In its publication of Rule 701.19 (April 2003), the NCUA recognized the need for credit unions to attract and retain key value creators in order to succeed, and their need for competitive options in financing such attraction and retention programs.
In the nearly 10 years since this guideline was published, many credit unions have implemented these programs for their senior management team. Boards have focused their attention on concerns such as benefit magnitude, timing of payments and other plan design issues. This is appropriate as part of the board’s fiduciary duty. However, many boards have paid less attention to how best to mitigate the expense incurred in implementing an effective executive program.
Some credit unions have defaulted to chasing the highest yield in the marketplace. This results in erratic returns, unpredictable performance and often untimely volatility that negatively impact both the benefit and the credit union financials. A well-thought-out funding strategy, established at the outset of implementing a program, can avoid this unfortunate outcome. This is as much a part of the board’s fiduciary duty as is the actual benefit program design.
The primary purpose of an articulated funding strategy is to define how the credit union intends to select and monitor funding vehicles used to informally fund its benefit liabilities. The preparation of the strategy can be expressed in three parts: establishment of objectives, the funding selection process and ongoing monitoring of the investments.
In order to establish the objectives of a funding strategy, it is essential to fully understand the purpose for which it is being implemented. For most credit unions, benefit funding is tied to some specific benefit plan. Once the objectives of a benefit program have been vetted and the annual financial impact to the credit union projected, the funding strategy should be crafted to most efficiently mitigate the annual costs of the program as well as its long-term projected liabilities. Attention should also be given to the timing of payment events, and what the impact of that timing might be on the funding vehicle.
Credit unions are accustomed to selecting vehicles in which to invest member funds. But often the decision around funding long-term benefits is done in a tactical rather than strategic fashion. Unlike its general investment pool, a credit union is allowed under Rule 701.19 to invest in “otherwise impermissible investments,” including vehicles such as annuities, life insurance and mutual funds. The first step in the creation of a funding selection process is to decide the risk level and types of asset classes the credit union is comfortable investing in. Such factors as historical performance, volatility, comparison to other assets, expenses, company strength, investment style and management experience should all be considered. Boards should consider not just the upside projections provided by product vendors, but the downside risks of performance that deviate from projections. Boards should insist on also seeing worst case scenarios, which will illuminate the flaws of many too-good-to-be-true strategies.
Most executive retention and retirement programs are long-term by definition and involve a significant allocation of credit union assets. It is critical that the board have an ongoing process to monitor funding performance. Obviously, actual performance vs. projections should be considered, but the evaluation should not end there. Additional considerations include factors such as historical volatility, a change in the investment company management or ratings, expense structure or investment style. Credit union changes, such as expansion of the benefit program or a change in the plan’s objectives, are also important. Specific measurement benchmarks should be set for acceptable return and changes in ratings status. Specific actions and a timetable for correction in the event benchmarks are not achieved should also be established. A monitoring plan can only be effective if the right questions are asked at the outset and results are reviewed in a consistent fashion.
The goal of an articulated funding strategy is to identify the credit union’s philosophy in both the benefit provided and its funding parameters and to provide usable, practical guidance now and into the future. A stated strategy can serve as documentation of the prudent process that the credit union board followed in creating a strategic approach to the funding of an executive retention and retirement plan, and keep future generations of executives and board members focused on the right things over the right time horizon, rather than chasing short-term returns that may or may not pay off.