LifeNotes Strategy Use Cases: How Credit Unions Can Add Flexibility to Life Insurance Based Executive Benefits

In a previous “C.U. on the Show” episode, Jay Rogers, senior executive consultant and director of business development at Stearns Financial, shared the firm’s groundbreaking LifeNotes Strategy. For over 40 years, Stearns Financial has worked with credit unions in succession and yield planning, retention, and balance sheet optimization. Its proprietary method involves credit unions and executives selling their life-insurance-based plans, such as collateral assignment split-dollar (CASD) or credit union-owned life insurance (CUOLI), which are no longer producing intended outcomes. The strategy helps credit unions develop more adaptive programs that reduce duration risk and increase value to credit unions and participants. In exchange, the plans are modified, for example, to provide a guaranteed annuity tied to a fixed maturity date rather than floating while maintaining the tax-free nature of the plan’s payments.

In this episode, Eric Stearns, principal at Stearns Financial, shares real-life use cases of how the LifeNotes Strategy has helped credit unions with various challenges, specifically in their CUOLI plans. It comes down to time versus money, a tradeoff that allows credit unions and participants to gain more value and the flexibility to maneuver in a changing world.

Use Cases of the LifeNotes Strategy

#1 Managing Percentage of Net Worth for Compliance Purposes

During the pandemic, financial institutions had more leeway in the amount they could invest relative to their net worth. In one example, a growing credit union with $100M in assets and a net worth of $10M had $6M invested in a life insurance policy backed by a single carrier, New York Life, one of the most secure insurance providers in the country. The policy was netting around 4.5% in returns. While there was little concern about New York Life’s solvency, as the world returned to pre-pandemic levels, regulators wanted the credit union to actively reduce its investments to less than 15% of its net worth. Stream the episode to hear how the LifeNotes Strategy helped optimize the asset, applying dynamic allocation to increase the credit union’s yield and become compliant.

#2 Increasing Liquidity in a Credit Union’s Portfolio

The CFO of a multi-billion dollar credit union wanted to increase its portfolio yield. The credit union had $100M invested in a life insurance policy with an annuity rider of 2% monthly. While the investment provided stability, it was less liquid than expected. The CFO wanted to address liquidity while keeping the insurance benefit in force when appropriate and increasing returns. Learn the details of how the LifeNotes Strategy separated the returns on the cash value of the policy and the returns on the life insurance to maintain the benefits, increase yields, and gain nominal liquidity.

Stream the full interview to hear Eric’s in-depth explanation of these two use cases, plus:

  • Hear how the strategy is possible and what tradeoffs credit unions must first consider
  • Learn about the minimal impact on the credit union and insurance provider relationship
  • Find out how credit unions and other investment groups can leverage the LifeNotes system

Listen now and be on the lookout for the second part of this interview featuring use cases involving collateral assignment split-dollar plans.

Jay Rogers, Eric Stearns, and Stearns Financial are not affiliated with or endorsed by ACT Advisors, LLC.

Audio Transcription (pulled from the podcast)

Doug English  (00:00)

Today on the show, we have Jay Rogers returning from the Stearns group to talk about the strategy we discussed last time. Now the strategy Jay and I discussed was this new innovation Stearns has developed that allows credit union leaders to have CUOLI or collateral assignment split-dollar options that have never been seen before. So with the reaction we got from the first episode, we decided to open up a second episode and really focus on use cases for this innovation. And with that Jay do you want to go ahead and introduce Eric?

Jay Rogers  (00:42)

Yeah, certainly. Thanks for having us back on, Doug. We’re excited to be here. I thought it would be really valuable for your listeners to not just hear my take on this, or even just Eric’s take on what we’ve built, but to be able to grasp some of the actual cases that have already gone through and moved in with this. So what we’ve seen, as you touched on the CUOLI side and the collateral assignment split-dollar side, we have been working with many credit unions already at what will refer to for this episode as the LifeNotes Strategy. And we’re going to go over a few of those cases today, and Eric Stearns, who is the principal of Stearns Financial Group, and really the brains behind the LifeNotes Strategy is going to go deeper into some of these case studies that we’ll see on how they’ve added value to these credit unions. So I think that’s the best use of our time here today. Eric, would you like to jump right in?

