08-4
08-4
December 10, 2008
VIA TELEFACSIMILE AND FIRST CLASS MAIL
Joseph A. McDonald
Law Offices of Joseph A. McDonald
1317 West Foothill Boulevard, Suite 146
Upland, CA 91786
Re: Split Dollar Life Insurance Plans
Dear Mr. McDonald:
This responds to your letter of September 26, 2008. I apologize for the delay in addressing your request. You have asked whether Financial Code Section 15050 prohibits a credit union from offering split dollar life insurance plans to its executive officers. For the reasons stated below, we believe the answer is no.
As stated in your letter:
“Split dollar life insurance is typically part of a Supplementary Executive Retirement Plan. The credit union advances insurance premiums as loans to the executive; the parties expect the loans will be repaid from insurance proceeds, in which the executive assigns a collateral interest to the credit union. The life insurance funds retirement benefits. Thus, the parties split the dollars of the plan.
* * *
“In a split-dollar life insurance plan, the executive is the policy owner. The credit union advances the premiums, secured by the executive’s collateral assignment of a corresponding interest in the insurance proceeds. Upon the executive’s death, the insurance proceeds repay advanced premiums. If he dies before retirement, the balance goes to his life insurance beneficiaries. Otherwise, during his retirement, the plan pays scheduled benefits to him; at his death, an amount is deducted from the insurance proceeds corresponding to the plan benefits distributed to him; and the balance, if any, goes to his beneficiaries.
“The premiums are advanced as loans to the executive. Typically, they bear low or no interest. Federal tax laws thus imputes to the executive, as income, either the applicable Federal interest rates, or the difference between that and the plan rate, and upon this imputed income is paid tax, by the executive, by the credit union as part of the compensation, or both.
“The executive is liable for these loans, and is personally at risk. For instance, if dismissed with cause, the executive would have to repay them. This on the one hand protects the credit union, e.g. in the event of misconduct by the executive, and on the other hand protects the executive, to whom the advances could be recognized as income if not made and treated as loans in compliance with taxation requirements.
“Should the paid-up value of the insurance rise to a sum against which the executive may borrow (i.e., a further benefit to him), the plan provides that he cannot do so to any extent jeopardizing the credit union’s security interest in the insurance proceeds.
“The credit union can defer accrual of its insurance-premium payments until the executive retires, which it may find financially advantageous. The executive does not have taxable income from the plan until he retires; and then only as he receives it, which is more favorable to him than a lump-sum effect of some other plans (e.g., under Internal Revenue Code Section 457).”
Financial Code Section 15050 governs obligations between directors, officers, members of the supervisory committee or members of the credit committee of a credit union (collectively referred to as “Insiders”) and that credit union. A close reading of Section 15050 reveals that one of its major tenets is to prevent Insiders from obtaining credit union loans products at a discount from what would otherwise be paid by members of the credit union. (See Section 15050(b).) Moreover, the law prevents one or more employees of the credit union from obtaining credit from the credit union at rates and terms better than those offered to other employees. (See Section 15050(e).)
As described above, a split dollar life insurance plan is not created with the intent of establishing a standard creditor-debtor relationship between a credit union and its executive officer. In other words, the credit union is not making a loan to the executive officer for the purpose of buying an item or service. Rather, the insurance plan is intended as a retirement benefit for the executive officer. The plan is structured as a secured loan primarily as a method of deferring taxable income to the executive. Thus, the structure of such plans is not to purchase an insurance contract with loaned money, but to provide a compensation benefit that avoids taxation during the executive’s primary earning years while protecting the credit union from the loss should that executive die before retirement. Finally, we note that a split dollar life insurance plan is not a traditional credit union product such as a residential mortgage loan, home equity line of credit, or personal loan, all of which are available to members of the credit union.
In sum, a split-dollar life insurance plan: (1) is not a traditional credit union product offered by the credit union to its members; (2) is intended as a retirement benefit due to the executive officer’s employment; (3) does not create a “standard” debtor-creditor relationship between a credit union and its executive officer; and, (4) does not represent a transaction that provides the executive officer with a discount as compared to what any other member of the credit union would pay for the same or similar product. As we believe that Section 15050 was primarily designed to keep Insiders from receiving traditional credit union products at a discount, and since that rationale does not apply to the four elements of a split-dollar policy discussed above, we conclude that Section 15050 does not apply to split dollar life insurance plans.
Please be advised that the opinions and conclusions contained in this letter are based upon the representations in your letter and attachments. Any changes to the facts set forth in your letter may result in a different conclusion on the part of the Department.
If you have any questions regarding this matter, please feel free to contact me at (916) 322-1570.
Very truly yours,
KENNETH SAYRE-PETERSON
Acting General Counsel
KSP102:pjp
THE LAW OFFICES OF
JOSEPH A. MCDONALD
A PROFESSIONAL CORPORATION
1317 WEST FOOTHILL BOULEVARD SUITE 146 UPLAND CALIFORNIA 91786
FAX (909) 579-6324
PHONE (909) 579-6300
joe@jmcdonaldlaw.net
September 26, 2008
Kenneth Sayre-Peterson, Esq.
