may impact short-term cash flow, executives should consider the effect of needing to potentially roll back pay increases in the future. 

Staff Compensation 
While hazard pay is one component of Covid-19 compensation, it is certainly not the only one. Many banks have faced a staggering increase in loan application processing due to both the Coronavirus Aid, Relief, and Economic Security (CARES) Act and mortgage refinancing. Planning for any overtime or performance bonus payments during the pandemic period will be a critical element of human capital and cash flow management. These decisions should be made in consideration of pay equity laws and best practices, which are additional focuses of ESG. 

Executive Compensation
In light of the Covid-19 economic slowdown, many financial institutions may decide to reevaluate and make material changes to the performance metrics used in their incentive compensation plans. 

Proxy advisory firms Institutional Shareholder Services (ISS) and Glass Lewis have offered guidance on such changes. ISS encourages boards “to provide contemporaneous disclosure to shareholders of their rationales for making such changes.” Glass Lewis cautioned companies that proposals “that take a proportional approach to the impacts on shareholders and employees look more likely to be widely supported.”  

No one knows for sure how long the pandemic and economic fallout will last; how companies manage their human capital through the crisis will be a key differentiator, both from an economic and a public relations standpoint.

Compensating Employees in a Crisis

It’s an old conflict with new, pandemic-created urgency: How to compensate employees during a crisis.

Compensation is one of the biggest variable expenses a bank has, and many incentive compensation plans may have components or goals that are no longer realistic at this state of the business cycle. At the same time, bank employees have served as first-responders to the economic crisis created by the coronavirus pandemic, putting in long hours to modify or originate loans. Boards are figuring out how to reward employees for these efforts while keeping a lid on expenses overall, balancing the bank’s growth and safety against the short-term operating environment.

The Paycheck Protection Program from the Small Business Administration creates an interesting compensation opportunity for banks, says Flynt Gallagher, president of Compensation Advisors. Many banks had employees who pulled all-nighters while working remotely to fulfill demand for these unsolicited loans. Some institutions may choose to exercise discretion by issuing spot awards, which reward employees for a specific behavior over a limited period of time, to bankers who worked overtime to help customers. Gallagher believes these may be larger than a typical award, citing one client that is setting aside $100,000 of PPP profits to distribute to employees who pitched in.

The pandemic created challenges for Civista Bancshares’ commercial lenders and their incentive compensation program, though it presented opportunities as well. Processing PPP applications took time that the Sandusky, Ohio-based bank’s commercial team may have spent monitoring and administrating their existing portfolios or prospecting for new customers. But after the $2.6 billion bank satiated demand from current customers, it opened its doors for new customers, says Civista Bancshares CEO Dennis Shaffer. Some new customers transferred their accounts and service needs as a result, which counts toward deposit goals that retail bank staff have.

Banks with plans featuring objectives or goals that may no longer be reasonable or prudent may be able to exercise discretion under their plans’ “extraordinary events” clause, Gallagher says. The clause applies to events that materially affect profitability, like selling a branch or implementing a new operating system. Banks electing that approach, he says, will also need to quantify the impact that Covid-19 has had on their performance.

At Civista, goals tend to be set in the first quarter, and Shaffer says that changing course on an incentive plan midstream could compromise its integrity. Gallagher adds that public companies like Civista may face scrutiny from proxy advisory firms if they make changes to a current plan or exercise too much description.

But boards have some options as they evaluate their current incentive compensation plans. Some may break their compensation plans into shorter plan periods. Gallagher predicts that banks may decide to shift or roll up individual goals into team or department objectives to reward the broad efforts of groups that may have gone beyond the four corners of their job descriptions.

“I don’t think you’re going to see any general methodology adopted. It’s going to be all over the board, based on the institution,” he says.