Eric Stearns  (01:52)

Yeah. Thanks, Jay. Certainly will. So I know a lot of you out there listening might recall I often joke that my knowledge shed is a foot wide and a mile deep. Part of having that mile-deep philosophy is that we took a very deep dive into how these programs work, specifically split-dollar life and credit union-owned life insurance—investments in general that we work on with our clients. And at a very high level, what we’re talking about and what the relative tradeoff is between priorities at the credit union, all comes down to time versus money. And that’s something that’s going to be very familiar if you’re sitting in the CFO role or the CEO role, you’re thinking about the relative tradeoff you’re making inside your portfolio, from an ALM perspective on mortgages, business member loans, car loans, credit cards, or other kinds of investments you may be making to generate a portfolio that’s going to have the outcome you’re trying to achieve. And we do the same thing when we look at split-dollar and credit union-owned life insurance when we’re looking at an investment amount and duration tradeoffs for every dollar of benefit being created. So we’re trying to create this optimization from a financial standpoint. And I’m going to say that once we go through the exercise of understanding what the benefit should be and how it can be used strategically at the organization, it then really turns into this optimization problem. And that’s how we approached this when we started really in earnest developing this about two years ago. And really over the last year, all of these things started coming together, and they started coming together at a very appropriate time, given the changes in the interest rates and markets and so forth. Because what we’ve come up with creates a set of tools, it’s a set of tools we can then use as professionals in the deferred comp space to create the type of retention and incentive packages that are really needed for retaining talent at your credit union, whether it’s the CEO and CFO or other senior management, doing that in a way that’s going to be more financially advantageous for the credit union and produce for the executive that has the plan, the participant in the plan, exactly what they need, and do it in a way that’s going to be more secure. So we created this, what we’ll call Secured LifeNotes Strategy. And some of the goals that we went in with and really part of the reason for doing this was taking on plans that maybe other, what we’re going to call independent agents, maybe a local agent had put together for a credit union. And as a national organization, we work with hundreds of these across the country. So we would often pick up a plan here or there. And those plans, what we found was they were really not going to produce what was originally intended. And they weren’t going produce that because of some of the factors we’ve seen over the last five, 10, even 20 years in a decreasing interest rate environment that’s impacted dividend rates, insurance companies crediting rates on the IUL products, and it puts some people in not the best position because all of a sudden you’ve got a plan you really were expecting to happen, things were expected to work out, and they’re not really occurring. So that’s really what drove us into this to say, how can we solve this in a way that’s really going to make sense for everybody. The spinoff of that was this tool set that allows us to do a whole bunch of things. And the questions that came out of the first podcast really led to the idea that we should share some of the ways we’ve used this tool set we’ve created on a case-by-case basis.

Doug English  (06:02) 

Yeah, and I think in our pre-discussion, my understanding was it seems like the CUOLI space is the easiest one to explain, with the interest rate change we’ve seen when rates are much higher than they were a few years ago. CUOLI may be the easiest one for our listeners to be able to immediately grasp. So can you give us some examples of that, Eric?

Eric Stearns  (06:28)

