BOARD OF GOVERNORS
FEDERAL RESERVE SYSTEM
WASHINGTON, D. C. 20551
DIVISION OF BANKING
SUPERVISION AND REGULATION
SR 94-23 (FIS)
April 12, 1994
TO THE OFFICER IN CHARGE OF SUPERVISION
AT EACH FEDERAL RESERVE BANK
SUBJECT: Split-Dollar Life Insurance at State Member Banks
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.
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.
Compliance With Applicable Law
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
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.
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.
Stephen C. Schemering
ATTACHMENTS MAY BE OBTAINED FROM FEDERAL RESERVE BANK
Supersedes SR 94-21 (FIS)
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
SR letters | 1994