By David Shoemaker and Ken DerksOne of the key roles of bank directors is to oversee compensation of the bank’s top executives and ensure the compensation plans reflect the bank’s strategic priorities. To that end, there are several things directors need to keep in mind related to key elements of these compensation programs: nonqualified benefit plans and bank-owned life insurance.
Nonqualified plans include supplemental executive retirement plans, deferred compensation plans, and supplemental life insurance plans. According to the most recent ABA Compensation and Benefits Survey, approximately two-thirds of banks have either a SERP or DCP in place. Many banks have had plans in place for a number of years, while others have more recently created new plans.
The goal of a nonqualified plan is to recruit, retain and reward select key contributors. To maximize the effectiveness of the plan, it is important to choose the right design, keeping in mind that one of the advantages of a nonqualified plan is the ability to custom-tailor the design for each participant. For example, a 35-year-old bank officer with a young family would likely value a DCP with distributions timed to college education for the children, combined with a SLI plan, more than a SERP with no benefits paid until age 65. In contrast, a 55-year-old executive with grown children would more likely value a SERP over a DCP.
Banks that have had plans in place for a number of years should review them to see if the intended objectives are being accomplished. Some questions board members can ask during the review include:
- Are the plans one-size fits all or are they custom-tailored to each participant?
- Have the benefit amounts been adjusted properly to keep up with changes in compensation?
- Is the change-in-control benefit appropriate? (Keep in mind that CIC benefits can, and often do, vary by position).
- Are there additional key contributors that should be added to the plan? (Studies show that replacing a high-performing employee who leaves can cost between 200 percent and 400 percent of the annual salary associated with that position.)
Even if the plans have been in place for some time, it is not too late to make warranted changes. Such changes must be in compliance with IRC Section 409A, but there are a number of methods available to meet the plan’s objectives while maintaining compliance.
For example, one bank we consulted provided a SERP to its senior management employees. The SERP was designed similarly for each participant and provided benefit payments scheduled to begin at age 65; this plan design worked well for those employees who were over 50 when the plan was implemented. However, several of the officers, especially those under age 40, did not see considerable value in a plan that would not provide benefits until age 65. When it was pointed out that this design was not providing the desired retentive impact, we worked with the bank to enhance the plan so that it was attractive to each participant. In order to stay in compliance with 409A, the bank froze the existing SERP for the younger officers and implemented a new plan for them that allows payments to commence as early as age 50. As a result, the younger officers placed much greater value on the plan and were pleased that the bank would customize the plan for them.
Meanwhile, approximately two-thirds of banks have BOLI on the balance sheet, with the cash surrender value totaling $186 billion as of March 31, 2021, according to FDIC data. In the last half of 2020 through the first half of 2021, banks have had record amounts of liquidity, and, as a result, BOLI purchases have been robust. Some banks are purchasing life insurance for the first time, while many who purchased previously are increasing the amount they own.
BOLI has been around for approximately 40 years and is generally viewed as a stable asset with very attractive returns. Current tax-equivalent yields (as of September 2021) range from 2.5 percent to 3.8 percent and compare favorably to other bank-eligible investments that generally yield 1 percent or less, according to the September 2021 NFP Executive Benefits BOLI Carrier Rate Survey. In addition, BOLI provides a death benefit of two to four times the amount invested and will be received tax-free by the bank when the policy is held to maturity.
Many banks purchase BOLI to informally fund SERPs and DCPs, and to provide SLI benefits to select employees. BOLI earnings help offset some or all of the benefit costs and the death benefit received by the bank recovers the payments made to the officer.
From a risk management prospective and to get the most out of the investment, directors should keep the following principles in mind:
- Regulatory guidance requires that an annual risk assessment review be performed and, in most instances, reviewed by the board. These risks include liquidity, credit, tax, compliance, interest rate and price.
- If the bank’s total BOLI holdings exceed 25 percent of capital, the bank should carefully document why it is comfortable being above the guideline amount. Likewise, if the cash surrender value to any one carrier exceeds the bank’s legal lending limit or its internal lending limit, it should carefully document why it has chosen to remain at that level.
- If the policies have been in place for several years, the bank should perform a coverage review. If the death benefits are higher than needed, current yields can be improved by reducing the death benefit. If they are too low to cover a specified benefit, an additional policy may be needed on that insured.
- BOLI is a long-term investment, and carrier crediting rates tend to move up or down on a lagging basis, so it is important to look at long-term performance rather than just current yields. However, if the current yield on a single policy is low, or if all of the yields with a particular carrier are low, the bank should perform an analysis to understand the cause and consider if anything can be done to improve the performance of the policy or policies. For example, the insured’s age or health rating may result in a justifiably lower yield or the carrier may have a shorter duration investment portfolio supporting the BOLI, meaning it is likely that the carrier’s rate will move up more quickly if and when rates rise.
- If your bank has acquired another bank that owned BOLI, make sure to transfer ownership of the policies to avoid delays in receiving payments when a death claim occurs.
David Shoemaker and Ken Derks are managing consultants with NFP Executive Benefits, which ABA endorses for executive and board benefits consulting, administration of BOLI and nonqualified benefit plans, BOLI portfolio solution and BOLI risk assessment. They are also registered representatives with Kestra Investment Services, LLC.