Absolutely. Yeah. So the interesting thing with CUOLI is that as interest rates decrease, the rate of change of the interest rates is slower at an insurance company than it is in the market in general. In other words, there’s a lag effect, a one- to two-year lag is what we see statistically. What that really means where the rubber meets the road is when you’re comparing an investment that’s earning, maybe your mortgage is getting 1% net or 2% net, which is the position we were in a few years ago, or even six months ago; it’s been a crazy year. But comparing that to a credit union-owned life insurance program that might be netting 2.5% or close to 3%, that looks pretty good. But if you reverse that picture, as the interest rates start to rise, that lag effect still occurs, which means you’re still going to have a 2% or 3% return, and now you’re getting 5% or 6% on a mortgage. So in a rising interest rate environment, it looks less attractive. Now there’s a very strong case for looking at the long-term picture, which, if we do look at that long-term picture, 10- to 15-year timeframe instead of 1- to 2-year timeframe, it begs the question, how do we maximize what you’re really going to get out of this credit union-owned life insurance program? And for an example, I want to give you an example of a credit union we worked with, $100 million in assets. So, a growing credit union, but on the smaller side of credit unions in general. They had a net worth of $10 million and they had $6 million invested into one life insurance policy. And that life insurance policy was netting them about 4.5% to 5%. The insurance company that backs that policy is New York Life. So they’re by almost every measure the most secure life insurance company in the United States. There was little actual concern about the solvency of New York Life. However, regulators were still very keen on the idea that you shouldn’t have more than 15% of net worth in any one insurance carrier. And with that guideline, 25% of net worth in any normally impermissible investments, they wanted the credit union to actively dial back that investment. Now, that was pre-COVID. Of course, the world changed a lot once COVID hit. And what we saw was there was a little more leeway in that because that was still a 5% asset in a time when we had 0% interest rates. So now that we’ve kind of come full circle, we start to see pressure on how we manage the compliance aspect of that. What we were able to do is take this program and put it into our LifeNotes Strategy. And the result of that was that the credit union is now earning 30 plus 360 basis points. So that’s the 30-day moving average of the secure overnight fund rate that’s published by the New York Fed, plus 3.6%. So they’re getting an API of 6.29% in the current month and the nice part is that it floats so it’s going to be a very ALM friendly rate. As interest rates go up, as interest rates go down, it’s going to be very sensitive, but because of that addition of 3.6% it’s not going to go below that. So it has a floor just like your life insurance, because it still is life insurance backing this program, the strategy, and the life insurance has a guaranteed rate of return underneath it. So what we were able to accomplish with this strategy is that now they’re at 15% of net worth backed by life insurance assets. And the remaining portion is now a permissible asset of the credit union. Their weighted average return is just over 5%, which means they were able to maintain that high yield they wanted to maintain while getting into compliance. This strategy and some of the flexibility that it allows is that the percentage of net worth versus of 701.19 are normally impermissible investments tied to employee benefits versus 703.14 investments that are permissible investments are dynamically allocated. So as their net worth changes, we can immediately adjust that and that allows them, a $100 million credit union where the CFO is wearing a lot of hats, to optimize that percentage of net worth, take as much advantage of it as possible and remain in compliance. And you know, in a larger credit union you might have a full department dedicated to optimizing that formula. Well, here we are, it’s hitting the easy button.

Doug English  (11:35)

Very interesting. So with the use of the LifeNotes Strategy, you achieve two objectives, you increase your return on the asset, and you optimize the type of asset in your net worth structure. The other thing I want to understand is the credit unions that have existing relationships with executive benefit specialists, with agents, with various professionals. They don’t have to just leave them behind and sign up with you guys, right? They can somehow work together.

Eric Stearns  (12:08)

Yeah, absolutely. So this is a strategy that allows us to keep the assets in force and in place. In fact, it relies on this idea that we need to keep the life insurance in force to maximize how much value is coming out of the program. I like to say we created a really nice mousetrap. But it’s a mousetrap everyone can take advantage of. We created a product that we saw was needed in the marketplace so we could use it as Stearns Financial Group but LifeNotes exists independently. And we have partnered with many other organizations that do similar or very similar, or even the same things we do as Stearns Financial Group, to allow them to have these tools available as well, because as you’ll see in the couple of cases we’ll talk about, this has a broad ranging applicability to fixing inforce plans, also to shortening duration or increasing yield. As I said, it was kind of born of the idea that we needed to take action on some of these programs that weren’t going to necessarily produce what everyone thought they were.

Doug English  (13:17)

I think that’s a really important point, because these relationships are powerful, multiyear relationships. And knowing a credit union doesn’t have to break that relationship to gain this flexibility I think is an important detail. So option one was under CUOLI. This use case is where a credit union is looking to increase their yield and optimize the type of asset that is in their net worth. And so it dynamically optimizes the type of asset and increases the yield. So that’s an easy first use case. What’s your second one under CUOLI?

