The Bank-Owned Life (BOLI) Insurance Market is Changing: Here’s How


BOLI-10-24-16.pngBank-owned life insurance (BOLI) has undergone a number of changes since it was first introduced in the early 1980s. The number of carriers offering BOLI was a handful in the 1980s, increased to 20 or so in the 1990s and 2000s, and since has decreased to 8 to 10 active carriers as a number of insurers have exited the market or are currently sitting on the sidelines due to the low rate environment.

As competition for attractive investments has increased due to low yields, many carriers have moderately increased duration. Interestingly, several carriers have reduced purchases of below investment grade securities as the yield spread available for them has decreased to the point where the investment return does not justify the increased risk.

On the sales front, in the first six months of this year, there was a 10 percent increase in the number of banks purchasing BOLI compared to a similar period in 2015. Despite the increase in BOLI purchases, there was a decline in the number of banks purchasing the hybrid separate account product as most banks opted for general account.

As the financial crisis passed and banks become more comfortable with the long-term credit quality of carriers, data shows that fewer banks selected hybrid account policies than in the past, which have a mix of variable and general account properties.

Some aspects of the market have, however, remained consistent over time: there have been steady annual increases in both the amount of BOLI assets held by banks and in the percentage of banks holding BOLI assets.

The focus of this article is to look more closely at the state of the market as of June 30, 2016, including changes that have occurred between June 30, 2015 and June 30, 2016 to help track market trends.

New Purchases of BOLI
IBIS Associates, an independent market research firm, publishes a report analyzing BOLI sales based on information obtained from insurers that market BOLI products. According to the IBIS Associates BOLI Report for the period January 1, 2016 to June 30, 2016:

  • During the first six months of 2016, 553 banks purchased BOLI. The 553 banks included institutions purchasing it for the first time as well as additional purchases by banks that already own BOLI. This was a 10 percent increase over the 502 banks that purchased BOLI during the same time period in 2015.
  • New BOLI premium from banks amounted to $1.78 billion as of June 30, 2016. During a similar six month period in 2015, the total was $2.10 billion or $320 million higher. The difference is attributable to one large variable separate account purchase in the first half of 2015 ($400 million).
  • General account purchases dominated the market during the first half of 2016. Of the $1.78 billion in new BOLI premium, $1.65 billion (92.8 percent) was invested in general accounts. Hybrid product purchases amounted to $75.8 million (4.3 percent) while variable separate account purchases (where the investment risk is held by the policyholders and investment gains flow directly to them rather than the insurance carrier) were only $51.4 million (2.9 percent).
  • During the period July 1, 2012 to June 30, 2014, 226 banks purchased a hybrid product while for the period July 1, 2014 to June 30, 2016, the number of banks with a hybrid product increased by just 42 banks.

The reasons cited by bankers for purchasing BOLI are that it provides competitive returns with superior credit quality. Current BOLI net yields are in the range of 3.00 percent to 3.75 percent which generates tax equivalent net yields of 4.85 percent to 6.05 percent for a bank in the 38 percent tax bracket. Income generated by BOLI can help offset the increasing costs of a bank’s benefit programs.

Status of Market
Based on a review of FDIC data, the September 2016 Equias Alliance/Michael White Bank-Owned Life Insurance Holdings Report, shows that as of June 30, 2016:

  • BOLI assets reached $159.0 billion reflecting a 3.8 percent increase from $153.1 billion as of June 30, 2015. Banks with between $1 billion and $10 billion in assets had the largest percentage increase in BOLI assets during this timeframe with 8.3 percent growth.
  • Of the 6,058 banks in the survey, 3,713 (61.3 percent) now report holding BOLI assets. This percentage has grown year after year. There is, however, a wide discrepancy in the percentage of banks holding BOLI by size category. For example, only 39.9 percent of banks with under $100 million in assets hold BOLI while 81.9 percent of banks with $1 billion to $10 billion in assets hold BOLI.

In summary, the positive trends in new purchases, growth in assets and usage of BOLI by banks continued in the first half of 2016.

Bank Compensation: Should You Award a Transaction Bonus?


incentive-pay-10-12-16.pngWhen a bank suddenly finds itself in the midst of a sale, merger, or other strategic transaction, retaining key talent and senior leadership becomes critical. Without proper incentives, executives can be left to wonder whether impending changes align with their own economic interests and long-term career goals. Banks need their key players to remain sharply focused on maintaining and growing the existing business, while simultaneously handling the increased responsibilities of working through a potential transaction.

