TO THE OFFICER IN CHARGE OF SUPERVISION AT EACH FEDERAL RESERVE BANK
This will summarize and describe our position regarding
split-dollar life insurance policy arrangements between state
member banks and their officers, directors, employees, and
principal shareholders.
Due to recent revisions to the Federal Deposit
Insurance Corporation's (the "FDIC") guidelines for the purchase
of life insurance by state banks, this SR Letter supersedes the
guidance on the treatment of split-dollar life insurance
arrangements at state member banks set forth in SR 94-21 (FIS),
dated March 29, 1994.
Background
Split-dollar life insurance is a type of life insurance
in which the purchaser of the policy pays the insurance premium
and receives only a portion of the death benefit. In SR 93-37
(FIS), dated June 18, 1993, we described split-dollar life
insurance arrangements between bank holding companies and their
subsidiary banks. We analyzed the bona fides of split-dollar
life insurance arrangements in two ways -- compliance with
sections 23A and 23B of the Federal Reserve Act, and from a
safety and soundness standpoint. We advised you that such
arrangements may violate sections 23A and 23B because the payment
of the entire insurance premium by a subsidiary bank -- without
its concomitant receipt of all of the death benefit -- may
represent an impermissible unsecured extension of credit to the
bank's parent holding company, and because the subsidiary bank
may not receive a favorable return on its investment. We also
advised you that a split-dollar life insurance arrangement may
also constitute an unsafe and unsound banking practice because it
may involve a diversion of bank income.
In SR 93-37, we did not analyze split-dollar life
insurance arrangements involving only a state member bank and its
insiders because such an analysis needed to address the legal
permissibility of an insured bank's investment in a split-dollar
life insurance policy under the then recently enacted section 24
of the Federal Deposit Insurance Act (the "FDI Act").
Section 24, which was enacted as part of the Federal Deposit
Insurance Corporation Improvement Act of 1991 and became
effective on December 19, 1992, limits the activities and equity
investments of insured state-chartered banks to the activities
and equity investments that are permissible for national banks.1
Under section 24 of the FDI Act, the FDIC has the sole
responsibility for determining the permissible activities and
equity investments of state-chartered banks. In some instances,
the purchase of life insurance by a state-chartered bank,
including split-dollar life insurance arrangements, is one of the
activities and equity investments governed by this statute.
Last year, the FDIC issued for its examiners extensive
guidelines for the purchase of insurance, including split-dollar
life insurance, by state nonmember banks; and, on August 31,
1993, the FDIC sent a letter to the chief executive officers of
all state nonmember banks regarding their insurance practices, a
copy of which is attached for your information. As the Federal
Reserve did in SR 93-37, the FDIC analyzed split-dollar life
insurance arrangements for compliance with applicable law, i.e.,
section 24 of the FDI Act, and with safety and soundness
standards in both its guidelines and bank letter. As further
described below, the same analysis of split-dollar life insurance
arrangements that the FDIC applied to state nonmember bank
activities is also applicable to state member banks.
Section 24 of the FDI Act provides that, after
December 19, 1992, no state-chartered bank that is insured by the
FDIC may engage as a principal in any activity that is not
permissible for a national bank, unless the state-chartered bank
is in compliance with applicable capital standards and the FDIC
determines that the activity will not pose a significant risk to
the deposit insurance fund.
In accordance with the FDIC's responsibilities under
section 24 of the FDI Act, the FDIC in both its guidelines and
bank letter considered whether participation by a state-chartered bank in split-dollar life insurance arrangements is a
permissible activity. The FDIC concluded that participation in
split-dollar life insurance arrangements is a permissible
activity for a state-chartered bank only if: (1) the policies
meet the tests outlined in the Office of the Comptroller of the
Currency's Banking Circular 249 ("BC 249"), a copy of which was
provided as an attachment to SR 93-37; and (2) the benefits to
the bank officer, director, employee, or principal shareholder
for whom the insurance is purchased are reasonable.2
Retroactivity
In both the FDIC's guidelines and bank letter, the FDIC
determined that section 24 of the FDI Act applies to all life
insurance purchases made by state-chartered banks, including
those made before December 20, 1992. Thus, if a state-chartered
bank wishes to purchase an insurance policy that does not meet
the FDIC's three standards set forth above, it must obtain the
prior consent of the FDIC. The FDIC further stated that a state-chartered bank presently holding an insurance policy that does
not meet these standards -- whether or not such a policy was
purchased before December 20, 1992 -- must obtain the FDIC's
permission to retain the insurance policy.