Eric Stearns  (13:57)

Sure. So this second one under CUOLI, I’m going to kind of combine a couple of ideas into it and look at it as a CFO who is looking to increase or add to their portfolio, increase their portfolio or add to the yield and the portfolio. The use case here is actually a multibillion-dollar credit union. And they have just under $100 million of credit union-owned life insurance. So they’ve made some significant investments already. And they’re looking to add a little bit more, but they’ve realized what all the listeners may have realized, which is life insurance, as CUOLI, ends up being a little less liquid than you really like to think because there are some strategic risks involved. Once you have somebody go through underwriting, you may have some life insurance spinoff benefit to them. And if you ever wanted to liquidate that from the cash value, that means that person is not going to have that benefit anymore. So there’s some tie that gets created in these that is to an employee benefit as it needs to be for a permissible or normally impermissible investment. But it creates stickiness that doesn’t lend itself to liquidity. Additionally, you’ve got the kind of lag of the returns we’re seeing. In this particular portfolio, they had a lot of what I call a combination product that used an annuity rider, in addition to a little bit of life insurance, which adds some stability to it, the life insurance program, but it also means you’re not taking advantage of full life insurance returns, you’re only getting your net to 1.5; I think they were getting 1.9% return on that portion of their portfolio. So we can do a lot better while taking less overall risk. If it’s an optimization problem, from a finance standpoint, you’re looking to take as little risk as possible and get as much return for that risk you’re taking as possible and here they’re not being compensated for that. So this is something where we went in and we’re able to add this portfolio to the strategy. And this strategy kept those assets in force and used them in a different way. And by doing that, we essentially break the cycle we get into as credit unions. Why is the credit union going into a 2% annuity-based life insurance program? Well, the biggest reason we come up with is that all your friends are doing it, just because all the credit unions, everybody else has done it. So it must be a good thing. Well, not necessarily, there’s a better way to approach things that allows us to break the cycle or expand the cycle of the binary relationship that exists between a credit union and the insurance company. And by leveraging our expertise in this area, we can increase the return. So here, where the rubber meets the road, again, where it really matters, we were able to take the portion of the portfolio that we were working with, take it from a net yield of just over 2% and turn it into what we mentioned before, so for 30 plus 360. In other words, a net current net yield of 6%. So it almost immediately tripled their monthly income. And we were able to keep the life insurance portion that was assigned to those executives who had assigned life insurance—there’s some kind of spinoff benefit from just a pure life insurance standpoint—and give the credit union liquidity in that underlying asset. So now they can redeem, sell, or convert that cash value into spendable, loanable cash without impacting the executive benefit of the life insurance. And again, some of that dynamic allocation was a little less important for this particular client because their multibillion-dollar credit union did have a department dedicated to optimizing these things. So they didn’t necessarily need the dynamic allocation. But what they gained was liquidity. And the liquidity, or at least nominal liquidity, allowed them to have greater diversification. Now, instead of being backed by just a handful of carriers, it’s more diversified. And it’s a higher return. So they end up with a much better, bigger yield. With very little expended effort. This was a very quick like, yes, do it and make it happen.

Doug English  (18:29)

So, Eric, I want to see if I can restate that correctly. What I think here, what you’ve used the LifeNotes Strategy to do in this case, is you’ve sort of broken apart the insurance aspect from the investment aspect of the tools the credit union has used. And you have given them the ability to kind of keep the insurance, if that’s appropriate, and have the investment still exist, but at a much higher yield, right?