While banks typically have change-in-control (CIC) severance and equity arrangements in place for senior executives, retention bonuses—and in special cases “transaction bonuses”—may be implemented as a deal is contemplated.

When establishing awards, banks should be mindful of the total retention opportunities for the group, including potential severance and equity vesting upon termination or CIC. Awards approved should be reasonable on a standalone basis, in the aggregate when considering all CIC-related costs, and relative to deal size. When current severance, equity, and other CIC related benefits are sufficient, there may be no need for additional transaction compensation.

Used less frequently than other retention vehicles, transaction bonuses can be used to motivate executives throughout the business sale process. They are usually paid in cash upon or shortly following a deal closing, although some awards are in shares. Terms vary based on the role a key executive will play.

  • For the deal makers, the select group of executives that are responsible for driving deal terms and value, a transaction bonus can be fairly significant and often is determined as a fixed dollar value, a percentage of the equity transaction value, or fixed number of shares. Some awards are hinged on the attainment of strategic performance goals or metrics such as negotiating a threshold transaction price.
  • For key administrators, those senior level executives critical to managing the due diligence and sale process, transaction bonuses are typically used to compensate for the additional work required. These awards tend to be smaller, taking the form of fixed cash bonuses determined based on a percentage of an executive’s base salary with amounts increasing as desired retention periods lengthen.

To understand how banks are using this incentive, we examined public disclosures over the last five years for the acquisitions of 88 public banks.

  • Of those, just a small number (17 percent) disclosed paying transaction bonuses to their named executive officers (NEOs). In contrast, about a third (31 percent) of the banks reported paying retention bonuses with service periods extending beyond closing. When transaction bonuses were paid, over half of the banks (53 percent) disclosed that there would be no further cash severance benefit provided.
  • Transaction award amounts were extremely varied based on the specific circumstances and size of each transaction and each individual’s contribution. When paid, aggregate awards to all NEOs ranged between $55,000 to over $10 million (on an absolute basis). Aggregate awards as a percentage of transaction values ranged from 0.15 percent at the 25th percentile to 1.36 percent at the 75th percentile with a midpoint of 0.78 percent. Percentages in relation to deal size tended to decrease as the deal size increased.

When considered on the eve of deal, legal and compensation advisors should be actively involved in the design and approval process; banks will be under a heightened level of scrutiny to demonstrate the prudence of their decisions. Also, banks should be mindful of institutional shareholder and shareholder advisory services concerns and a number of tax, legal, and accounting potholes. For example, Internal Revenue Code Section 280G applies when the present value of all payments related to a CIC equals or exceeds three times the individual’s base amount (i.e., an individual’s five-year average W-2 earnings). When 280G is triggered, punitive excise tax penalties apply and intended CIC benefits can be significantly eroded.

In practice, transaction bonuses for senior executives are paid much less frequently than compared to standard retention awards and tend to cover a smaller, more senior group of executives. However, for deal makers, these awards can be a significant incentive and worth considering since they are meant to reward value realization. For key administrators, transaction awards are sized to effectively compensate for the additional time and effort needed to bring a transaction to close. Transaction awards may provide the right retention hold and motivation when severance and equity benefits are insufficient to retain senior level executives through or shortly following close and may help your institution get a deal over the finish line.

Do Executives Want Equity?


Compensation_WhitePaperCover_tb.pngAre equity awards still effective tools that tie the interests of executive management to those of a bank’s shareholders?

Equity is an important piece of the compensation pie for many banks, particularly those that are publicly traded, according to the 262 directors, CEOs, human resources officers and other senior executives responding to Bank Director’s 2016 Compensation Survey, sponsored by Compensation Advisors, a member of Meyer-Chatfield Group. Forty percent say that their institution allocates equity grants to executives annually. Boards and shareholders like equity because, in theory, it ties the interests of the executive to the long-term success of the company. For executives, it’s a reward that, hopefully, grows along with the value of the bank.