Unsafe and Unsound Banking Practices
In a recent revision to its insurance guidelines, the
FDIC has suggested that banks establish their own internal
concentration limits for investments in split-dollar life
insurance policies. These internal limits should not exceed the
maximum allowable amounts, if any, that exist under applicable
state laws or regulations. In addition, if the aggregate amount
of a bank's investments in all of its insurance policies exceeds
25 percent of Tier 1 capital, it may be viewed as a concentration
of credit.
Notwithstanding the legal limitations placed on a
state-chartered bank's participation in split-dollar life
insurance arrangements by the FDIC's guidelines implementing
section 24 of the FDI Act, such insurance arrangements at state
member banks may also, in our view, constitute an unsafe and
unsound practice involving the diversion of bank income or
assets. When a state member bank purchases a split-dollar life
insurance policy and arranges for one of its insiders, rather
than the bank, to receive all or most of the benefits of the
policy in excess of the amount of the premium paid, the state
member bank, in effect, provides a significant economic benefit
to its insiders. In those instances where the bank purchases
life insurance in amounts that exceed the levels necessary to
provide reasonable compensation benefits to the bank insider, the
premium payments for such policies may be viewed as an
inappropriate use of bank funds because the bank loses the
opportunity to use its assets in a productive manner.3
The issues related to reasonable compensation are
complex and require case by case analysis. Generally, the test
of "reasonableness" is the overall level of compensation to the
insider, including salary and other benefits, as well as the
compensation or benefit to be derived from the split-dollar life
insurance arrangement. Guidance on the standards of reasonable
compensation as it applies to split-dollar life insurance
arrangements can be found in the FDIC's August 18, 1993
memorandum to its Regional Directors and accompanying staff
discussion paper, and in BC 249. Notwithstanding these
guidelines, a Reserve Bank should make an independent
determination of whether the split-dollar life insurance
arrangement under review is part of a reasonable overall
compensation package for the bank insider involved in such an
arrangement.
Follow-Up Action
Reserve Banks are asked to ensure that their examiners
are fully aware of the problems inherent in split-dollar life
insurance arrangements between state member banks and their
insiders. During the course of all bank examinations, examiners
should review corporate life insurance arrangements for
compliance with applicable banking laws and safety and soundness
standards. If a split-dollar life insurance arrangement exists
between a state member bank and its insiders, such an arrangement
may need to be modified to comply fully with the law, especially
the law relating to the permissible activities of national banks
now made applicable to state-chartered banks by section 24 of the
FDI Act, and safe and sound banking principles. In the absence
of such a modification, a state member bank holding an insurance
policy that does not conform to the aforementioned FDIC standards
must, under the FDIC's guidelines, obtain the FDIC's permission
to retain the insurance policy.
In the event that a state member bank fails to take
appropriate action to bring its split-dollar life insurance
arrangements into compliance with the law, including obtaining
the consent of the appropriate FDIC office, and safe and sound
banking practices, then appropriate follow-up supervisory action,
including a formal enforcement action against the bank, or its
institution-affiliated parties, or both should be considered.
Notification to State Member Banks
In order to ensure that all state member banks are
advised about the laws relating to split-dollar life insurance
and the applicable FDIC policies, we would appreciate you sending
the attached suggested letter to the state member banks in your
District. The letter provides some brief background information
about split-dollar life insurance arrangements at their banks, a
copy of the FDIC's August 1993 release on the subject, which was
not sent to state member banks by that agency, and a copy of
BC 249 for easy reference by the banks. The letter also includes
some general information about split-dollar life insurance
arrangements between federally insured banks and their parent
holding companies.
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, or Pamela
Nardolilli, Senior Attorney, Legal Division, at (202) 452-3289.
Deputy Director
ATTACHMENTS MAY BE OBTAINED FROM FEDERAL RESERVE BANK Supersedes SR 94-21 (FIS)
Footnotes 1. AD Letters 92-97 (FIS) and 92-98 (FIS), dated December 16 and 21, 1992, respectively, describe the provisions of section 24 of the FDI Act. Return to text 2. Our previous SR Letter 94-21 included a third test concerning the bank's aggregate investment in split-dollar life insurance policies in relation to the lending limits to a single borrower. The FDIC recently changed the criteria for the test of permissibility by eliminating a reference to the legal lending limit. Return to text 3. It should be noted that an individual who is a principal shareholder of a state member bank and holds no office at the institution is generally not entitled to compensation and, therefore, should not be a party to a split-dollar life insurance arrangement. Return to text |
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