Acting General Counsel
Department of Financial Institutions
1810 13th St.
Sacramento, CA 95811
Re: Financial Code §15050 and split-dollar plans
Our file no. [deleted]
Dear Mr. Sayre-Peterson:
In a telephone conference with you on August 23, 2008, I raised the question of whether a California-chartered credit union could fund executive retirement benefits by a collateral-assignment split-dollar life-insurance plan. I thought such plans should be permissible; you indicated you were inclined to think similarly, and to issue an opinion letter clarifying the point. You invited me to address the matter in writing.
Two lesser aspects of the loan transaction, origination and approval, are addressed in Sections 7.1004 and 7.1005. Section 7.1004(b) sets forth the circumstances under which banks may originate loans at loan production offices without the loan production office being considered a branch:
Introduction
Split-dollar life insurance is typically part of a Supplementary Executive Retirement Plan (SERP). The credit union advances insurance premiums as loans to the executive; the parties expect the loans will be repaid from insurance proceeds, in which the executive assigns a collateral interest to the credit union. The life insurance funds retirement benefits. Thus the parties split the dollars of the plan.
Such loans are not extended to other members (except any other executives who may participate in split-dollar plans). NCUA was therefore asked whether, for Federal credit unions, the loans were prohibited by NCUA Regs. §701.21, and answered, Op. Ltr. 06-0924, January 19, 2007, that they are not.
The California statute comparable to Regs. §701.21 is Fin. §15050. NCUA’s reasoning, that §701.21 is “intended to prevent … unsafe loans . and compensating volunt[eers] otherwise prohibited from being compensated” (Op. Ltr. 06-0924, 5th paragraph), also applies to Fin. §15050, which leads to the reasonable conclusion that split-dollar loans should be permissible for California-chartered credit unions. However, small differences between the Federal regulation and the California statute render the conclusion awkward without your guidance.
In our telephone conference, we considered the power of the Commissioner under Fin. §14202 to authorize California credit unions to act as may be permitted for Federal credit unions. That authorization, however, lasts only two years. We also considered the possibility of seeking a statutory amendment. However, that might take substantial time, during which the uncertainty would remain unresolved. Also either of those alternatives might yield a result which was only prospective in application.
It is likely that other California credit unions are similarly situated. As I discuss below, I am in touch with CUNA Mutual Group; NCUA Opinion Letter 06-0924 was addressed to CUNA Mutual’s Associate General Counsel Robert K. Rusch, Esq. Although I can speak only for the credit union I represent, I think an opinion letter would be helpful to guide California-chartered credit unions generally.
For convenience I enclose copies of NCUA Regs. §701.21 and Op. Ltr. 06-0924. I also enclose [detail deleted] from other State regulators, obtained as described below.
Split-dollar plans
In a split-dollar life insurance plan, the executive is the policy owner. The credit union advances the premiums, secured by the executive’s collateral assignment of a corresponding interest in the insurance proceeds. Upon the executive’s death, the insurance proceeds repay advanced premiums. If he dies before retirement, the balance goes to his insurance beneficiaries. Otherwise, during his retirement, the plan pays scheduled benefits to him; at his death, an amount is deducted from the insurance proceeds corresponding to the plan benefits distributed to him; and the balance, if any, goes to his beneficiaries.
The premiums are advanced as loans to the executive. Typically they bear low or no interest. Federal tax law thus imputes to the executive, as income, either the applicable Federal interest rate, or the difference between that and the plan rate, and upon this imputed income is paid tax, by the executive, by the credit union as part of his compensation, or both.
The executive is liable for these loans, and personally at risk. For instance, if dismissed with cause, the executive would have to repay them. This on the one hand protects the credit union, e.g. in the event of misconduct by the executive, and on the other hand protects the executive, to whom the advances could be recognized as income if not made and treated as loans in compliance with taxation requirements.
Should the paid-up value of the insurance rise to a sum against which the executive may borrow (i.e. a further benefit to him), the plan provides that he cannot do so to any extent jeopardizing the credit union’s security interest in the insurance proceeds.
The credit union can defer accrual of its insurance-premium payments until the executive retires, which it may find financially advantageous. The executive does not have taxable income from the plan until he retires; and then only as he receives it, which is more favorable to him than the lump-sum effect of some other plans (e.g. under Internal Revenue Code §457).
Split-dollar plans, which are relatively recent, are offered primarily by insurance companies, e.g. CUNA Mutual. In 2007, CUNA Mutual Executive Benefits Marketing marketed such a plan to my client.
Particular circumstances of my client
[deleted] Credit Union, [deleted], California, elected to provide its President, [deleted], with a split-dollar plan.
[deleted] was hired as President in [deleted]. His contract provided that in addition to his cash salary, and in lieu of certain increases and bonuses, the Credit Union would arrange a Supplemental Executive Retirement Plan.
[paragraph deleted]
In [deleted], during negotiation of a new contract for [deleted], my client accepted CUNA Mutual’s proposal of a split-dollar plan. Inquiring about Fin. §15050, my client was assured that NCUA had already approved split-dollar plans, and that as to California-chartered credit unions the matter was under DFI consideration with approval imminent. CUNA Mutual also represented that [deleted] required quick action. My client began advancing insurance premiums.