The survey also finds many banks preparing for the next generation of bank CEOs, but there remains a lot of work to do in this area. Almost one-third anticipate the retirement of the bank’s CEO within the next five years, and responding CEOs indicate differing desires, based on age, when it comes to their compensation packages. Can banks weather the transition from a baby boomer CEO to someone who is younger—maybe even a millennial? Twelve percent of bank CEOs are now between the ages of 32 and 46, so the dawn of the millennial CEO isn’t that far off. But more than one-third of respondents indicate that attracting talented millennial employees is a challenge for their bank, and they cite two factors: Millennials aren’t interested in working for a bank, and their bank’s culture is too traditional.

With just a few exceptions, the 2016 Compensation Survey finds that few banks have millennials serving on their board. But bank boards are also aging, and 90 percent of respondents indicate their board will see at least one director retire within the next five years. Almost half expect to lose more than three directors to retirement. As they seek new directors to fill these slots, 63 percent indicate that their board seeks to foster more diversity among its members.

For more on these considerations, read the white paper.

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

Do You Understand the New Incentive Compensation Proposed Rules?


compensation-9-7-16.pngFederal banking and securities regulators published a notice of proposed rulemaking revisiting incentive compensation standards that were originally proposed in 2011. The 2016 proposal provides a more prescriptive approach for larger financial institutions than the previous proposal, and it applies to institutions with $1 billion or more in assets. As with prior guidance applicable to incentive compensation, the overarching principles should be considered by financial institutions of all sizes when designing their compensation programs consistent with the Interagency Guidance on Sound Incentive Compensation Policies issued in June 2010, which applies to all banking organizations regardless of asset size.

The 2016 proposal is similar to the previous proposal in that it prohibits excessive compensation to “covered” persons. However, unlike the 2011 proposal, the 2016 proposal more clearly defines requirements of institutions by creating three levels based on average total consolidated assets, with the lowest scrutiny applying to Level 3 institutions, those that have assets of $1 billion or more but less than $50 billion.

The proposal has implications for any incentive compensation provided to officers, directors, employees and principal shareholders associated with an institution with assets of $1 billion or more. As required under the Dodd-Frank Act, the proposal tries to discourage excessive compensation and compensation that could lead to a material financial loss.

Excessive Compensation
There are two distinct elements for consideration. First is excessive compensation, which involves amounts paid that are unreasonable or disproportionate to the amount, nature, quality and scope of services performed by the covered person. Types of information the regulatory agencies will consider in making this assessment include, among others:

  • The combined value of all compensation, fees or benefits provided to the covered person;
  • The compensation history of the covered person and similarly-situated individuals;
  • The financial condition of the covered institution;
  • Peer group practices; and
  • Any connection between the individual and any fraudulent act or omission, breach of fiduciary duty or insider abuse.

Material Financial Loss
In determining whether incentive-based compensation could lead to a material financial loss, regulators have previously stated that they will balance potential risks with the financial reward and assess whether the institution has effective controls and strong corporate governance. The 2016 proposal specifically provides that an incentive-based compensation arrangement would not be considered to appropriately balance risk and reward unless it:

  • Includes financial and non-financial measures of performance;
  • Is designed to allow non-financial measures of performance to override financial measures of performance, when appropriate; and
  • Is subject to adjustment to reflect actual losses, inappropriate risks taken, compliance deficiencies, or other measures or aspects of financial and non-financial performance.

Additional Elements of the 2016 Proposal
The 2016 proposal re-emphasizes that internal controls and corporate governance are essential in monitoring risks related to incentive compensation. The 2016 proposal also contains a requirement that certain records must be disclosed upon request of the covered institution’s federal banking regulator.

The 2016 proposal will be effective 540 days after publication of the final rule and does not apply to any incentive plans with a performance period that begins before the effective date. Similarly, an institution that increases assets to become a Level 1, 2 or 3 institution must comply with rules applicable to that level within 540 days of the triggering size (determined based on asset size over the four most recent consecutive quarters).

Considerations
We recommend that boards begin taking steps in order to comply with the 2016 proposal and the Guidance.

  1. Consider whether any of the institution’s incentive-based compensation is excessive or encourages risks that could result in a material financial loss by: applying the excessive compensation factors as set forth above; making compensation sensitive to risk through deferrals, longer performance periods and claw-backs; and considering a peer group study.
  2. Document relevant considerations as evidence of compliance with the Guidance at the committee and board levels.
  3. Implement controls and governance to oversee and monitor compensation and determine whether to risk–adjust awards.
  4. Review compensation policies annually.

