Split-dollar agreement best practices

Split-dollar life insurance agreements can be a valuable tool to attract and retain executives. Though there are two types of agreements, the endorsement and collateral assignment, there are various ways to set up the arrangement with the executives — some more beneficial to the financial institution than others. 

As a refresher, the difference between the endorsement and collateral assignment is dependent on who owns the insurance policy. In an endorsement agreement, the insurance policy is owned by the financial institution and the executive’s rights are filed with the insurer under an endorsement. For endorsement agreements, the financial institution records the value of the life insurance as an asset and records a liability for any postretirement benefit owed to the executive, usually the estimated cost of maintaining life insurance after retirement. With a collateral assignment agreement, the executive owns the life insurance policy and the rights to the policy are assigned to the financial institution. A collateral assignment agreement is recorded as a note receivable for the premiums paid by the financial institution based on the terms of the agreement between the executive and the financial institution.

Most plans are set up for the CEO and other executives and approved by the board of directors. Since the board should approve the arrangement, it needs to fully understand the details, including the costs and benefits for the financial institution, before entering into an agreement. To best protect the financial institution and the executive, the following should be considered:

• The agreement including all associated documents must be maintained and well documented. Since the agreement can be outstanding for many years into the executive’s retirement, without well-documented records, the benefits intended for the executive and/or financial institution could be lost in translation through staffing changes and/or mergers.
• For collateral assignment agreements, there may or may not be a rate set for the note receivable. If the agreement does not have a stated interest rate, the executive will be required to pay tax on the imputed interest, so it is important that this be communicated to prevent the executive from being blindsided at tax time.  In some instances, the financial institution may work out an arrangement with the executive to cover the tax effect of imputed interest. If this arrangement is made, it is also important to document it and obtain board approval.
• Be sure to obtain the signed notes for the premiums paid for collateral assignment agreements. If a new note agreement is set up for each year that a premium payment is made, the financial institution must have a process in place to ensure the agreement is signed. Without the notes, the financial institution may not have recourse to collect. 
• When deciding on the terms of a collateral assignment arrangement, the board needs to ask questions and document its intent and understanding. Some questions and considerations when working out the details are as follows:
  • Will the premium note receivable be paid back based on a scheduled payback period, or will it be paid only upon death of the executive?
  • If the insurance policy cannot cover the outstanding note receivable, will the executive be responsible for the difference?
  • Will the financial institution receive a portion of death proceeds as well as the premiums paid?
  • Will the financial institution receive interest on the note receivable?
  • Can the executive borrow against the policy, and if so, what is the limit?
  • What is the financial institution entitled to if the agreement is cancelled?  Is it the lesser of cash surrender value or premiums paid?
• Another consideration before entering into an agreement is how it could affect future executives. These arrangements can sit on the balance sheet for many years and could inhibit the institution from offering arrangements to the next generation of executives.  There may be regulatory and/or self-imposed limits on these receivables, so it is important to allow for these future needs.
• For collateral assignment arrangements, the note receivable for premiums paid is meant to be repaid via the insurance policy. Like any other investment, life insurance policies are not guaranteed and are subject to market volatility. The financial institution must evaluate the collectability of the note receivable like any other loan on the books and determine whether a reserve is needed. The financial institution must also recognize obligations it has to the executive that are not connected to the performance of the life insurance.
• Before finalizing any agreements, the board should consult with independent legal counsel to help ensure that the agreement between the financial institution and the executive is consistent with the board’s intent. The agreement should include terms for payback of the premiums as well as any other deferred compensation plans tied to the life insurance policies.
• It is also important for the institution to consult with its CPA before signing any documents to help ensure the accounting for the agreement will be consistent with the financial institution’s understanding of the arrangement. This includes any amendments made throughout the life of the arrangement.

Though these arrangements can be complicated and confusing, with the appropriate due diligence conducted, they can be a win-win for both the executive and the financial institution. 

Please feel free to contact Alison Herrick at alison.herrick@wipfli.com with any questions or assistance you may need. Wipfli provides various audit functions for financial institutions, including financial statement audits, internal audits, compliance audits, information technology general control reviews, cybersecurity reviews, penetration/vulnerability scans, social engineering, benefit plan audits, and many other services.