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cost by as much as 10% while preserving the credit union’s first lien on the account and the insurance policy. 6. Regulatory Issues for a Top Hat Plan – Federal Credit Unions. Under NCUA rule
requires affirmative action by the regulator after submission of a fairly substantial application describing the proposed plan, its cost, implications for credit union earnings and capital and the internal governance process that resulted in the decision to offer the plan. In other states (such as New Hampshire), the process is more streamlined (a notice versus an
AS A MATTER OF GOOD GOVERNANCE (AND IN SOME PLACES REGULATOR INSISTENCE) THERE ALSO IS EMPHASIS ON ASSURING THAT THE CREDIT UNION’S MANAGEMENT AND DIRECTORS HAVE DONE THEIR DUE DILIGENCE AND ARE AWARE OF THE DETAILS OF THE PLAN. 701.19, top hat plans of any type can be offered by federal credit unions, and they can be funded in any manner, including insurance policies, mutual funds, and publicly traded domestic and foreign equity and debt securities, subject to the bedrock conditions that the cost of the benefit for all covered executives must be reasonable in relation to the credit union’s condition and resources, and the amount of the benefit for each executive must be reasonable in relation to the person’s duties and overall compensation (most plans aim at up to 70% employment income replacement, taking into account other anticipated retirement benefits, including social security, 401Ks, and any other ERISA plans). Advance approval of top hat plans for federal credit union executives is not required (or possible) and oversight will take place as part of ongoing examinations under safety and soundness criteria. 7. Regulatory Issues for a Top Hat Plan – State Credit Unions. State regulation of top hat plans naturally presents a more varied landscape. Nevertheless, some general observations can be offered as to the current state of legal regulation of top hat plans offered by state-chartered credit unions. First, those states with broad parity powers (such as Rhode Island) generally will permit such plans with no prior approval or notice process and only ongoing safety and soundness review. Second, a number of states do require prior approval of top hat plans (at least those with dedicated current funding), and in some of those states (such as Massachusetts) approval 22 | centerpoint | fall.2013
application) and approval is automatic unless the regulator issues a timely denial or request for additional information. Third, in some states where top hat plans require prior approval, there appears to be a growing focus on the magnitude and duration of the investment to fund the arrangement, measured against credit union assets and net worth (some states have cited 25% of net worth as a benchmark on total credit union investment in funded top hat plans, but this appears to be a soft rather than a hard cap, especially for smaller credit unions). Of course, as a matter of good governance (and in some places regulator insistence) there also is emphasis on assuring that the credit union’s management and directors have done their due diligence and are aware of the details of the plan, including structure, cost, benefits, and the nature and health of any third party funding mechanism, be that the issuer of a life insurance policy or an independent investment adviser managing the monies intended to fund the plan. It is not clear at this point whether there is or will be the same degree of regulatory scrutiny of formally unfunded arrangements (such as 457(f ) plans). In principle, there ought to be the same focus on unfunded plans since the all-in cost of unfunded arrangements likely will exceed those of currently funded plans, and by their nature, unfunded arrangements can accrue substantial obligations for which no adequate provision for payment is made, creating a threat to future earnings and capital. Insofar as state regulation of top hat plans is all over the map, it is essen-
tial that any state charter considering a top hat plan of any kind consult with legal counsel familiar with the relevant rules. 8. Pre-Funding Employee Benefit Costs. An increasingly popular means of helping fund the rising cost of all employee benefits, from broad-based ERISA-qualified plans to individual top hat plans, is “pre-funding,” whereby credit unions are able to make investments outside the tight universe of “legal investments” where those investments are effectively dedicated to defray the cost of employee benefits, broadly defined. Pre-funding is available automatically to all federal credit unions (under NCUA Rule 701.19) and to state charters in some states, while in others (including Massachusetts) prior approval is needed. While CASD plans effectively pay for themselves over time, other top hat plans do not and therefore are likely to require offsetting investments that yield far above the return on assets currently achieved by most credit unions. Pre-funding allows credit unions to access professionally managed, diversified portfolios designed for credit unions, including mutual funds, REITs, domestic and offshore debt and equity issues as well as certain alternative investments, including insurance policies, that can close the gap between rising benefit costs and credit union income. Again, board and management due diligence is key, including checking on the pre-funding experience of other credit unions of comparable size and condition. 9. Accounting Issues. Evolving FASB/ GAAP rules also need to be taken into consideration when choosing a top hat plan. Different plans will have varying financial statement effect. Unfunded long-term plans generally will require accretion of the payout amount in increments over time, resulting in recurring charges to income and a growing liability, while a CASD plan with full recourse loans to the executive and assurance of payment of all premiums prior to the executive’s retirement will usually be reflected as offsetting cash and asset entries, with no net charge against income or capital. Discretionary bonuses or severance payments, of course, will be expenses in the year accrued, which typically but not always will be the year actually paid. 10. Pitfalls-When Things Go Wrong. It is beyond the scope of this article to discuss comprehensively how things can go wrong with top hat plans and what happens if they do. All that is fact-specific. Suffice it to say that executives whose employment ends before they have vested in much if any of their long-term