Addressing Problems with SERPs in Benefit Plan Designs


SERPs-8-5-16.pngSupplemental Executive Retirement Plans (SERPs) are a valuable compensation tool that banks can use to attract and retain executive talent. SERPs are nonqualified deferred compensation arrangements that are non-elective, meaning the company is responsible for contributions to the plan. Unfortunately, improper design of these plans can result in significant expenses for banks without providing the intended retention value. As a result, SERPs have gained a lot of negative press (particularly during the economic downturn), but if used properly, they can be a powerful tool in compensation. Here’s what you need to know about executive retirement benefits and how banks can avoid the common issues that arise with SERPs.

SERPs have some lingering reputational issues, although this isn’t entirely fair. Many banks do their due diligence and pay close attention to the expenses they will incur as a result of their benefit plans, but this hasn’t always been the case. When SERPs rose in popularity, many banks entered into inappropriately designed plans without understanding their implications. A poorly designed SERP can accelerate vesting schedules in the event of early retirement or cause banks to pay benefits in excess of 100 percent of final salary. Problems also arise due to IRC Section 280G (which deals with golden parachutes) in the event of a change of control. Additionally, many of these SERPs were designed solely with the placement of Bank Owned Life Insurance (BOLI) in mind, ignoring the strategic purpose and future impact. Fast forwarding to 2016, we see a number of problems related to SERP plans. The primary concerns are the following:

  • Banks absorbing mortality risks for lifetime benefit plans.
  • Defined benefit structures whereby a SERP benefit is contingent upon a final pay calculation.
  • Not considering 280G excise tax concerns in the case of M&A activity.
  • Unreasonable benefit structures that are either too lucrative or conservative.
  • Equity-based SERP designs.

Many boards have been soured by a bad experience and vowed to never implement another SERP plan at their bank. From a strategic perspective, this is a mistake that will hinder the bank’s ability to retain and recruit the talent necessary to stay competitive.

The real problem isn’t SERPS—its poor design. A SERP isn’t the answer to all the retention or recruitment issues, but it is a tool that should be used to complement the other components of compensation. SERPS themselves are not the problem; poorly designed SERPs are. Let’s address a few key design considerations:

  • Know what your expense is going to be. The benefit should be fixed day one, plain and simple.
  • Understand the potential 280G impact, regardless of the probability of a change in control.
  • Know that financing tools exist to reduce plan expense and provide a lifetime benefit with a fixed cost through proven methodologies. Explore all financing options—BOLI is not the only tool available for bankers.
  • Understand the strategic purpose behind the benefit plan structure, and conduct peer compensation studies to ensure that the benefit and compensation are reasonable and competitive.
  • Make sure the bank is protected in the event of premature death, but don’t allow life insurance to drive the design of your plan.

If your plan does not incorporate some of these features, it’s time to take a hard look at your plan design. Although IRC 409A (which regulates the tax treatment for nonqualified deferred compensation plans) imposes limitations on plan design changes, there are a number of strategies to help reduce the general plan expense, mortality risk concerns, 280G exposure and other issues without violating IRC 409A. There are hedging vehicles in the market to generate efficiencies at the benefit expense level. Consult with a compensation professional to help you navigate these waters.

Many banks continue to use SERPs effectively. A bad experience should not deter you from exploring the plan’s positive benefits. That said, a SERP can be complex and should be designed objectively by compensation professionals. If you explore all financing tools to make sure the bank is getting the most efficient design, your bank will be in an excellent position to accomplish your goals.

Three Reasons Why You Should Care About the New Proposed Incentive Compensation Rules


compensation-7-4-16.pngOne of the dangers of the snail-paced rulemaking under certain sections of the Dodd-Frank Act (DFA) is that we all get lulled to sleep and simply yawn when another set of proposed rules surfaces—especially when five years elapse between proposals. But here we are. Another round of proposed rules under DFA Section 956 was jointly released by six regulatory agencies in April and is intended to establish incentive compensation rules for financial institutions with assets greater than $1 billion.

Here are three reasons why you should care.

