A Guide to Getting CEO Transitions Right in 2020 and Beyond

Banks need to get CEO transitions right to provide continuity in leadership and successful execution of key priorities.

As the world evolves, so do the factors that banks must consider when turnover occurs in the CEO role. Here are some key items we’ve come across that bank boards should consider in the event of a CEO transition today.

Identifying a Successor

Banks should prepare for CEO transitions well in advance through ongoing succession planning. Capable successors can come from within or outside of the organization. Whether looking for a new CEO internally or externally, banks need to identify leaders that have the skills to lead the bank now and into the future.

Diversity in leadership:
Considering a diverse slate of candidates is crucial, so that the bank can benefit from different perspectives that come with diversity. This may be challenging in the banking industry, given the current composition of executive teams. The U.S. House Committee on Financial Services published a diversity and inclusion report in 2020 that found that executive teams at large U.S. banks are mostly white and male. CAP found that women only represent 30% of the executive team, on average, at 18 large U.S. banks.

Building a diverse talent pipeline takes time; however, it is critical to effective long-term succession planning. Citigroup recently announced that Jane Fraser, who currently serves as the head of Citi’s consumer bank, would serve as its next CEO, making her the first female CEO of a top 10 U.S. bank. As banks focus more on diversity and inclusion initiatives, we expect this to be a key tenet of succession plans.

Digital expertise:
The banking industry continues to evolve to focus more on digital channels and technology. The Covid-19 pandemic has placed greater emphasis on remote services, which furthered this evolution. As technology becomes more deeply integrated in the banking industry, banks will need to evaluate their strategies and determine how they fit into this new landscape. With increased focus on technology, banks must also keep up with leading cybersecurity practices to provide consumers with the best protection. Succession plans will need to prioritize the skills and foresight required to lead the organization through this digital transformation.

Environmental, Social and Governance (ESG) strategy:
Investors are increasingly focused on the ESG priorities and the potential impact on long-term value creation at banks. One area of focus is human capital management, and the ability to attract and retain the key talent that will help banks be leaders in their markets. CEO succession should consider candidates’ views on these evolving priorities.

Paying the Incoming and Outgoing CEOs

Incoming CEO:
The incoming CEO’s pay is driven by level of experience, whether the CEO was an internal or external hire, the former CEO’s compensation, market compensation and the bank’s compensation philosophy. In many cases, it is more expensive to hire a CEO externally. Companies often pay external hires at or above the market median, and may have to negotiate sign-on awards to recruit them. Companies generally pay internally promoted CEOs below market at first and move them to market median over two or three years based on their performance.

Outgoing CEO:
In some situations, the outgoing CEO may stay on as executive chair or senior advisor to help provide continuity during the transition. In this scenario, pay practices vary based on the expected length of time that the chair or senior advisor role will exist. It’s often lower than the amount the individual received as CEO, but likely includes salary and annual bonus opportunity and, in some cases, may include long-term incentives.

Retaining Key Executives

CEO transitions may have ripple effects throughout the bank’s executive team. Executives who were passed over for the top job may pose a retention risk. These executives may have deep institutional knowledge that will help the new CEO and are critical to the future success of the company. Boards may recognize these executives by expanding their roles or granting retention awards. These approaches can enhance engagement, mitigate retention risk and promote a smooth leadership transition.

As competition remains strong in the banking industry, it is more important than ever to have a seamless CEO transition. Unsuccessful CEO transitions are a distraction from a bank’s strategic objectives and harm performance. Boards will be better positioned if they have a strong succession plan to help them identify CEO candidates with the skills needed to grow and transform the bank, and if they effectively use compensation programs to attract and retain these candidates and the teams that support them.

Unlocking Meaningful Compensation to Keep Essential Talent

Banks are no strangers to using nonqualified deferred compensation plans to attract, retain and motivate their employees and strengthen their succession plans.

According to the American Bankers Association’s 2019 Compensation & Benefits Survey, nearly 65% of banks report utilizing deferred compensation plans. These plans can include supplemental executive retirement plans, or SERPs, which are typically designed for the seasoned bank executive talent. Unlike a 401(k) plan, a SERP has no contribution limit or rules that mandate that all employees must be able to participate. They are purposely designed for highly compensated executives and key employees for whom the 401(k) contribution limits act as a form of “reverse discrimination” toward retirement. These limits can cause a whole host of problems if not addressed by the introduction of a SERP.

Meaningful, thoughtful compensation will be essential for banks interested in motivating and retaining key executives and talent as they continue navigating through these unprecedented times. Guaranty Bancshares’s CFO Cappy Payne called the SERP a “cornerstone” of the Addison, Texas-based bank’s compensation approach.

