NYLEX Benefits - Not-for-Profit Organizations

Not-for-Profit Organizations

Recruit, Retain and Reward Top Performers

Many not-for-profit organizations are creating supplemental executive benefit plans to help recruit, retain and reward top performers.These plans can help you remain competitive in the marketplace for executives who have the talent to make a difference for your organization.

How Can Your Not-For-Profit Organization....

• Structure benefit packages for key executives that help them maximize their after-tax income?
• Attract top-flight management level talent that may be working in the private sector?
• Provide incentives for selected executives that encourage tenure with the organization?
• Provide retirement benefits commensurate with executive pay?
• Create management benefit packages that motivate long-term performance?
• Upgrade management benefits without jeopardizing the tax-preferred status of your organization’s qualified pension plan?

The Need

Qualified pension plans and social security provide limited incentive for talented executives to improve the financial performance of not-for-profit organizations, or to even remain with your organization. In fact, qualified plan benefits can be an incentive for executives to leave, because of early vesting and full portability.

Qualified plans do not provide top executives with retirement benefits that are in line with their pre-retirement compensation levels or with their contribution to the economic success of the organization.

Not-for-profit organizations are competing with for-profit companies for executive talent. Total compensation packages of not-for-profits must be competitive with those offered by all employers.

Because of this disparity and the heightened competition for talented managers, many tax-exempt organizations are following in the footsteps of tax-paying companies by creating supplemental benefit plans for their top executives.

The 2008 Replacement Ratio Study conducted by Georgia State University and Aon Consulting indicated that in order to maintain their pre-retirement lifestyle, many senior executives earning more than $250,000 would need retirement income at about 88% of pre-retirement levels.  At current levels, an executive earning $250,000 per year, for example, would receive a Social Security benefit of about 14% of that income.

When considering that an employer’s qualified plans are subject to statutory limitations, the gap between a replacement ratio of 88% and what an executive would receive from Social Security plus qualified plans is significant.

Because of this disparity and the heightened competition for talented managers, many not-for-profit organizations are following in the footsteps of for-profit companies by creating supplemental benefit plans for their top executives.

A Well Designed Supplemental Benefit Plan Can…

• Provide additional post-retirement income for selected executives.
• Provide sufficient cash to executives upon retirement to meet the income tax liability issues associated with IRC §457(f) benefit plans
• Provide retirement benefits to executives of your organization that are comparable to your tax-paying peers and competitors.
• Establish performance benchmarks that must be attained before supplemental retirement benefits are awarded.
• Comply with ERISA restrictions on participation, funding and vesting.
• Provide performance-based incentives for executives.
• Replace benefits lost when an executive leaves a previous employer to work for your company.
• Protect executives from the risk of change of control.

The Payoff

For the Tax-exempt Organization:

Remain competitive in the market for executives who have the talent to make a difference for your organization.

For the Executive:

Achieve greater retirement security as a reward for superior performance.

The “Plus” In Serp-Plus-457™

NYLEX Benefits has developed SERP•PLUS•457™, a unique and proprietary management tool and actuarial modeling system. This system helps not-for-profit organizations design the best Supplemental Executive Retirement Plan (SERP) arrangements to meet their specific objectives in the most efficient and cost-effective manner. Efficient financing of benefits can:

• Provide your organization with the cash wherewithal to pay benefits when they become due,including the income tax liabilities of the executives
• Establish favorable accounting to minimize, and ultimately offset, the impact on your bottom line
• Provide recovery of 100% of the executive benefit liabilities

To Top

Use of Company-Owned Life Insurance (COLI)

Why finance the benefit promise?

• Pre-funding makes sound economic sense for the organization.
• Provides a measure of security for the executives, especially when combined with a Rabbi (Grantor) Trust.
• Rationally builds an asset to offset the benefit liability.
• Optimizes the cash flow impact of benefit payments to executives once they retire.

Why does COLI make sense?

