Defray Increasing Employee Benefits Cost with Pre-Funding

John Moreno
March 19, 2009 | COMMENTS

The increasing cost of employee benefits will continue to eat away at the ROA of credit unions that can't increase their income—or cut benefit costs—to keep pace. The NCUA has opened a door to pre-fund employee benefits with investments that credit unions otherwise haven't been permitted to use for this purpose.

Given the foreseeable economic landscape, it's time for more credit unions to step through this door.

Pre-funding employee benefits is more complex than pre-funding for a specific liability, such as a defined-benefit pension. However, it can be done even if you lack the in-house expertise by using some due diligence and an experienced partner.

Diminishing Returns

Premiums for employer-sponsored health insurance rose an average of 7.7% in 2006 and 6.1% in 2007, according to the Kaiser Family Foundation's annual survey of employers. By comparison, overall inflation was 2.6% in 2007.

NCUA statistics show a net operating expense ratio of 3.34% through the second quarter 2008, compared with an investment income ratio of 3.08%. Employee benefits increases have certainly helped to drive expenses further beyond investment income, which has contributed to a steady drop in the industry's ROA from 1.07% at year-end 2002 to 0.52% through the second quarter 2008.

The Kaiser survey indicates that 21% of employers were “very likely” to raise their employees' premium contribution in 2008, while smaller percentages were very likely to increase deductibles and other out-of-pocket expenses. This may be unavoidable. But now that credit unions have an avenue to defray these mounting costs, why not consider it?

FAQs about Pre-Funding Employee Benefits

1. Which employee benefits may be pre-funded?
   Common expenses to pre-fund through investments include premiums for group health, group life, and short/long-term disability insurance; 401(k) matching funds; executive deferred compensation; future defined benefit plans; and retiree health coverage.
   
2. Which investment strategies are used?
   Banks have traditionally used bank-owned life insurance to pre-fund future employee benefits, because of its tax advantages. That is also a viable option for credit unions. However, because credit unions don't have the tax liabilities of banks, a diversified, conservative investment portfolio may offer more flexibility and income potential. Each credit union requires a thorough assessment to determine the best course.
   
3. What will auditors look for in pre-funding programs?
   As with any investment strategy, safety and soundness is the paramount concern when pre-funding benefit costs. You must show that your investment amount and projected return are strongly linked to your projected future benefit costs. Unlike 457(f) plans for executives, you are not funding an explicit obligation. You're projecting obligations that the credit union will assume in the future. Auditors will need to see that these projections are based on sound actuarial principles.
   
4. Are state-chartered credit unions allowed to use a pre-funding program?
   The concept of pre-funding with otherwise impermissible investments is available primarily to federal credit unions. However, some states automatically follow the NCUA rules and regulations with respect to state-chartered credit unions. Plus, some state regulators have specifically stated that they will permit pre-funding of employee benefits with investments that would normally not be allowed. Thus, before deciding whether to pre-fund, check with your state credit union regulator to see if it will be allowed.

Getting Started: The Hard Work Happens Before a Dime Is Invested

To lay the foundation for a pre-funding program, credit unions need a thorough assessment of their current and future benefit expenses.

The Board of Directors should join your CFO and other leaders in this process. Also include anyone who would be directly involved in implementing a pre-funding program, such as a general counsel or independent auditing firm.

Working with an experienced partner to develop a compliant program is critical. It should be a partner prepared to review and adjust the program annually, to keep the investments in sync with the credit union's balance sheet.

John Moreno is an employee benefits specialist at CUNA Mutual Group, a provider of financial services to credit unions and their members. Contact him at John.Moreno@cunamutual.com or 800-356-2644, ext. 6921.