“[W]e have a wide variety of executive compensation and benefit plans for our senior level management,” he says. “We purposely diversify their compensation such that it increases our ability to attract, retain and motivate the talent we need to differentiate in this incredibly tough economic environment.”

SERPs are often offered alongside several other types of long-term incentive compensation vehicles. Long-term plans can include stock options, stock appreciation rights, phantom stock, restricted stock, restricted units, performance shares of units and combinations of two or three plans. All of these programs are also a form of deferred compensation, like a SERP, but don’t offer as much customization as a SERP. Additionally, most institutions use bank owned life insurance as an indirect funding approach.

A bank may design the SERP so the executive receives a benefit at a later date — like retirement or after 15 years of service. The benefit of the SERP may be issued as a lump sum, a series of payments or combination thereof. It can also have performance criteria added as a motivational incentive. And because there are no contribution limits, this ability to customize and design around one executive team generates a significant ROI. Payne says Guaranty “strongly believes” in the customization of its long-term compensation plans.

“We find customization increases the appreciation of our efforts. In addition, when used with other plans like the annual incentive plan, and other stock-based long-term incentives, we believe we are able to sustain bank leadership that creates a successful banking atmosphere,” he says.

But SERPs aren’t perfect; just like any other executive compensation and benefit plan, it’s critical that bank executives and boards understand their disadvantages. One disadvantage is the funds that accumulate for a SERP are not protected from bankruptcy and creditor claims in the event of insolvency. SERP participants become general creditors of the bank. Still, the plans offer significant advantages and can be incredibly attractive to banks as employers.

  1. They are easy to implement.
  2. The don’t require IRS approval.
  3. They can be customized to the executive team and included as a retirement benefit.
  4. Banks can use BOLI to help recover their costs and offer a split-dollar life insurance benefit while employed.

All of these advantages combined make for a powerful compensation cocktail that, when used in conjunction with other plans and communicated appropriately, is dynamite.

Banks are under more pressure than ever before to succeed. The pandemic, low interest rates and political uncertainty all contribute to questions and uncertainty in the workplace — including among top executives. SERPs can be a powerful tool in the hands of visionary banks. The flexibility afforded in a SERP is second to none. Finally, it’s just smart business to make sure banks can differentiate themselves while being sustainable by attracting, retaining and motivating the best talent possible.

Key Compensation Issues in a Turbulent Market

As compensation committee chair, Susan knew 2020 was going to be an important year for the bank.

The compensation and governance committee had taken on the topic of environmental, social and governance (ESG) for the coming year. They had conducted an audit and knew where their gaps were; Susan knew it was going take time to address all the shortfalls. Fortunately, the bank was performing well, the stock was moving in the right direction and they had just approved the 2020 incentive plans. All in all, she was looking forward to the year as she put her finished notes on the February committee meeting.

Two months later, Susan had longed for the “good old days” of February. With the speed and forcefulness that Covid-19 impacted the country, states and areas the bank served, February seemed like a lifetime ago. The bank had implemented the credit loss standard at the end of March — due to the impact of the unemployment assumptions, the CECL provision effectively wiped out the 2020 profitability. This was on top of the non-branch employees working from home, and the bank doing whatever it could to serve its customers through the Paycheck Protection Program.

Does this sound familiar to your bank? The whirlwind of 2020 has brought a focus on a number of issues, not the least of which is executive compensation. Specifically, how are your bank’s plans fairing in light of such monumental volatility? We will briefly review annual and long-term performance plans as well as a construct for how to evaluate these programs.

The degree to which a bank’s annual and long-term incentive (LTI) plans have been impacted by Covid-19 hinge primarily on two factors. First, how much are the plans based upon GAAP bottom-line profitability? Second, and primarily for LTI plans, how much are the performance-based goals based upon absolute versus relative performance?

In reviewing annual incentive plans, approximately 90% of banks use bottom-line earnings in their annual scorecards. For approximately 50% of firms, the bottom-line metrics represent a majority of their goals for their annual incentive plans. These banks’ 2020 scorecards are at risk; they are evaluating how to address their annual plan for 2020. Do they change their goals? Do they utilize a discretionary overlay? And what are the disclosure implications if they are public?

There is a similar story playing out for long-term incentive plans — with a twist. The question for LTI plans is how much are performance-based goals based upon absolute versus peer relative profitability metrics? Two banks can have the same size with the same performance, and one bank’s LTI plan can be fine and the other may have three years of LTI grants at risk of not vesting, due to their performance goals all being based on an absolute basis. In the banking industry, slightly more than 60% of firms use absolute goals in their LTI plans and therefore have a very real issue on their hands, given the overall impact of Covid-19.