• COLI can provide funding wherewithal, giving the organization another source of cash to pay benefits when they become due.
• COLI can be structured to provide a pre-retirement survivor benefit to executives on a tax-advantaged basis, in addition to providing cost recovery for the organization both pre- and post-retirement.
• COLI is self-completing, providing cash through death proceeds upon the death of each insured executive.
• COLI can provide a very favorable accounting treatment under FAS TB 85-4 to offset accounting for the benefit liability.
• COLI can be structured to provide recovery of the cost of benefits, cost of the financing itself (COLI premiums), and a factor for the use of cash.

Why not buy term and invest the difference?

• Term insurance has no cash value.
• Term insurance cannot provide any favorable accounting to offset the benefit liability.
• Term insurance cannot be economically structured to provide tax-advantaged pre-retirement survivor benefits.
• Term insurance cannot provide for self-completion nor cost recovery, since it cannot be economically purchased past retirement age, when the likelihood of mortality is the greatest.

COLI and SERP-PLUS-457™

• Insurability is of no concern since the COLI is used to create a pool only on insurable participants.
• Level face amounts are purchased through aggregate funding to minimize carrier underwriting issues.
• Pre-retirement split dollar arrangements are used to confer tax advantages on executives.

To Top

Frequently-Asked Questions About Company-Owned Life Insurance (COLI) & Not-for-Profit Organizations

Company Owned Life Insurance (COLI) is commonly used by organizations and business entities to provide key-person protection and as a stable financing vehicle to provide informal funding for various compensation related deferred obligations, such as benefits covered under a "nonqualified," "unfunded," supplemental executive retirement plan (SERP).

Q: Why do not-for-profits institute COLI programs?

A: Primarily to finance employee benefit plan expenses.  The reasons not-for-profits use COLI include:

• COLI matches the long-term nature of benefit plan expenses.
• COLI assets can be matched with benefit liabilities to offset the impact on earnings created by the benefit expenses.
• Use of COLI to fund benefits is a self-completing program.
• COLI can be structured so that the not-for-profit funds its benefits obligations and recovers its premium cost as well.
• COLI death benefits or cash value assets are available to pay pre-retirement survivor benefits.
• COLI provides important indemnification for the loss of one or more key executive (key person life insurance).

Q: Do many employers have COLI plans today?

A: Many not-for-profits, including some of the country’s largest, are using COLI to fund benefit obligations. For-profit companies also use COLI in this way. Based on industry surveys from 2007, 75% of the Fortune 1000 companies finance SERP obligations with COLI programs; and of the 50 top banks and thrift institutions in the United States, 43 have implemented COLI programs.

Q: How does COLI work?

A: The not-for-profit purchases insurance on lives of a group of employees.  The insureds usually request a group of highly compensated or key management employees.

The not-for-profit pays the premium(s) and owns the cash value of the policies.  The not-for-profit is also the beneficiary of the insurance.  The insured employees do not receive any of the insurance benefits directly, nor do they pay any of the premiums.  The coverage does not replace nor interfere with any other insurance provided by the not-for-profit (e.g., group-term life insurance) or insurance held by the employees.

The COLI policies produce financial statement income for the not-for-profit as the cash value increases exceed the premiums paid.  The income earned may be higher than the return available on other alternative investments.

Q: Do the policies actually fund the benefits like a pension plan funds retirement benefits?

A: No. The policies are part of the general assets of the not-for-profit. Properly stated, the insurance informally finances the cost of the benefits.  The policies are often placed in a grantor trust (generally a “rabbi” trust), which is an asset of the not-for-profit, or they may be held by the not-for-profit directly.

MAKING A COLI PLAN WORK

Q: Do the insurance policies have to be placed into a separate trust?

A: No, the policies always remain subject to the claims of the unsecured general creditors of the not-for-profit.  To provide some additional limited security to plan participants or for other administrative reasons, the not-for-profit may choose to implement a grantor trust to own and hold the policies.

Q: Does the not-for-profit keep the insurance coverage when the insured employees terminate or retire?

