Questions Concerning The Application Of Section 701.19 For Eligible Credit Unions.

Can credit unions use equity investments in a segregated portfolio to pre-fund and offset the current cost of benefit programs?

Yes, variable investment accounts including Equities, Bonds, Mutual Funds, REITS, Commodities, and Fixed Income Accounts are now permissible investments provided the variable accounts are segregated accounts invested for the sole purpose of pre-funding present benefit cost.

What federal and state regulations support pre-funding benefit cost with variable investment accounts?

Credit Unions have historically pre-funded benefit obligations with Equity investments for the purpose of Executive Benefit Programs, Defined Benefit Pension Plans and Post Retirement health insurance obligations. NCUA regulations under Section 701.19 ( c ) provides authority for Federal Credit Unions to invest General Account Assets in variable investments provided the investments are prudent as determined by the Directorship Board and the investments are segregated in such a fashion to be reserved solely for the funding of current benefit plan obligations. This pre-funding must be reviewed annually to insure that the return on investment for the variable accounts does not exceed the present annual cost of benefit plan obligation. At the time of each annual review, any excess earning must be transferred back to the Credit Union's General Asset Account.

What is the maximum amount that a Credit Union can transfer from General Account Assets to pre-fund present benefit plan obligations?

Credit Unions cannot over fund the present value of annual benefit cost. If the Credit Union does not post unfunded benefit liabilities on it's financial statements, then the maximum pre-funding capital investment cannot produce a return on investments which exceeds the annual present value of benefit cost. In situations where Credit Unions have obligated themselves to future benefit requirements, then an actuary would need to calculate the present value of the future benefit obligations. That value would then be added to the present cost of current benefit plans to determine the maximum funding level. This calculation is based on the return of investment associated with the historic annual return of the investment portfolio selected for pre-funding.

Which employee benefit plan obligations are eligible for pre-funding with variable investment accounts?

Benefit cost can be pre-funded for the following Credit Union obligation that are fully insured or self-insured: Health Insurance, Dental Insurance, Prescription Drugs and Vision Insurance, Short Term Disability, Long Term Disability Insurance, Long Term Care Insurance, Executive Non Qualified Benefit Programs, Directors Benefit Programs, Qualified Retirement Programs, and Post Retirement Benefit Programs.

How does a Credit Union determine suitable investment options and manage these portfolios?

Normally a Credit Union would draft an Investment Policy Statement consistent with its objectives and then appoint an Investment Committee to review proposals from Institutional Money Managers who propose asset allocation models consistent with the risk preferences identified in the investment policy statement. Management of the portfolio is normally left to the expertise and guidance of the Institutional Money Manager who customizes an investment portfolio consistent with the investment policy statement of the Credit Union.

What are the timing requirements for review of separate account investments?

Pre-funded Benefit Programs need to be reviewed at least annually to demonstrate that segregated investment accounts have not over funded the present annual calculation of benefit cost. It is recommended that the investment committee review portfolio performance quarterly to evaluate manager performance in relationship to their peer group of Money Managers using a similar style of asset allocation. Within the investment policy statement guidelines should be identified which gives guidance to the Investment Committee concerning the criteria for its evaluation of investment performance results.

For Pre-funding calculations, what is the effect of interim benefit changes which increase or decrease the cost of benefit plans?

It is incumbent on Credit Unions to calculate its expected present cost of benefit plan obligations for the plan year. If during the plan year, benefit obligations change , then benefit cost should be recalculated and compared to initial pre-funding analysis to determine if capital investment can be added to the program or if capital investment needs to be removed from the program to prevent over-funding benefit cost. Credit Unions can alter at any time, their amount of pre-funding capital investment so long as the ROI on the capital investment does not exceed benefit cost as audited at the end of the plan year. Any excess earnings at the end of the plan year will be transferred back to the General Asset Account.

What is the process for Credit Unions to access investment gains during the plan year?

Credit Unions have access to both principle and investment gains during the plan year. Normally Credit Unions will audit plan cost and investment gains at the end of the plan year. At that time, investment gains are normally transferred to the Credit Union's General Account. Annual reviews and subsequent investment gain transfers provide for more accurate pre-funding calculations.

Under what circumstances can a Credit Union discontinue its participation in a pre-funding program?

Credit Unions can discontinue its pre-funding program at any time and transfer all capital investments back to its general account. Internal records should be maintained which identify the reasons for program termination to avoid regulatory challenges as to the Credit Unions participation with impermissible investments.

How do Credit Unions report on their financial statements the impact of capital investments used to pre-fund benefit programs?

Capital investments used to pre-fund benefit obligations normally are reported at book value where gains or losses are not realized until actual sale of the capital investment. Typically, a Credit Union will transfer investment gains at the end of the plan year by selling part of their capital investment representative of their investment gains. At the time of sale, unrealized gains or losses will be reported on the Credit Union's financial statements for the respective plan year.

What impact will pre-funding benefit programs with capital investments have on a Credit Union's ROA?

Capital investments in variable accounts will fluctuate in value reflective of market performance which could produce positive or negative results on ROA. In most situations, gains or losses will not be realized until the time of sale; therefore, the impact on ROA would usually be minimal.

What are the financial incentives for Credit Unions to consider pre-funding employer benefit obligations with variable investment?

For the 2007 calendar year, the average return on investment for Michigan Credit Unions was 4.50% and the average return on assets was about 1%. The financial incentives to pre-funding benefit cost with variable investments is that variable investments total returns have historically out-performed fixed income total returns which comprises the general portfolio of most Credit Unions. The difference in return on investment provides additional revenues to off-set the cost of benefit programs. .