TO THE OFFICER IN CHARGE OF SUPERVISION AT EACH FEDERAL RESERVE BANK
This will summarize and describe our position regarding
certain split-dollar life insurance policy arrangements between
bank holding companies and their subsidiary banks. Split-dollar
life insurance is a type of life insurance in which the purchaser
of the policy pays at least part of the insurance premiums and is
entitled to only a portion of the cash surrender value, or death
benefit, or both.
Background
Certain split-dollar life insurance policy arrangements
involving banks and their parent bank holding companies raise
legal and safety and soundness concerns. These arrangements fall
into two general categories: (1) those in which the subsidiary
bank owns the policy, pays all or substantially all of the
premiums and is reimbursed for the premium payments (if at all)
at some time in the future ("Endorsement Plan"), and (2) those in
which the parent holding company owns the policy, and pays the
premium, but uses the insurance policy as collateral for loans
from its subsidiary bank ("Collateral Assignment Plan").
Under the Endorsement Plan, the subsidiary bank
purchases a policy in which its parent bank holding company or an
officer, director, or principal shareholder thereof is the
primary beneficiary, rather than the bank or one of its officers
or directors. In this instance, the subsidiary bank receives
only a limited portion of the death benefit--usually an amount
equal to its premium payments plus interest. The primary
beneficiary--the holding company or one of its officers,
directors or principal shareholders--receives a majority of the
insurance proceeds and pays little or nothing for such a benefit.
Many of the policies in this category are single premium
universal life policies, whereby the subsidiary bank pays one
large lump sum premium payment for the policy. Generally, a
subsidiary bank involved in an Endorsement Plan would record the
cash surrender value of the policy as an asset on its books; and
the bank holding company does not record anything at the parent-only level.
A variation of the Endorsement Plan includes instances
where the bank pays an annual premium towards the policy and the
parent holding company reimburses the bank for a nominal amount
of the annual premium payments. These amounts are substantially
lower than the premium payments made by the subsidiary bank and,
therefore, do not accurately reflect the economic benefit derived
by the holding company as primary beneficiary of the insurance
policy.
Under the Collateral Assignment Plan, the parent bank
holding company owns the policy and pays the entire premium. The
subsidiary bank makes annual loans to the bank holding company in
an amount equal to the annual increase in the cash surrender
value of the policy (or, in some cases, in amounts equal to
premiums paid) with the policy itself serving as collateral for
the loan. The loans are repayable at the termination of
employment or death of the insured employee, and will be paid
using the death benefits available from the policy.
Compliance With Applicable Laws
Both of the aforementioned types of split-dollar life
insurance policy arrangements may be inappropriate where the
arrangements are inconsistent with sections 23A or 23B of the
Federal Reserve Act. Section 23A places quantitative
restrictions and other requirements on certain transactions,
including loans, between banks and their affiliates. The statute
also requires that loans between banks and their affiliates be
secured with collateral having a specified market value that
depends on the type of collateral used to secure the loan. Under
the Endorsement Plan, where the subsidiary bank pays all or
substantially all of the insurance premiums, an unsecured
extension of credit from the subsidiary bank to its parent
holding company generally results because the subsidiary bank has
paid the bank holding company's portion of the premium, and the
bank will not be reimbursed fully for its payment until sometime
in the future.
Under the Collateral Assignment Plan, where the
insurance policy held by the parent bank holding company serves
as collateral to secure a loan from its subsidiary bank, a
violation of section 23A may exist unless the loan meets the
quantitative requirements of sections 23A, and the cash surrender
value of the insurance policy used to secure such loan is equal
to 130 percent of the amount of the loan. Thus, a bank loan to
the parent bank holding company that equals the cash surrender
value of the insurance policy that is serving as collateral would
not be adequately secured under section 23A, unless additional
collateral was provided to secure the loan.
Both categories of split-dollar life insurance policy
arrangements may also be inconsistent with section 23B of the
Federal Reserve Act, which requires that certain transactions
involving a bank and its affiliates be on terms and under
circumstances that are substantially the same or at least as
favorable to the bank as those prevailing at the time for
comparable transactions with or involving nonaffiliated
companies. Because the bank holding company is the beneficiary
of the life insurance policy, it is a participant in a
transaction between a bank and a third party; therefore, the
split-dollar life insurance transaction must meet the standards
of section 23B.1 In order to conform to the statutory
restrictions of section 23B, the return to the bank from
ownership of the policy should be commensurate with the size and
nature of its financial commitment. In most split-dollar
insurance arrangements, the bank makes an investment in the
policy not for the purpose of insuring itself against risk but
for the purpose of obtaining insurance for its holding company.