A: Yes. The coverage on each individual insured is carried as part of an aggregate COLI pool.  To make sure death benefits are collected on retired employees on a timely basis, we track all covered employees in COLI pools administered by NYLEX Benefits via the Social Security System.  When the retired employee dies we access information via the Social Security System so the policyholder can file the death claim with the carrier.

Q: What has been employee reaction to the plans?

A: Very favorable.  Keep in mind, the coverage does not cost the employees anything.  It makes the employer more financially viable and it is a plan that has been implemented by many of the country’s largest and most reputable not-for-profits and regular corporations.  While an employee is not required to consent to be insured within the COLI pool, our experience is that well in excess of 90% do participate.

Q: Do the employees receive any of the cash benefits from COLI?

A: Generally, no.  However, some not-for-profits provide additional survivor benefits to insured COLI participants.

Q: How long does it take to implement a COLI arrangement?

A: Normally 2 to 3 months from start to finish.

COLI FINANCIAL IMPACT

Q: Will COLI have an impact on a not-for-profit’s financial performance?

A: COLI will favorably impact a not-for-profit’s financial performance by creating net income to offset the benefit expense.  The result is an increase in earnings.

Q: Are COLI premiums a charge to earnings?

A: To the extent that COLI premiums result in cash surrender value, the not-for profit is treated as having purchased an asset. COLI premiums (except for the recognition of any early surrender charges) require a cash flow outlay, but over time enhance earnings.

Q: Is COLI liquid?

A: Yes. COLI policies allow the not-for-profit to borrow against the cash value, and the policies can be surrendered at any time and the cash value will be paid to the not-for-profit.  In very large COLI programs, some carriers may require a 4 to 5 year surrender period to allow them to gradually wind down their investment in the arrangement.

Q: What happens if the coverage is surrendered?

A: The carrier pays the not-for-profit the cash surrender value of the policies.

Q. What is the credit risk of a COLI program?

A: Before any COLI purchase, the not-for-profit should carefully review (with our help) the financial strength of each proposed carrier, as well as its track record in the market.  Regardless of product type, the financial strength and reputation of a carrier is critical to the future viability and credibility of a COLI program.

Q: What happens if we wish to change the COLI insurance carrier?

A: In such a situation, the coverage may be transferred to another carrier via an IRC Section 1035 tax-free exchange.

Q: What is the effect of a policyholder merger on COLI plans?

A: Merger and acquisition activity has no direct impact on COLI performance.  However, for an acquiring not-for-profit, the COLI from the acquisition should be a beneficial addition to its existing portfolio.  It will be reviewed in terms of concentration and credit for the newly merged entity.  For the not-for-profit being acquired, COLI is an attractive balance sheet asset and will enhance the net worth and earnings results.

COLI ACCOUNTING TREATMENT

Q: How is the income earned and recorded?

A: The not-for-profit earns income in a COLI arrangement from two sources.  The first is from the growth of the cash value of the policy.  While the full cash value works for the not-for-profit, the not-for-profit records as an asset the cash surrender value (the full cash value less any applicable surrender charges in the event the contract is surrendered in the year being recorded).  The cash value increases each year as the insurance carrier credits interest or as the separate account increases in value.  The second source of income comes from the insurance proceeds paid to the not-for-profit when an insured employee dies.

The accounting treatment for a typical COLI plan can be summarized as follows:

• COLI purchase is reflected as an OTHER ASSET.
• Earnings (increases to cash surrender value) will be recorded as a credit to an income account (OTHER INCOME).
• Receipt of the net-at-risk portion of death proceeds is also reflected as a credit to an income account (OTHER INCOME).

Q: How does the balance sheet change with the purchase of COLI?

A: The not-for-profit will normally use funds generated through cash flow to purchase COLI.  Since both are assets, there is no charge to the balance sheet (other than the possible recognition of an early year COLI surrender charge).  The income statement will show additional income, which translates into increased surplus.