Reason #1: These will be rules—not guidance.
The underlying intent of the proposed rules should be familiar to banks and thrifts, as the foundation for the rulemaking is taken directly from the interagency Guidance on Sound Incentive Compensation Policies (SICP Guidance) which has applied to all banks and thrifts since June 2010. However, not all institutions have made a serious effort to comply with the spirit of the SICP Guidance and bank regulators have been somewhat lax in this area for community and regional institutions unless there have been problems in other areas of the bank. But under the pending rules, covered institutions will be required to create and maintain records for a minimum period of seven years, demonstrating compliance with the rule. Presumably, that means noncompliance in any given year could be challenged by regulators during an examination conducted up to seven years later, heightening the importance of ensuring compliance from the very first year the rules are in effect (as early as 2019). We encourage covered institutions to use this interim time in advance of the final rules to reevaluate policies, procedures and documentation related to incentive compensation risk management to determine if they are prepared for compliance.

Reason #2: There are certain plan features you must include.
A more prescriptive tone is being set by this round of the proposed rules, with three “musts” outlined for incentive arrangements at all covered institutions:

  • Must include both financial and non-financial measures;
  • Must allow non-financial measures to override financial measures, if appropriate; and
  • Must provide for downward adjustments to reflect actual losses, certain risk-taking, compliance deficiencies, and other measures or aspects of performance.

The concept of non-financial performance measures in incentive arrangements is not new for banks. But a regulator’s definition of “non-financial” almost certainly is focused on safety and soundness, and not necessarily on business or leadership strategy. Start thinking about how your incentive arrangements will address the “musts,” particularly related to the ways in which risk-oriented non-financial performance measures might be incorporated in a way that doesn’t diminish the incentive plan’s effectiveness.

Reason #3: You may need to punch above your weight class.
Sure, the most rigorous requirements under the proposed rules appear to be focused on institutions with assets over $50 billion. But don’t take too much comfort in being under $50 billion in assets, or under $1 billion, for that matter. The proposed rules explicitly provide for the relevant agency to treat a covered institution with $10 billion in assets as though it’s the one of the big guys if it deems the institution warrants such treatment. And since there are explicit provisions for ignoring the size of an organization under the rules, trickle-down regulatory expectations will inevitably reach institutions not technically covered under the rules, even if only through deeper review of compliance with the SICP Guidance. Our advice: err toward complying with the requirements of the next level up.

Given this is round two of the proposed rules, the final rules will likely be very similar to the April proposal. So, if we caught you yawning, we encourage you to wake up, grab a cup of coffee, and take some productive steps. Now is the time for action, so you can rest assured your institution will be ready.

The Four Habits of Successful Bank Compensation Committees


compensation-committee-6-17-16.pngCompensation committees are responsible for setting the foundation of a bank’s compensation program, subsequently impacting the bank’s underlying culture. The banking industry is more competitive than ever, so attracting and retaining top talent should be the number one priority. With a compensation committee that is educated on industry trends and modern-day compensation best practices, your bank will be on its way to developing programs that attract and retain top talent. Here are the top four best practices a bank’s compensation committee should consider.

1. Committee Members Should Take Steps to Stay Educated
Your committee members are responsible for staying aware of compensation trends. They need to always be in-the-know of complications, IRS penalties, and other factors with unintended consequences or expenses that can impact both the bank and the executives. Committee members should regularly review market trends in executive compensation; staying aware of banking trends as well as trends in other industries will better position the bank for success in recruiting, rewarding, and retaining talent. Your board should also be educated by the committee regarding your compensation philosophy and how the committee functions.

A few areas the compensation committee has direction over include equity grants, incentive structure, benefits, qualified plans, board compensation and other aspects of compensation. The directors should have a full understanding of structuring compensation plans, and if not, the committee should consult an adviser.

2. Establish the Duties and Responsibilities of Each Committee Member
In addition to staying educated, members of the compensation committee must have a framework for their efforts. This involves establishing the duties and responsibilities of each member, but before you begin, you’ll need to develop a compensation philosophy if you don’t already have one. Without an established compensation philosophy, your compensation committee will lack direction, clarity, and consistency regarding compensation practices. In addition to putting your philosophy in print, you should ensure that everyone on your committee understands it and is able to relay its message. The philosophy should be comprehensive as well as consistent with the culture of your bank, the interests of your shareholders and market trends.