Firms that are impacted by absolute goals for their LTI plans have to navigate a myriad level of accounting and SEC disclosure issues. At the same time, they have to address disclosure to ensure that institutional investors both understand and hopefully support any contemplated changes. Everyone needs to be “eyes wide open” with respect to any potential changes being contemplated.

As firms evaluate any potential changes to their executive performance plans, they need to focus on principles, process and patience. How do any potential changes reconcile to changes for the entire staff on compensation? How are the executives setting the tone with their compensation changes that will be disclosed, at least for public companies? How are they utilizing a “two touch” process with the compensation committee to ensure time for proper review and discourse? Are there any ESG concerns or implications, given its growing importance?

Firms will need patience to see the “big picture” with respect to any changes that are done for 2020 and what that may mean for 2021 compensation.

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.

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.

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.

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.

Using Succession Planning to Unlock Compensation Challenges

compensation-9-16-19.pngSuccession planning could be the key solution boards can use to address their biggest compensation challenges.

Succession planning is one of the most critical tasks for a bank’s board of directors, right up there with attracting talented executives and compensating them. But many boards miss the opportunity of allowing succession planning to drive talent retention and compensation. Banks can address two major challenges with one well-crafted plan.

Ideally, succession planning is an ongoing discussion between executive management and board members. Proper planning encourages banks to assess their current talent base for various positions and identify opportunities or shortfalls.

It’s not a static one-and-done project either. Directors should be aware of the problems that succession planning attempts to solve: preparing future leaders, filling any talent voids, attracting and retaining key talent, strategically disbursing training funds and ultimately, improving shareholder value.

About a third of respondents in the Bank Director’s 2019 Compensation Survey reported that “succession planning for the CEO and/or executives” was one of the biggest challenges facing their banks. More popular challenges included “tying compensation to performance,” “managing compensation and benefit costs,” and “recruiting commercial lenders.”

But in our experience, these priorities are out of order. Developing a strategic succession planning process can actually drive solutions to the other three compensation challenges.

There are several approaches boards can use to formulate a successful succession plan. But they should start by assessing the critical roles in the bank, the projected departure dates of those individuals, and information and guidance about the skills needed for each position.

Boards should be mindful that the current leaders’ skill sets may be less relevant or evolve in the future. Susan Rogers, organizational change expert and president of People Pinnacle, said succession planning should consider what skills the role may require in the future, based on a company’s strategic direction and trends in the industry and market.

The skills and experiences that got you where you are today likely won’t get you where you need to go in the future. We need to prepare future leaders for what’s ahead rather than what’s behind,” she said.

Once a board has identified potential successors, it can now design compensation plans that align their roles and training plans with incentives to remain with the organization. Nonqualified benefit plans, such as deferred compensation programs, can be effective tools for attracting and retaining key bank performers.

According to the American Bankers Association 2018 Compensation and Benefits Survey, 64% of respondents offered a nonqualified deferred compensation plan for top management. Their design flexibility means they can focus on both longer-term deferrals to provide retirement income or shorter-term deferrals for interim financial needs.

Plans with provisions that link benefits to the long-term success of the bank can help increase performance and shareholder value. Bank contributions can be at the board’s discretion or follow defined performance goals, and can either be a specific dollar amount or a percentage of an executive’s salary. Succession and training goals can also be incorporated into the plan’s award parameters.

Such plans can be very attractive to key employees, particularly the young and high performing. For example, assume that the bank contributes 8% of a $125,000 salary for a 37-year-old employee annually until age 65. At age 65, the participant could have an account balance equal to $1,470,000 (assuming a crediting rate equal to the bank’s return on assets (8%), with an annual payment of $130,000 per year for 15 years).

This same participant could also use a portion of the benefit to pay for college expenses for two children, paid for with in-service distributions from the nonqualified plan. Assume there are two children, ages three and seven, and the employee wants $25,000 a year to be distributed for each child for four years. These annual $25,000 distributions would be paid out when the employee was between ages 49 and 56. The remaining portion would be available for retirement and provide an annual benefit of $83,000 for 15 years, beginning at age 65.

Boards could use a plan like this in lieu of stock plans that have similar time horizons. This type of arrangement can be more enticing to younger leaders looking at shorter, more mid-term financial needs than a long-term incentive plan.

And many banks already have defined benefit-type supplemental retirement plans to recruit, retain, and reward key executives. These plans are very popular with executives who are 45 and older, because they provide specific monthly distributions at retirement age.

It is important that boards craft meaningful compensation plans that reward older and younger executives, especially when they are vital to the bank’s overall succession planning efforts and future success.