Walden Savings Bank is comparing its compensation plan, which uses a scorecard of 12 metrics evaluated monthly, to its expected financial performance, says Stephen Burger, who has chaired the Montgomery, New York-based bank’s compensation committee for 16 years. He says there is already “no way” to achieve at least four of those metrics, reducing the incentive accrual by 25%. The board and CEO of the $603 million bank also decided to cut their pay, but so far no employees have been laid off or furloughed.

“The scorecard is just a guideline,” he says. “We do have latitude to look at other opportunities and reward or cut in certain areas.”

The bank is already trying to keep a tight lid on expenses. They stayed local for their strategic planning weekend instead of going out of town, implemented a hiring freeze, paused a branch transformation project and are mulling alternations to certain benefits or staff reductions.

“We will find a way to reward our employees,” Burger says. “At the same time, if earnings aren’t there, we’ll also do a very effective job of making sure that they recognize that it’s a unique type of year.

Gallagher cautions against banks making short-term cuts in employment or not rewarding producers. Good employees need to be retained in anticipation of better operating periods. And some banks may actually look to hire new employees right now, given that mass unemployment has flooded the marketplace with talent.

“One banker [I spoke to] said he doesn’t think he is overstaffed, he just doesn’t think he has people in the right places,” Gallagher says. “Companies that are forward-thinking will go hard on people while they’re available, even if they don’t need them. You’ll figure out how to use them to the best of their ability later. Get the talent right now.”

The Significance of Size, Scale and Structure in BOLI

A bank is only as strong as its people, its client base and its assets. If your bank owns bank-owned life insurance (BOLI) among its assets, it’s important to know that your BOLI is only as strong as your BOLI insurance provider.

Bank executives familiar with the broad contours of BOLI may not be aware of other important considerations relative to their policies — considerations that may be unique to the product or the insurance carrier. Understanding these nuances can provide valuable insights into the resiliency, financial stability, and performance of your BOLI policy.

BOLI can be one of the most attractive assets on a bank’s balance sheet; in a low-rate environment with market volatility, it’s a good idea to consider including BOLI as part of a well thought-out asset strategy.

Two popular approaches for determining the crediting rates applicable to general account BOLI products are the “portfolio rate” and the “new money rate” methods. The new money rate method features crediting rates based on currently available securities, whereas portfolio-rate general account BOLI policies feature crediting rates based on the performance of an underlying seasoned portfolio. Crediting rates derived from well-diversified, low-turnover portfolios can serve as a form of hedge against volatile and lower market interest rates, while a new money rate product can benefit during a period of persistent and material increased market interest rates.

Each BOLI policy’s minimum guaranteed rate is backed by the credit quality, size and diversification of the issuing insurer’s investment portfolio. A portfolio’s resilience and financial strength are derived from the interplay between the core of investment-grade fixed income securities and holdings of potentially higher-yielding assets.

When it comes to BOLI, size and scale matter. Larger insurers are typically better equipped to purchase and provide exposure to a wider range of diversified assets, which contribute to the portfolio’s yield and BOLI crediting rates that banks value. Smaller carriers may not necessarily have access to the wide range of investment asset classes and market opportunities relative to larger carriers like MassMutual.

Beyond comparisons of the carriers’ investment portfolios and crediting rate approaches, there can be important differences when it comes to the insurers themselves. Because there is a limited universe of BOLI carriers, and their capabilities and strengths vary, each carrier brings unique types and levels of resources to bear. Each insurer offers banks different results based on its investment philosophy and expertise in managing the general investment account underlying its BOLI policies. Certain characteristics that differentiate insurers from each other include company structure, business mix, asset/liability management strategy, access to less widely available investment opportunities, and culture. The expertise, breadth and depth of experience of the insurer’s investment and business professionals should not be overlooked.

As a large mutual life insurer, MassMutual has a dedicated investments group that leverages our expertise in fixed income, equities and alternative assets, including real estate. The asset managers are insurance investors first and foremost, and they understand the business and the characteristics of the liabilities that the investments support.