In [deleted], [deleted] observed to me that Fin. §15050 had arisen at a meeting of the Credit Union Advisory Committee, in the context of considering the 15050(c)(2) limitation upon loans to officials. [deleted] asked me to verify that split-dollar plans were acceptable. Unable to locate any conclusive document, I got in touch with Eugene E. Zumwalt of CUNA Mutual Executive Benefits Marketing, and Robert K. Rusch, Vice President and Associate General Counsel (mentioned above).
It emerged that CUNA Mutual had obtained NCUA Op. Ltr. 06-0924, and favorable regulatory opinions in [deleted] other States, but no similar opinion in California.
[paragraph deleted]
I am thus most grateful for your attention. I trust that the circumstances of my client may be the occasion to clarify this point generally.
The Federal regulation and the California statute
The NCUA regulation, Title 12, Code of Federal Regulations, §701.21(d)(5), prohibits loans “more favorable than . comparable loans . to other credit union members”. The California statute, Financial Code §15050(b), says “more favorable than . extended to other members”.
NCUA’s analysis is that §701.21 is “intended to prevent … unsafe loans . and compensating volunt[eers] otherwise prohibited from being compensated” (Op. Ltr. 06-0924, 5th paragraph). NCUA finds that the prohibition of §701.21 does not reach an executive who may be compensated, even if the executive has a seat on the Board of Directors (i.e. among the other directors who are volunteers and cannot be compensated). I think Fin. §15050 should also be so understood.
NCUA begins by reasoning from the word “comparable” in the Federal regulation. Emphasizing this word (06-0924, 2nd paragraph), NCUA finds that loans under a split-dollar plan are not comparable to loans available to other members (id., 6th paragraph). I think this is correct, but since the term “comparable” is not in our statute, §15050(b-c), I would like to have clarified that split-dollar-plan loans as an executive benefit, even if literally more favorable than extended to other members, are not within the intent of the statute, and not prohibited by it.
Another difference between the Federal and California rules is that evidently a Federal credit union president, although he is seemingly an officer, is not an official. NCUA notes that §701.21 regulates loans to credit union “officials”, §701.21(d), defined in §701.21(d)(2): “any member of the board of directors, credit committee or supervisory committee” – not the president, about whom NCUA finds that, even if the loan in question were preferential, “Nothing in NCUA’s rules prohibits preferential loans to FCU [Federal credit union] employees who are not officials” (06-0924, 2nd paragraph).
Under Fin. §15050(b-d), “official” means “a director, officer, or member of the supervisory committee or the credit committee”, §15050(a); Fin. §14500 explicitly provides that the president is an officer. I would like to have clarified that permissibility of split-dollar loans does not rest on this definition.
Looking further at §15050, I note that §15050(c)(1) limits the aggregate amount of obligations, and (c)(3) requires approval by the credit committee or credit manager and by the Board of Directors. To me these subparts suggest that Fin. §15050, like Regs. §701.21, is aimed against unsafe loans.
As noted above, split-dollar loans are secured by insurance proceeds up to the amount advanced, and should that amount eventually allow the executive to borrow against his policy, he can do so only insofar as will leave the credit union’s security intact. This is one reason split-dollar loans have not been considered unsafe.
Under §15050(c), “No credit union shall enter into any obligation with any official” unless either fully secured by shares, or meeting requirements detailed in (c)(1-3). Under §15050(c)(2), the obligation must not exceed 10% of savings capital, a limit about [deleted] the sum to be advanced in my client’s case, which I do not believe is atypical. Perhaps “fully secured by shares” might be compared to the security interest in proceeds of insurance under a split-dollar plan, so that these requirements, if they apply, might be satisfied.
NCUA finds, “Split dollar life insurance is a valuable tool for funding . benefit plans used to attract and retain senior managers” (06-0924, 4th paragraph). That is what my client is trying to do. I believe other similarly-situated credit unions are also. I think Fin. §15050 should be likewise held not to prohibit split-dollar plans.
Opinions of other State regulators
In conferring with CUNA Mutual Associate General Counsel, Mr. Rusch, I asked him to inform me if he could, for your use in considering this matter, how split-dollar plans have been treated by credit union regulators in other States. I enclose [deleted].
Mr. Rusch said, “All the information . may be shared with the CA DFI as a part of our joint efforts to confirm the authority of CA state chartered credit unions to adopt an SDLI [split-dollar life insurance] plan. I would ask, however, that these documents not be shared with anyone else outside of your firm as they are proprietary in nature and may provide competitors with information they do not currently possess. I would also ask that you make the same request of the CA DFI.” I forward his statement, and respectfully request that you treat his contribution in confidence as far as may be appropriate.
Conclusion
I trust that this analysis and information will be helpful, that you may conclude split-dollar plans are permitted and thus bring California-chartered credit unions into parity with Federal credit unions, and that a written opinion to such effect may be issued as soon as may be. I will gladly be of any further service; please do not hesitate to write or call.
Sincerely,
JOSEPH A. McDONALD, P.C.
Joseph A. McDonald
Attorney
Enclosure