The Opacity of the OTR and Confusion Over an Insurance Premium
The news in November that the NCUA would reduce the overhead transfer rate for 2017 – the first such reduction since 2013 – was encouraging for the state system (and especially for NASCUS; we’ve been working on this issue on behalf of the state system for at least 20 years).
Shortly after that decision was announced, agency Chairman Rick Metsger and Board Member J. Mark McWatters – as well as the rest of us – heard in a staff briefing that an insurance premium for credit unions was likely in the New Year. That was discouraging, for all parts of the credit union system.
And incredibly confusing.
The juxtaposition of the discussion about these two actions has led to a misconception that one caused the other, or vice versa. I can tell you, I have heard exactly that as I have spoken to state credit union executives and regulators in the weeks following the board meeting, as I’ve traveled across the country and in Washington.
So, let me clear up any misunderstanding: Simply put, the OTR and the insurance fund's equity ratio have an inverse relationship. That is: As the OTR goes down, the equity of the fund potentially increases (with the opposite being true as well). A decrease in the OTR did not – and could not – force an insurance premium to be assessed.
Here's some background: The OTR represents that rate at which the NCUA will cover its operating expenses in funds drawn from the National Credit Union Share Insurance Fund. (The agency can do so to cover “insurance-related expenses” it incurs going about the jobs of both safety and soundness regulator and insurer of credit union savings. There's a whole, additional discussion related to that set up, which we won't get into here – but it needs to be broached as well.)
In 2016, the NCUA covered its operating expenses from the insurance fund at the rate of 73.1%. A better way of saying that is that the insurance fund paid for 73.1% of the agency's expenses this year, about $212 million. Those dollars come right out of the equity of the fund. (Note: The remainder of NCUA's budget is covered by operating fees paid by federal credit unions and other sources: Interest income, rents, publication sales, etc.)
If the agency had not changed the OTR for 2017 (instead of reducing it to 67.7%), the insurance fund would have been charged just about $218 million. Instead, at the reduced rate, the bill to the insurance fund is about $10 million less for 2017 (just a tad under $202 million) than the previous year (and about $15 million less than the charge would have been under the previous rate). In any case: The difference is potentially available to contribute toward the fund's equity ratio.
Now, suppose that the NCUA had held the line on the OTR at the 2013 rate (of 59.1%) in the years 2014 to 2016, rather than raising it in each one of those three years – what would be the impact on the fund equity? A quick calculation shows a significant savings to the fund: $103.3 million in just those three years. (By the way, we’re only using the 2013 OTR rate as a benchmark – we think it should be, year over year, lower than that. But, again, that's another discussion for another time.)
The $103.3 million noted above, certainly, isn't enough to deter an insurance premium in 2017. As the NCUA has said, the equity ratio of the fund is dropping, not because of the OTR, but because of the rising number of insured shares and the extended low interest rate environment. In other words: Insured shares are growing at a faster rate than income to the fund from its investments, due (primarily) to low rates of return – which means the ratio of dollars in the fund to total shares insured is dropping to below the 1.3% “normal operating level” of the insurance fund set by the board. By law, the normal operating level for the fund must fall between 1.2% and 1.5%.
Confused? You are not alone. The very fact that some folks initially thought the decrease in the OTR is to blame for an insurance premium only underscores the opacity of the OTR and how difficult it is to understand.
Efforts are underway, thankfully, to ease – or end – the confusion. To their credit, at the November board meeting, Metsger and McWatters both voiced strong interests in adopting a future OTR methodology for the agency that is rooted in “transparency, understandability, fairness.”
We could even see a proposal by early next year. NASCUS is very much supportive of their efforts.
Until next year, keep this in mind about the relationship between the OTR and insurance premiums: The lower the rate at which funds are transferred to the NCUA budget from the insurance fund, the more remains potentially available to contribute toward the fund's equity ratio. On the flip side, the higher the OTR, the more all credit unions – state and federal – will be on the hook for future premium assessments to maintain the equity ratio.
Reducing the OTR – and ending the confusion around it – is in everybody's interests and will help drive down the need for insurance premiums.
Lucy Ito is president/CEO of NASCUS. She can be reached at 703-528-8688 or email@example.com.