The mutual structure enables insurers like MassMutual to take a long-term perspective. Decisions made with the next several decades in mind, not the next quarter, better align with the long-term nature of BOLI assets. This long-term view fuels our approach to maintaining financial strength and stability and drives our competitiveness.

Further, a carrier’s long-term market presence and commitment can be aided by diversification within its own subsidiaries, business lines and income streams. Just like in banking, having a diverse set of businesses can help reduce the economic sensitivity of an insurer. Diversified insurance carriers that offer a variety of solutions with varying characteristics are built to weather economic cycles and provide stability to a carrier. The combination of diverse income streams with a diversified pool of assets is a sound approach to help endure a wide variety of economic environments.

Banks have a variety of options when it comes to which BOLI insurer they select. Understanding each carrier’s structure, business mix, investment philosophy and market approach can inform executives’ choices as they embark on financial relationships that last decades.

Insurance products issued by Massachusetts Mutual Life Insurance Company (MassMutual), Springfield, MA 01111-0001.

Survey Results: Crisis Reinforces Need for Talent

Throughout the Covid-19 pandemic, banks have relied on their employees to counsel customers and process billions of dollars of Paycheck Protection Program loans — not to mention working behind the scenes as they adapt to a virtual work environment.

The crisis reinforces the old adage that good talent is hard to find. “Hire right,” investor Ray Dalio once wrote. “The penalties of hiring wrong are huge.”

Bank Director’s 2020 Compensation Survey, sponsored by Compensation Advisors, confirms that talent can be difficult to find in key areas. More than 70% of directors, CEOs, human resources officers and other senior executives responding to the survey point to skills that are particularly difficult to hire and retain, such as information security, technology, lending and risk.

But hiring less-skilled staff also proves challenging: Half indicate that it’s “somewhat” or “very” difficult to attract and retain entry-level employees who fit into the organization’s culture. What’s more, concerns around recruiting younger talent have risen slightly in the past three years: 30% cite this as a top-three challenge this year, compared to 21% in 2017.

Yet, 79% believe their bank offers an effective compensation package that helps attract and retain top talent.

This apparent disconnect could stem from the generation gap between bank leadership and younger staff. Two-thirds of survey respondents are over 55, while more than half of their bank’s workforce is 45 or younger. One can infer that these employees, mostly Gen Z and millennials, primarily occupy entry and mid-level positions.

The survey was distributed in March and April, as the coronavirus forced banks to rapidly shift operations to work-from-home arrangements and adjust branch procedures. Ninety-two percent of respondents indicate their bank instituted or expanded remote work, and 80% introduced or expanded flexible scheduling in response to Covid-19. As the industry emerges from this crisis, how will this impact corporate culture moving forward, as well as expectations from prospective employees?

Key Findings

Covid-19 Response
In addition to adapting to remote and flexible work arrangements, more than half expanded paid leave to encourage staff to stay home if they showed symptoms of the virus. In addition, 81% have limited service to drive-thru only, and 78% limited in-person meetings to appointment only, in order to keep customers and staff safe.

Top Compensation Challenges
The top two compensation challenges that respondents identify remain the same compared to last year: tying compensation to performance (48%), and managing compensation and benefit costs (44%).

Few Measure D&I Progress
Stakeholders have increasingly paid attention to corporate efforts around diversity & inclusion. However, 42% of respondents say their bank lacks a formal D&I program, and doesn’t track progress toward hiring and promoting women, minorities, veterans or individuals with disabilities. Of the metrics most frequently tracked by banks, 58% look at the percentage of women at different levels of the bank, and 51% at the percentage of minorities. Less than half track the gender pay gap, participation of women or minorities in development programs, or participation by employees in D&I-focused education and training.

CEO Retirement
More than 20% expect their CEO to step down within the next three years; an additional 7% are unsure whether their CEO will retire. This metric is, naturally, age dependent: For CEOs over the age of 65, more than half are expected to retire.

