BOARD OF GOVERNORS
FEDERAL RESERVE SYSTEM
WASHINGTON, D. C. 20551
DIVISION OF BANKING
SUPERVISION AND REGULATION
SR 93-37 (FIS)
June 18, 1993
TO THE OFFICER IN CHARGE OF SUPERVISION
AT EACH FEDERAL RESERVE BANK
SUBJECT: Split-Dollar Life Insurance
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.
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.
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.
Stephen C. Schemering
ATTACHMENTS MAY BE OBTAINED FROM FEDERAL RESERVE BANK
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
SR letters | 1993