Common triggers for an ‘expanded scope’ look by regulators
In a National Credit Union Association examination, a certain type of investment on a credit union’s books is likely to trigger extra attention from the examiner. In this post, I’ll describe what raises that red flag, and what you can do to prepare for—or even avoid—an “expanded scope” NCUA exam.
According to the online NCUA Examiner’s Guide, examiners should document the expected scope of an exam before the on-site portion of the exam. This includes identifying any areas that require an expanded scope.
The most common trigger for an expanded scope of your employee/executive benefits program is when you have investments that:
- are not allowable under the Code of Federal Regulations, Part 703, (and Part 704 where applicable) except when used for funding employee/executive benefits or for charitable donation accounts; and
- total more than 25% of your net worth (or 15% of net worth for a single non-government obligor).
Typical examples of this type of investment are those purchased to fund 457(f) non-qualified deferred compensation plans and split-dollar life insurance for supplemental executive benefits.
It’s not a given that your credit union would have to immediately change these investments. But NCUA examiners will want to make sure you understand the risk this level of commitment to this type of investment represents.
On the page of the guide that describes the employee benefits-related investments that should result in expanding an examination’s scope, the guide explains that these credits unions need to “demonstrate a higher level of understanding and due diligence, which includes more sophisticated processes, controls, and governance.”
Here’s some advice to help you prepare for this type of expanded scope examination:
1. Be ready to answer basic questions about benefit program investments.
Board members and executives may be questioned about the types of products used in senior executive benefit plans, such as a 457(f) non-qualified deferred compensation plan or a collateral assignment split-dollar life insurance program.
Also be ready to address exit strategies for investments. What happens, for example, if an executive leaves or is fired before becoming vested in a deferred compensation plan? For insurance products, the exit strategy should address the adverse impact of early surrender.
2. If you have documentation from product providers, be ready to show that you understand the products and that the provider is trustworthy.
If board members and management need a refresher on the products you’ve used to build your employee benefits funding program and executive compensation packages, work with the product providers for a quick overview before your next examination.
However, you should also have your CPA and attorney review the products and agreements involved in these programs. Vendors—even long-term, trusted providers—are not neutral parties.
According to the guide, “When evaluating a credit union’s due diligence process, field staff should place more weight on internal analysis conducted by a credit union versus analysis prepared by a third party.” (See Supervisory Letters No. 07-01, and 07-13: Evaluating Third-Party Relationships.)
In short, you need to be able to provide evidence of your own due diligence. This should include your product research, and the ratings and track records of the providers themselves.
3. The board must be especially involved and aware of investments for executive benefit packages.
Most credit union board members are acutely aware of their oversight obligations regarding investments. But when the investments are attached to executive benefit packages, oversight is doubly important because of the potential for conflicts of interest and unrealistic projections.
On the Expanded Examination Scope page, the guide states:
A credit union’s board needs to apply enhanced oversight if the investments for employee benefits are for senior executive benefits. For example, management should not focus primarily on the benefit of any related investments in optimistic scenarios while putting less focus on potentially negative scenarios. Furthermore, boards are often presented investment and plan structures that appear to be “zero cost” (that is, the credit union projects that it will recover the benefit funding costs when the plan terminates). When evaluating a plan presented as “zero cost,” the board should ensure the proposal accounts for all costs, including any lost earnings potential.
Assume that examiners will assess not only the nuts and bolts—products, contracts and earnings—of your employee benefits funding program, but also your policies and procedures for ensuring due diligence and ongoing oversight.
Following these three practices can do more than help you prepare for an expanded scope examination of your employee benefits funding program—it can help you create a program won’t raise any red flags to begin with.
John Pesh, CCE, is director of executive benefits TLE for CUNA Mutual Group, Madison, Wisconsin, a CUESolutions provider. For more information about using the online NCUA Examiner’s Guide to create a robust investment program to fund your employee benefits, download John’s eBook produced by CUNA Mutual Group in association with CUES.