CEO, Board Pay Increased
Median total CEO compensation increased in fiscal year 2019, to $649,227. Pay ranged from a median of $251,000 for banks under $250 million to $3.6 million for banks above $10 billion. More than 70% measure CEO performance against the bank’s strategic plan and corporate goals.

To view the full results of the survey, click here.

BOLI Carriers Prepare for COVID-19 Impact

Purchases of bank-owned life insurance were strong in 2019 as bankers capitalized on its attractive yields relative to other investments available to banks.

What 2020 holds remains to be seen, given trends in the market and broader economy. Total BOLI purchases likely could be lower this year, as carriers are generally not willing to accept large premiums from a single policyholder. However, BOLI activity in the $10 million and under purchase size may be similar to 2019 levels. At the close of the first quarter, it is too early to know the full impact of COVID-19, but we have a few observations based on discussions with several major BOLI carriers:

  1. The carriers have not priced in any risk premium for potentially higher mortality rates and do not expect to do so. In addition, the carriers do not expect to tighten the requirements to obtain guaranteed issue underwriting. In a guaranteed issue BOLI case, the insureds answer several questions, but no physicals are required. Guaranteed issue underwriting can be obtained with as few as 10 insureds.
  2. It is virtually impossible for carriers to find fixed income investments that produce yields that approximate the yield on the existing portfolio, given that short-term interest rates have dropped to near zero and the 10-year Treasury declined from 2.49% on April 1, 2019 to 62 basis points a year later.
  3. While carriers continue to accept new BOLI premium, some are reluctant to take a large premium from any one customer to avoid diluting the portfolio for existing policyholders. Movements in the yield of the portfolio tend to lag the market because carriers’ portfolios are very large (often $50 billion to $200 billion) and generally have a duration of five to 10 years. For this reason, current crediting rates for several carriers remain above 3%.
  4. Several carriers indicated that they started reducing credit exposure and increasing asset diversification several years ago. While they did not anticipate a pandemic, the market had been good for so long and they thought it would be wise to start reducing the risk in the portfolio ahead of a potential downturn. In addition, credit spreads had also narrowed, so there was less reward for additional risk.
  5. Carriers primarily invest in fixed-income investments; a decline in the stock market has minimal impact on most carrier investment portfolios.

BOLI Growth In 2019
BOLI purchases totaled $4.3 billion in 2019, an increase of 147% over the 2018 total, according to IBIS Associates, an independent market research firm. The total represents the third-highest amount of BOLI purchases in the past dozen years.

It’s even more impressive when considering that most banks continued to have strong loan demand and less liquidity than in most previous years. At year-end 2019, BOLI cash surrender value (CSV) held on the balance sheets of U.S. banks totaled $178 billion, according to the December 2019 NFP-Michael White report.

Robust BOLI activity has been driven by attractive tax-equivalent yields, strong credit quality and leverage ($1 invested in BOLI typically returns $3 to $4 of tax-free death benefits). Banks can use BOLI as a way to retain key employees by providing life insurance benefits or informally funding nonqualified benefit plans; BOLI earnings can also be used to offset and recover health care and 401(k) or other retirement plan expenses.

According to the IBIS report, 77% of 2019 BOLI purchases were for general account, 22% for variable separate account and just 1% was for hybrid separate account. In general account policies, the general assets of the insurance company issuing the policies support the CSV. In variable separate and hybrid separate products, the CSVs are legally segregated from the general assets of the carrier, which provides enhanced credit protection in the event of carrier insolvency. The credit risk and price risk of the underlying assets remain with the policyholder in a variable policy, whereas the carrier retains those risks in a general account or hybrid policy.

Purchases of variable separate accounts dominated the market in 2006-07; since that time, general account BOLI has typically led the way. This is due to the simplicity of general account products relative to variable separate products as well as the increased product options, generally higher yields, and the high comfort level bankers have with the creditworthiness of mainstream BOLI carriers.