3. Review the Committee’s Performance Quarterly
Quarterly, you should hold a meeting to assess the success of your committee. Check on what’s working and what isn’t with regards to committee function, meeting processes and other aspects. It’s important to look at whether you’re hitting benchmarks—and whether you’re attracting and retaining the talent you need to hit those benchmarks. There’s always room for improvement, so discuss what the committee may need to change in order for your bank to be more successful with recruiting and retention.

4. Engage Expert Consultants When Necessary
There’s a delicate balance that must be struck with compensation; it needs to be competitive enough to retain executives but as efficient as possible to drive shareholder value. With the increasing competition for talent and the rising costs of benefits like health care plans, many banks have been pre-funding benefits through plans such as bank-owned life insurance (BOLI). Choosing the best insurance carriers and structuring pre-funding plans is something that requires outside help from qualified consultants.

Professionals can help you determine competitive compensation packages and discern what investments will bring you the greatest return for the lowest risk.

If you don’t feel your compensation committee is hitting the mark, it’s time for something to change. Rewarding talent and funding those rewards is a complicated topic, so outside help from a compensation consultant who specializes in banking may be helpful to bring direction to your committee. If your committee follows these four best practices, you’ll be on a path to success applying your finest approach to compensation and benefits plans.

Hot “Banking” Jobs: As Banking Changes, So Are the Job Titles


banking-jobs-5-16-16.pngBanks today must adapt to a world where “digital”, “cyber risk” and “fintech” are the new business lexicon. As the bulk of the workforce shifts from baby boomer to millennial, there is an increased need to attract talent from outside traditional financial services. Below we highlight some changing and emerging roles and a few strategies banks can use to attract top talent.

Emerging Skills and Roles

Chief Technology Officer/Chief Digital Officer
Banks today are pressured to enhance mobile capabilities and compete with fintech companies such as Lending Club, Square and Circle. These new competitors have disrupted traditional financial services offerings, which is forcing banks to adapt their product offering and service platforms to remain competitive. This new competition and technology focus have also led banks to reach outside their typical talent pool to attract candidates with new skills.

Chief Risk Officer/Chief Compliance Officer
Since the financial crisis, regulators have significantly increased the requirements for banks to manage and mitigate risk practices. Add to that the increased threats of cyber risk and it is clear that risk and compliance officers are critical members of the senior leadership team.

Chief People Officer/Chief Culture Officer
As a service related industry, people are a critical asset. And as more millennials enter the workforce, traditional banking environments may need to change. Talent development, succession planning and even culture will be differentiators and expand the traditional role of human resources.

Chief Strategy Officer/Chief Innovation Officer
Part of the transition in the banking industry involves shifts in customer profile, competitors and new products. As banks emerge from the financial crisis and focus on growth and profitability, many are turning to innovators from outside the banking industry to help find creative M&A opportunities, new products and a new customer base.

Do’s and Don’ts

Attracting and retaining non-traditional banking talent can create both challenges and opportunities.

Do:

  • Think strategically: Assess the talent, skills and capabilities you need to execute your strategic plan (new regions, new products, new capabilities). What skill “gaps” need to be filled? Do you need to go outside or can you offer nontraditional career paths and transition current leadership into different roles? How should the leadership structure and team evolve? Create a leadership strategy that supports your business strategy.
  • Think outside the industry: Many of the roles discussed above are outside the norm for the traditional banking industry. Technology roles may be filled from start-ups or Silicon Valley firms and culture or innovation roles may be filled by ex-consultants or top talent from other industries. If you do recruit from outside of banking, you may need to access different sources of talent (e.g. recruiters) and different benchmark data than you typically use.
  • Be creative: If you fear you can’t “afford” talent from other industries, think beyond traditional compensation solutions. Compensation is only a part of a total rewards package and there are other important factors such as development and growth opportunities, as well as company culture and lifestyle. Be open to new work environments and career opportunities that will appeal to new (and current) staff.
  • Reward and retain: In the race to attract the “best” it can be tempting to offer large up-front compensation packages and buyouts of existing unvested awards to acknowledge that the executive is taking a risk to change jobs. While there are reasons to provide these usual pay components, if not designed right, they can be short-lived. A well-designed new hire package and ongoing compensation program should allow the bank to attract top talent, reward performance and create powerful retention.