The only return that the bank will obtain from its participation
in ownership of the policy is the return of its initial
investment and possibly some interest. However, the cost of
maintaining the insurance coverage is deducted by the insurance
company from interest which would otherwise be credited to the
equity in the policy. These costs will include policy loads,
surrender charges and mortality costs. The reimbursement the
holding company pays the bank should fully recompense the bank
for all of these charges. Examiners should carefully evaluate
these arrangements because, in many cases, the reimbursement
provided the bank by the holding company is based on an implied
value of the insurance coverage received by the holding company
which is less than the assessments that are made to the policy
equity.
In the process of evaluating split-dollar insurance
arrangements, examiners should keep in mind the fact that the
advances made by a bank to purchase the insurance are the
equivalent of a loan to the holding company. As such, the terms
of the loan, such as its duration and interest rate must be on
market terms in order to comply with section 23B.
Participation by bank holding companies and their
state-chartered and national bank subsidiaries in split-dollar
life insurance policy arrangements also may raise concerns
relating to the treatment of the policies as permissible bank
investments under section 24(7) of the National Bank Act. The
Office of the Comptroller of the Currency's interpretation of
this provision of the National Bank Act, which is set forth in
OCC Banking Circular 249 (dated May 9, 1991) is attached. In
addition, under section 24 to the Federal Deposit Insurance Act,
a state-chartered bank, without the FDIC's permission, generally
may not engage in any activity that is impermissible for a
national bank.2
Unsafe and Unsound Banking Practices
The purchase of a split-dollar life insurance policy
may also constitute an unsafe and unsound banking practice
involving the diversion of bank income or assets. By paying the
entire insurance premium where the bank is not the beneficiary, a
subsidiary bank provides an economic benefit to its parent
holding company or other beneficiary for which the bank is not
being adequately reimbursed or compensated. In this instance,
the bank loses the opportunity to use its assets in a productive
manner. Generally, the premium paid by the bank represents the
price of the policy in return for payment by the insurance
company of the entire proceeds. When the bank receives less than
the entire proceeds, it has, in effect, paid a higher than market
price for whatever limited benefit it may receive.
The foregoing is also applicable when the primary
beneficiary of the policy is an officer, director, or principal
shareholder of the parent holding company. Such an arrangement
is not consistent with safe and sound banking practices because
the subsidiary bank is conferring an economic benefit on an
insider of the parent bank holding company for which the
subsidiary bank does not receive adequate compensation.
Follow-Up Action
Reserve Banks are asked to ensure that their examiners
are fully aware of the problems inherent in split-dollar life
insurance policy arrangements between bank holding companies and
their subsidiary banks. During the course of all bank
examinations and bank holding company inspections, examiners
should review corporate life insurance policy arrangements for
compliance with applicable banking laws and safety and soundness
standards.3 If a split-dollar life insurance policy arrangement
exists in either a bank holding company or a state member bank,
such an arrangement should be modified to comply fully with the
law and safe and sound banking principles. In the event that a
bank holding company or a state member bank fails to take
appropriate action to bring its split-dollar life insurance
policy arrangements into such compliance, then appropriate
follow-up supervisory action, including a formal enforcement
action, against the banking organization, or its
institution-affiliated parties, or both should be considered.
In the event that you have any questions regarding this
matter, please contact Nancy Oakes, Senior Attorney, Division
of Banking Supervision and Regulation, at (202) 452-2743,
Pamela G. Nardolilli, Senior Attorney, Legal Division, at (202)
452-3289, or Deborah M. Awai, Senior Attorney, Legal Division,
at (202) 452-3594.
Deputy Director
ATTACHMENTS MAY BE OBTAINED FROM FEDERAL RESERVE BANK
Footnotes 1. The Federal Deposit Insurance Corporation ("FDIC") has taken the same position in a published interpretive letter, FDIC 92-40, dated June 18, 1992, a copy of which is attached. Return to text 2. SR Letters 92-97 (FIS) and 92-98 (FIS), dated December 16 and 21, 1992, respectively, describe the provisions of section 24 of the Federal Deposit Insurance Act. Return to text 3. Examiners conducting examinations of U.S. branches and agencies of foreign banks and Edge corporations should also be alerted about the problems associated with split-dollar life insurance arrangements because these institutions could purchase insurance for the benefit of a parent foreign bank or company, or one of the parent's officers or directors. In addition, section 7(h) of the International Banking Act of 1978 provides that state-licensed branches or agencies are prohibited from engaging in any activity that is impermissible for a federal branch unless the Board determines that such activity is consistent with "sound banking practice" and, in the case of an FDIC-insured branch, the FDIC determines that the activity poses no significant risk to the deposit insurance fund. Return to text |
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