According to the IBIS data, 2019 general account BOLI purchases were at their highest level in the last 16 years. According to the NFP-Michael White report, 3,346 banks — representing 64.6% of all US banks — now hold BOLI assets. This is an increase from the 64.1% of banks that held BOLI at the end of 2018. Seventy-one percent of banks with over $100 million in assets hold BOLI; 77.3% of banks with over $300 million in assets do.

3 Ways a Democratic Presidency Could Impact Executive Compensation

Sen. Elizabeth Warren, D-Mass., recently wrote, “Almost ten years ago, Congress directed federal regulators to impose new rules to address the flawed executive compensation incentives at big financial firms. But regulators still haven’t finalized (let alone implemented) a number of those key rules, including one that would claw back bonuses from bankers if their bets went bad in the long run. As President, I will appoint regulators who will actually do their job and finish these rules.”

Warren is referring to the Dodd-Frank Wall Street Reform and Consumer Protection Act, which was introduced in 2010 as a response to the 2008 financial crisis. The act contained over 2,300 pages of provisions, including a number that impact executive compensation, to be implemented over several years. A few provisions — like management say-on-pay, say-on-golden-parachutes, CEO pay ratio — have been implemented, while others like incentive-based compensation arrangements (§ 956), clawbacks (§ 954) and pay-versus-performance (§ 953(a)) remain in limbo.

In any Democratic presidency, incentive-based compensation (§ 956) may be the easiest provision to finalize. The 2016 proposal creates a general restriction for banks with more than $1 billion in assets on incentive compensation arrangements that encourage inappropriate risks caused by a covered person receiving excessive compensation that could lead to a material financial loss. As proposed, it is very prescriptive for banks with assets of $50 billion or more, requiring mandatory deferrals, a minimum clawback periods, ability for downward adjustments and forfeiture.

The final rules for § 956 were re-proposed in 2016, but regulators’ interest in the topic has been muted during President Donald Trump’s administration. There are other ways that executive compensation programs could be impacted by a Democratic president, of which Warren is one contender for the nomination. While not exhaustive, we see three potential changes — beyond § 956 — that could impact  executive compensation programs.

1. Increased Regulatory Oversight
In almost all scenarios, a Democratic presidency will be accompanied by an increase in regulation. The 2016 sales practices scandal at Wells Fargo & Co. brought incentives into the spotlight. The Federal Reserve Board has stressed the importance of firms having appropriate governance of incentive plan design and administration, and have audited the process and structure in place at banks. One key thing that firms can and should be doing, even if the party in power does not change, is implement a documented and thorough incentive compensation risk review process as part of a robust internal control structure. Having a process in place will be key in the event of regulatory scrutiny of your compensation programs.

2. Mandatory Deferrals
Warren re-introduced and expanded the concept of mandatory deferrals through her Accountable Capitalism Act of 2018. This proposed legislation restricts the sales of company shares by the directors and officers of U.S. corporations within five years of receiving them or within three years of a company stock buyback. Deferred compensation gives the bank the ability to adjust or eliminate compensation over time in the event of material financial restatements or fraudulent activity, and is sure to be a topic that will come up with a Democratic presidency.

While the concept is different from deferred compensation, many firms have introduced holding periods in their long-term incentive programs for executives. This strengthens the retentive qualities of the executive incentive program and provides some accounting benefits for the organization, making it something to consider adding to stock-based incentive plans.

3. Focus On More Than The Shareholder
The environmental, social and governance (ESG) framework has been a very hot topic in investment communities, with heavy-hitting institutional investors introducing policies relating to ESG topics. For example, BlackRock is removing companies generating more than 25% of revenues from thermal coal production from its discretionary active investment portfolios, and State Street Corp. announced that it will vote against board members for “consistently underperforming” in the firm’s ESG performance scoring system. Warren believes that companies should focus on “the long-term interests of all of their stakeholders — including workers — rather than on the short-term financial interests of Wall Street investors.” It remains to be seen exactly what future compensation plans for banking executives will look like, though the myopic focus on total shareholder return may become a thing of the past.