Don’t:

  • Rely on compensation surveys: Many banks rely on established compensation surveys and/or peer group data to benchmark roles. However, such data for “hot jobs” is rare or far from perfect. Sample sizes may be small and data is often over a year old. Use multiple data perspectives/views and “triangulate” the information to determine fair and appropriate pay.
  • Over-focus on internal pay relationship: Respect and align with internal relationships but be flexible. In order to attract an executive in one of these “hot” areas, a bank may need to pay outside of the current compensation structure, but there should be a clear path to pay equity among the executive team over time.
  • Rush the process: It is important to undertake a thoughtful process when hiring a new executive, particularly those from other industries or non-traditional areas. The compensation committee should receive background information on the candidate(s) as well as detailed information on the compensation package, contractual arrangements and performance expectations.

What Are the Best Ways to Fund Your Retirement Plans for Executives and Directors?


retirement-plan-4-20-16.pngNonqualified deferred compensation (NQDC) plans continue to be important tools to help banks attract, reward and retain top talent in key leadership positions. In order to retain their critical tax deferral benefits, such plans must remain unfunded. For tax purposes, a plan is “funded” when assets have been unconditionally and irrevocably transferred for the sole benefit of plan participants. Formal funding of qualified plans, such as a 401(k), does not subject the participants to immediate taxation—participants can defer taxes until they actually receive such income. However, qualified plans have limitations on the level of benefits that can be provided and these limits can lead to substantial shortfalls in expected retirement income for executives and other highly compensated persons. NQDC plans came about specifically to help offset those shortfalls.

The restrictions on funding NQDC plans leads plan sponsors to search for solutions to finance or economically offset the costs of providing enhanced benefits to NQDC plan participants. When you hear someone refer to “funding a NQDC plan,” this is what they mean. Economic, or informal, funding means that the bank acquires and owns the particular asset of that funding method and that at all times such assets are subject to the claims of the bank’s creditors. Our objective for this article is to review and compare the financial statement impact of various methods for economically funding such plans. In our examples we use a Supplemental Executive Retirement Plan (SERP) and the following funding methods: 1) unfunded; 2) bank-owned annuity contract; 3) bank-owned life insurance (BOLI); 4) a 30-year, A-rated corporate bond; and 5) a 30-year, bank-qualified municipal bond. The same investment allocation and same cost of money were used in scenarios two through five.

  1. Unfunded
    A benefit plan is implemented and no specific assets are earmarked to generate income to offset the expenses. The bank accrues an accounting reserve for the benefit liability as required under GAAP and makes payments out of general cash flows. This method is simple and has often been used when the bank does not have additional BOLI capacity.
  2. Bank-Owned Annuity Contract
    The bank purchases a fixed annuity contract (variable annuities are not a permissible purchase for banks) on the lives of the plan participants. While the primary advantage of purchasing an annuity is that the cash inflows from annuity payments can be set to match the cash outflows for benefit payments, because corporate-owned annuities do not enjoy the tax deferral benefits of individually owned annuities, there is a mismatch of income taxation (annuity) with income tax deductions (benefit payments). Fixed annuity contracts with a guaranteed lifetime withdrawal benefit provide a specified annual payment amount commencing when the executive reaches a certain age (usually tied to retirement). Payments are made for the life of the annuitant. Fixed annuity contracts generally do not respond to movements in interest rates.
  3. Bank-Owned Life Insurance (BOLI)
    The bank purchases institutionally priced life insurance policies on eligible insureds to generate tax-effective, non-interest income to offset and recover the cost of the benefit plan. When properly structured and held to maturity, earnings on BOLI policies remain tax-free, eliminating the tax mismatch issue. The tax-free nature of BOLI earnings often allows the bank to exceed the yields on taxable investments on a tax-equivalent basis. Top BOLI carriers structure their products so that they do respond to market rate movements, albeit on a lagging basis.
  4. 30-Year, A-Rated Corporate Bond
    A 30-year, A-rated corporate bond is a simple and transparent investment vehicle. Because investment earnings are taxable as earned, and benefit payments are not deductible until paid, the tax mismatch is the primary disadvantage. Corporate bonds do respond to market rate movements, leading to potential volatility in market values.
  5. 30-Year, Bank-Qualified Municipal Bond
    A 30-year, bank-qualified municipal bond is similar to a 30-year corporate bond except the earnings are tax free.