Eric Stearns  (19:01) 

That’s correct. It’s one of the curious things about credit unions versus the BOLI world—bank- owned life insurance. In some ways, I think the reason they’re doing it is because their friends are doing it. And the reason they do it really is because banks did it. And the reason banks buy bank-owned life insurance is for tax savings; it’s not so much for yield or return but because they have some very distinct tax advantages. And if you take away those tax advantages and strip that all out, the credit union can still take advantage of stable yields and very secure assets. However, because it doesn’t have those features, the cost of the life insurance really becomes an add-on cost and you don’t really need to bear as much of that as many credit unions are bearing. And if you choose not to have that cost, you’re essentially going into that strategy we just talked about where you have an annuity writer, so it has less pure life insurance, so there’s less cost, however, the return on that ends up being very low. So what we’ve done is created a way to take advantage of life insurance returns without having to have a direct impact on the cost of the life insurance or have essentially separated those two things—the return on the cash value versus the return on the life insurance. And by separating those and essentially parceling them out in a different way, we’ve maximized what a credit union can earn.

Doug English  (20:34)

It’s one of those things that kind of gets you thinking in the back of your head, sounds a little too good to be true. Like there’s got to be a catch here because you’re going from, I’ve gotten this benefit and it pays this rate of return and it was sort of semi locked in when I bought it. We all agreed this is what is going to be, we’re going to have this on our books for the lifetime of the executive in the split-dollar case that we haven’t got to yet I recognize that. We agreed to what these terms are. And what I’m hearing you say is that I can sort of redo that and modernize my interest rate-based return and also get flexibility. It seems a bit too good to be true to get both of those things without some kind of a cost to the credit union.

Eric Stearns  (21:31) 

There’s always tradeoffs. A lot of my formal training has been in economics and finance. And the professors are very quick to remind you there’s no such thing as a free lunch. So where does this really come from? And really, what you’re trading is the potential for a lump sum windfall at death. So if you think about the purchase of credit union-owned life insurance, it’s the stream of income you recognize as a result of the increase in cash value, and then a big check at the end. And if we take that big check at the end and say, well, why don’t we spread that out differently, and spread it out earlier in the program, you don’t end up with that big lump sum at the end but you end up with earlier. So that means your net internal rate of return is going to go up because you’re getting it earlier. However, there is something you give up to make that happen; you’re giving up some portion of that lump sum amount to spread it out. So it’s an explicit tradeoff, as I said early on, it’s time versus money. Is it more important to have a potential windfall 30 years from now? Or is it more important to have a cash flow stream? And there are very good reasons for having both, very good reasons for having credit union- owned life insurance, especially from a key person standpoint. If there’s an insurable risk, that’s the place for insurance. If you’re trying to earn a rate of return, the insurance is just going to be a drag on your return. So we need to do something else with it.

Doug English  (21:58)

Very, very interesting. And perhaps the biggest takeaway, just thinking about it from CFOs chair, is choice, the ability to react to change as the people in the executive suite change. And as credit unions merge, and as interest rates change, to have the ability to react, separate the insurance from the investments, put them together in ways that might make sense for the way things are today.

Eric Stearns  (23:25)

That’s correct. So I sound like an older person when I think about it, but if there’s one thing I’ve learned it’s that no one’s going to predict the future. What we need to have is enough flexibility and enough knowledge and enough wisdom to use the flexibility to maneuver to a changing world. And by giving ourselves those tool sets we can do this; it can work. These plans, split-dollar plans and credit union-owned life insurance, they’re very good products. The key to this is making them flexible enough to dynamically adjust to a changing world.

Doug English  (24:02)

So, one final thing Eric is again, you stated earlier that the LifeNotes Strategy exists independent of any executive benefits system or agent and those folks who have existing relationships can partner with Stearns to implement the LifeNotes Strategy. Who do they reach out to? What’s their method of getting in contact there?

Eric Stearns  (24:29)

Yeah, I say there’s always reaching out directly to me on LinkedIn. And or I would have to point them to Jay Rogers, who did the initial podcast. He and our associate Jesse Brady are leading the charge on the implementation and operation of that. So reaching out to any of the three of us would be a good first step.

Doug English  (24:50)

Thank you, Eric. Thank you, Jay. Listeners, be sure to check out part two of this interview. In the next part, we talk about use cases for the LifeNotes Strategy focused on the collateral assignment split-dollar and the impact for those looking for flexibility in that area.

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