Expanded Examination Scope

The purpose of the expanded scope is to identify potential risk to the credit union and evaluate management’s understanding of the employee benefit-related investments. Credit unions with an aggregate exposure to otherwise-impermissible investments greater than 25 percent of net worth need to demonstrate a higher level of understanding and due diligence, which includes more sophisticated processes, controls, and governance. When evaluating a credit union’s due diligence process, exam staff should place more weight on internal analysis conducted by a credit union versus analysis prepared by a third party.

The safe and sound use of otherwise-impermissible investments depends, in large part, on effective senior management and board oversight. Regardless of a credit union’s financial capacity and risk profile, its board must be sufficiently informed about the potential complex risk characteristics of the credit union’s insurance and investment holdings and the role these assets are intended to play in the overall business strategy. Although it may delegate decision-making authority related to purchases of otherwise-impermissible investments to senior management, the board is ultimately responsible for ensuring that the purchase and holding of otherwise-impermissible investments is consistent with safe and sound practices.

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.

Exam staff need to ensure that credit unions with otherwise-impermissible investments have strong controls, processes, and governance in place to adequately identify, monitor, and control the potential risk.

Specifically, from a safety and soundness perspective, exam staff will:

1. Determine whether the credit union conducted adequate due diligence over purchases of otherwise-impermissible investments. Adequate due diligence includes the following:

   1. Conducted sufficient due diligence over any third-party providers. For more information, see NCUA Letter to Credit Union 07-CU-13, Evaluating Third Party Relationships. If the credit union uses reports and analyses conducted by one or more third parties, the officers and management of the credit union must be able to explain the results in a manner that demonstrates sufficient understanding of all relevant risks.
   2. Evaluated alternative investment options and identified the risks associated with each alternative investment product considered.
   3. Considered compliance and legal risks, paying particular attention to insurance products due to their increased complexity. The credit union should seek the advice of counsel on legal and regulatory issues to mitigate the potential for compliance risk.

   4. Developed exit strategies for the investment products that address the potential:

      • Illiquidity of the investments.
      • Adverse impact of early surrender, in the case of insurance products.
   5. Documented and properly approved investment purchases.

2. Review the credit union’s ongoing oversight of otherwise-impermissible investments. In particular, determine if the credit union:

   1. Evaluates periodic reports to the board of directors on the otherwise-impermissible investments which may include, but not limited to:

      • Recently purchased investment products.
      • Significant changes in the performance or credit quality of existing investment products.
      • Any investments purchased that do not comply with the credit union’s policy.
      • Status of any concentration limits established.
      • Status of benefits for retirees.
      • Exit strategies for policies tied to terminated employees.
   2. Conducts additional board reviews if there are material changes in strategy, activity level, or a decline in the financial condition or performance of the insurance or investment counterparties.

Last updated September 25, 2017