Many potential incentive compensation changes that are likely to occur under a Democratic presidency already exist in the marketplace, including holding periods for long-term incentive plans; incentive compensation risk review, including the internal control structure; mandatory deferrals and clawbacks; and aligning incentive plans with the long-term strategy of the organization. Directors should evaluate their bank’s current plans and processes and identify ways to tweak the programs to ensure their practices are sound, no matter who takes office in 2021.

The High Cost of Good Talent and the Value of Retention

How would your bank fare if your top-performing lenders left tomorrow?

A bank succeeds because of its employees who grow the bank and keep it safe. The departure of these employees can impose massive costs to a bank in lost relationships and the effort to find new personnel. Has management at your bank adequately assessed the financial cost and risk of losing its key employees? What would be the financial impact to the bottom line and shareholder value if a key employee is not retained?

The direct cost of replacing a high-performing employee is up to 213% of the annual salary associated with the position, according to research by the Society for Human Resource Management. Total costs can rise to as much as 400% when considering indirect expenses. Direct costs include screening, interviewing, acquisition cost, onboarding and training, while indirect costs include lost productivity, short-staffing, coverage cost and reduced morale.

The following are hypothetical examples that help illustrate both the costs and risks associated with replacing a key employee at a bank:

Example 1: A lender in their early 40s who maintains a $40 million loan portfolio with a 4% margin joins a competitor bank. The estimated earnings on the lender’s portfolio were $1.6 million. If 30% of the portfolio moves to the competing bank, that would create an annual impact of $480,000. The bank stands to lose $1.4 million in three years. Assuming this lender generates $10 million in new loans annually, that adds another $400,000 in additional lost income. Losing this one lender results in lost annual revenue of almost $900,000.

Now imagine the bank has seven lenders with similar portfolios and margins. If the entire team left, the lost revenue potential could be over $6 million annually.

Example 2: A bank loses its compliance officer. In addition to the direct financial costs of replacing the officer, this could cause both short- and long-term regulatory and financial risks and challenges. If the officer had a salary of $90,000, the cost to replace them is between $191,700 and $360,000, using the 213% and 400% of base salary replacement cost assumptions. There could also be additional costs associated with potential outsourcing the compliance services until the bank can hire a new compliance officer.

Fortunately, in both of these examples, management preemptively responded by strategically designing compensation programs to retain the officers. Quantifying the lost revenue and costs to replace the employees demonstrated the substantial risks to the bank, and convinced executives of the  inadequacies of the compensation plan in place.

It is critical that banks design and implement competitive compensation plans that provide meaningful benefits. Some compensation committees believe a salary and an annual performance bonus are adequate to retain key employees. But based on our experience, banks with higher retention rates offer two to four types of compensation plans, in addition to salary and bonus. Examples include employee stock ownership plans, stock options, restrictive stock, phantom stock, profit sharing, salary continuation plans and deferred compensation plans. These plans provide for payments either at retirement or while employed, or a combination of pre- and post-retirement payments. Banks can strategically design and customize these plans in ways that incentivize strong performance but fit the demographics and needs of the key personnel. There is no one-size-fits-all plan.

Additionally, nonqualified executive benefit programs such as supplemental executive retirement plans (SERPs) and deferred compensation plans (DCPs) can help your key employees accumulate supplemental funds for retirement. Their flexibility allows them to be used alongside other forms of compensation to enhance your bank’s overall executive benefit program by offering additional incentives and incorporating special features intended to retain top performers who may not be focused on retirement. For example, a deferred compensation plan with payments timed to when the officer’s children are college age can be highly valued by an officer fitting that demographic.

The significant potential financial impact when your bank loses key employees quantifies and underlines the value and importance of retention, so it is paramount that executives meaningfully and competitively compensate these employees. Banks without a strong corporate culture and a competitive compensation plan in place are at a higher risk of losing key employees and may have an emerging potential retention problem.