In summary, key to the funding analysis is evaluating the best investment for the bank that will mitigate the impact of the plan expenses and liabilities on the bank’s financial statements with bank-eligible investments. The following table summarizes the projected net financial statement impact of the five methods discussed above in both today’s interest rate environment as well as the projected impact in a rising rate environment. As you can see, BOLI and a 30-year bank-qualified municipal bond offer some of the better ways of funding the plan over time.

Funding Your NonQualifed Deferred Compensation Plan

  Projected Life of Plan Net Income(Expense)*
Method of Funding Today’s Rate Environment Rising Rate Environment
Unfunded $(772,439) $(772,439)
Bank-Owned Annuity Contract $(164,229) $(439,597)
Bank-Owned Life Insurance (BOLI) $190,369 $1,598,371
30-Year A Rated Corporate Bond $(114,989) $(235,872)
30-Year Bank-Qualified Municipal Bond $221,007 $701,441

*Based on $500,000 single premium investment. Current rates are as of March 2016. For more detailed information as well as the relevant assumptions used, please contact David Shoemaker at dshoemaker@equiasalliance.com or 901-754-4924.

Equias Alliance offers securities through ProEquities, Inc. member FINRA & SIPC. Equias Alliance is independent of ProEquities, Inc.

Mitigating Risk When Choosing a BOLI Carrier for Your Community Bank


BOLI-3-9-16.pngIf your community bank is considering revamping your benefits offerings, you’ve probably thought about Bank-Owned Life Insurance (BOLI). Purchasing BOLI is one of the lowest risk ways for banks to fund the cost of their benefits, and for a community bank struggling to compete with commercial banks for top talent, this may be a strategic financial decision. While BOLI is a long-term investment, it generates tax-free interest, making it extremely appealing to community banks. As with any investment, the decision to purchase a BOLI portfolio must be carefully considered so you can get the most return with as little risk as possible. Here are some ways to ensure you choose the right BOLI carrier and get the most out of your policy.

  1. Document every part of the process to ensure compliance. Regulations require careful attention, and national bank regulators provide a roadmap for the pre-purchase due diligence and ongoing risk management of BOLI. Before beginning the process of selecting a BOLI carrier, keep in mind that every step your community bank takes needs to be documented. From when you first purchase BOLI and throughout the life of your policy, documentation is absolutely critical for regulatory compliance, so you should frequently review reports of the performance of your BOLI assets. If any process isn’t documented, then in the eyes of regulators, it doesn’t exist. If you’re unsure of the proper protocol, working with a consultant who understands the regulatory process can help you with any issues that arise.
  2. Conduct a financial analysis of BOLI carriers. When choosing between BOLI carriers, you need to look at a variety of metrics to make the best decision. In the past, some banks’ decision making was reliant on ratings from independent agencies, and while ratings are still important, they are not the only thing you need to consider. By conducting a financial analysis of the carrier, you can get a clearer picture of whether the purchase will keep risk low while providing the yield your bank needs to fund competitive benefits. Here are financial metrics that can help you narrow down your options to a shortlist of low-risk choices:

    • Financial strength: Looking at the carrier’s balance sheet and income statement can help you determine the company’s financial strength, as can ratings from outside agencies.
    • Asset quality: By reviewing publicly available information about the carrier’s assets, you can identify any unusual trends and verify the carrier’s claims paying ability.
    • Risk-Based Capital: Review the carrier’s level of capital over time, compared to the regulatory required amount.
    • Investment philosophy: How does the carrier approach their investment portfolio; what techniques do they use for asset liability matching?
    • Experience in the BOLI market: How long has the carrier been active in the BOLI industry, and have they built a reputation for success in that time?
    • Ownership structure: Is there a parent company that could provide support in time of distress? Does the carrier have a stock or mutual ownership structure?
  3. If you need help, work with an executive benefits consultant. Choosing the right BOLI package for your community bank is an important decision and there are many compliance and regulatory issues that some banks just don’t feel comfortable navigating on their own. Working with an expert is the best way to make the most profitable, lowest-risk decision and to ensure regulatory compliance. Your consultant must understand the operating environment of your bank and your strategic interests in order to help you reach your financial goals and fund your benefits package. While selecting a BOLI carrier and deciding how to fund your purchase is complicated and may require outside help, it is an option that has enabled many community banks to offer more competitive benefits to employees.