Weighing Risks, Returns of Pre-Funding Benefits
Most of the investments generally permitted to credit unions by the NCUA pay returns in the 1% to 2% range but operational costs, especially for key employee benefits, are ballooning.
Indeed, health care expenses have shot up 80% over the past decade, according to research sponsored by the Henry J. Kaiser Family Foundation. The mounting struggle to pay for for retiree health care, defined benefit pensions and long-term care coverage has become the main problem.
To help pay for some of the costs, more credit unions are considering pre-funding employee benefits. In 2003, the NCUA amended Regulation 701.19 to give federally chartered credit unions the option to put assets earmarked for future employee benefits costs into investment funds that were normally off-limits, such as corporate bonds.
With the change, the NCUA extended relief from investment restrictions that it already offered credit unions for pre-funding specific benefit obligations, such as defined benefit pension plans and non-qualified 457(f) plans for executive deferred compensation.
Some of the common expenses to pre-fund through investments include premiums for group health, group life, short- and long-term disability insurance, 401(k) matching funds, executive deferred compensation, future defined benefit plans and retiree health coverage.
According to data supplied to CU Times by Madison, Wis.-based CUNA Mutual Group and harvested from 5300 call reports, approximately 1,050 credit unions have some investments in higher-yield instruments. Roughly 120 credit unions with at least $1 billion in assets and nearly 600 with assets from $100 million to $1 billion have such holdings. Around 350 credit unions with assets under $100 million also invest in pre-funding.
How much bigger are the returns in typical pre-funding? Christian Zernich, a partner with Executive Benefits Solutions in Sewickley, Pa., said the firm's goal is to achieve 200 to 300 basis points more than a typical investment. That typically translates into a 4% or 5% return, Zernich noted. Executive Benefit Solutions works with nearly 25 credit unions on pre-funding, said John Sinclair, another partner with the company.
Zernich said that nationally, an estimated 10 investment consulting firms are active in the credit union space. While there are just as many firms in the banking industry, the decisions are fundamentally different than they are with tax-exempt, not-for-profit credit unions.
“We don't recommend tax-free municipal bonds, for instance,” Sinclair said.
John Moreno, senior executive benefits specialist with CUNA Mutual, said credit unions are investing their own money, not deposits. The company has nearly 200 credit union clients that are doing pre-funding, he added. Investments frequently are split between life insurance policies bought on key executives through corporate owned life insurance and an investment portfolio, often mutual funds.
At the Dallas-based $1.1 billion Credit Union of Texas, pre-funding has been around for five years and seeks to cover general benefits such as medical, dental, and 401(k) plans, said John-Paul Morgante, vice president of human resources.
Morgante stressed that pre-funding is a possible answer to the question, “How do we fund benefits?” But it is not necessarily the only response. What's key, he suggested, is for the credit union to understand what its benefits obligations are and to have a plan for paying them. Pre-funding often will play a part, he said.
The $885 million Motorola Employees Credit Union in Schaumburg, Ill., has around $16 million invested in pre-funding vehicles and so far this year, the return is about 5.6%, said Larry Rosin, CFO and EVP. Last year, the program returned 3.8%.
“We are very happy with pre-funding. It has let us increase our yield,” he said.
Motorola Employees CU could invest more without raising the hackles of regulators but the cooperative is content to cap how much money it puts into pre-funding, Rosin explained. Investments are typically recommended by the vendor. In MECU's case, it's CUNA Mutual.
“We bounce our own ideas off them. The final decisions are approved by a senior management committee,” said Rosin, who serves on it along with the CEO, COO and the controller.
Pre-funding also may bring its own problems, primarily in the form of increased risk. Higher yield inevitably means higher risk.
According to the Federal Credit Union Act, “A federal credit union investing to fund an employee benefit plan obligation is not subject to the investment limitations of the Act...and may purchase an investment that would otherwise be impermissible if the investment is directly related to the federal credit union's obligation or potential obligation under the employee benefit plan and the federal credit union holds the investment only for as long as it has an actual or potential obligation under the employee benefit plan.”
An NCUA spokesperson added: “Credit unions should treat these investments as they would any other, i.e., perform due diligence, keep safety and soundness foremost in mind, and be certain you understand all the terms of the investment.”
One key to managing risk is to diversify investments, Moreno said. He has seen instances where a credit union has more than 50% of its potential pre-funding capital invested in a single instrument.
“That's not wise,” Moreno offered. “Regulators and examiners will set boundaries to keep credit unions from doing silly things.”
Zernich said liquidity is a key driver in the portfolios they recommend, in part because regulator and examiner thinking is not necessarily transparent.
“Our goal is for (more than) 90% of the investment portfolio within 72 hours,” Zernich said. “We don't want to lock them into long-term investment.”
Others have said they follow a similarly flexible approach. That may change in coming months. The problem, according to some, has been considerable vagueness in what the NCUA deems an acceptable investment for pre-funding schemes. Different examiners may issue different opinions about the same investments.
According to some sources, there are signs the NCUA may issue more concrete guidance on this score either in late 2014 or early 2015. The NCUA did not comment on the matter.