It's Time to Recreate Credit Union Share Insurance

For the past three years there has been an exodus from the federal credit union system. The trickle is turning into a torrent. While field of membership is often a precipitating event, the momentum is about a bigger issue: the responsiveness of the credit union charter in an era of extraordinarily rapid change.

 
 

For the past three years there has been an exodus from the federal credit union system. The trickle is turning into a torrent. While field of membership is often a precipitating event, the momentum is about a bigger issue: the responsiveness of the credit union charter in an era of extraordinarily rapid change.
More and more credit unions are looking not just to state charters, but outside the credit union system for opportunity. Changing charters for FOM flexibility is only part of the constraint. The major concern is the unlimited reach of the NCUSIF insurance authority. Without a change to cooperative insurance or change of a new charter, NCUA through its insuring power, still sets critical limits on the evolution of every NCUSIF insured credit union.

Once New-Now Old
Credit unions in 1984 changed the face of federal insurance by creating the first federally managed fund that grew at the same pace as the insurance risk. The 1% deposit plan not only capitalized the fund but established a system that relied on self-help, not governmental bailouts, for solution to any system crisis.
The NCUSIF, using the model of the state based credit union share insurers, has worked better than any other federal fund. Both the FSLIC and FDIC required Congressional action to maintain those fund's commitments to their depositors. The NCUSIF came through this same period without a single glitch. The NCUSIF never sought or received any public assistance; whereas the American public is still paying for the thrift/FSLIC problems.
In the last five years when losses to all three federal funds have been minimal, the NCUSIF has still proved to be a superior system. For instead of hoarding capital, the fund, as required by law, has paid dividends of over $500 million to the Fund's credit union owners.
The critical question is whether a fund designed on principles over 20 years old is still the appropriate model for today. Is there evidence that change is overdue?

The Return of the Prodigal Fund
The extraordinary success of the NCUSIF has produced an extremely troubling side effect. No insurance losses have been charged to the P&L for the past five fiscal years. (see graph 1)
However NCUA has routinely charged 50% and more of its total operating expenses to the fund. The result is that over $254 million has been charged to the NCUSIF for "administration" in this same timeframe. In the FY 2000 budget, these costs are planned at over $60 million.
Since the fund was capitalized in 1985 the amount of NCUA's operating expenses charged to the fund has risen from $10.8 million to $58.4 million, a 535% increase.
(see graph 2)
No outside authority approves NCUA's budget. No congressional funds are used to run the agency, therefore no congressional or executive control is available. The result is that while the number of federally insured credit unions has declined by over 7,000 in the past 20 years, the cost of insurance per credit union has risen from $726 in 1985 to $5,494 in 1999, an increase of 756%. These are strictly the administrative expenses and include no loss provisions for years in which losses occurred.
The role of the NCUSIF has shifted from funding insurance activities to underwriting the operating costs of the federal charter. In essence, the state charters are providing a subsidy to the federal system.
The consequences are more than a discussion of accounting transfers and fairness. Because the NCUA has been exempt from assessing the full amount of its operations on its charters, it has not been accountable in the management of its core supervision and examination processes. The NCUSIF is being used to underwrite outdated cost structures and business processes that would need to be rethought if the full cost were being borne by the federal system.

The Urgency for Change
Why look for a better way?
There are at least six reasons.

  • The time to make change is when the system is doing well. Both politicians and regulators are reluctant to try something new when there is economic uncertainty. Capital is at an all time high and credit unions have the capacity to take a new approach.
  • Federal insurance brings federal regulation. Whether the issue is member business loans, membership shares or capital adequacy both Congress and the NCUA have used the insurance power to impose their views of appropriate business practice for all credit unions. To restore the innovative role of the state charter will require a complete alternative to the NCUSIF.
  • Both the FDIC and banking lobbies are seeking changes in the FDIC's administration and coverage. The goal is to merge the BIF and SAIF funds and seek an expansion of the insured deposit coverage from $100,000 to $200,000. Any change sought by the FDIC in insurance will open issues for the NCUSIF. Anytime Congress looks at the Fund, changes could be made which would make it harder for the credit union owners to exercise their options. For example when HR 1151 was passed, Congress unilaterally raised the ceiling on the NCUSIF's size to 1.5% of insured savings versus the prior 1.3%. This change alone allows NCUA to keep over $600 million more in equity rather than paying these earnings to the credit union owners.
  • The Internet changes everything. In five years financial services will be dramatically different. Today the core of the credit union business model operates at breakeven. That is, if the non-interest income is subtracted from ROA, then the net income for most credit unions would be close to $0 or even negative. Federal insurance fosters uniformity rather than innovation. The key to change is many credit unions seeking new ways to serve members and sharing that learning with the movement. The state charters have been the traditional incubators for credit union breakthroughs.
  • Creating an effective insurance alternative is the most promising way to bring responsiveness to the NCUSIF. Competition makes any organization more attentive when their members have choice. A creative alternative may be the fastest way that those who wish to remain in the NCUSIF's orbit can make changes in the Fund.
  • It can be done. There is enough experience with insurance and momentum from credit unions to underwrite a truly national alternative to the NCUSIF.

Some Parts of the Puzzle
How could a new fund be better structured? A cooperative approach to insurance would recognize that 95% of the insured institutions will never need insurance or turnaround help. Moreover there will be periods when no insured institutions are truly at risk as in the last five years. The fund's strategy would focus on strengthening the entire insurance base, not just restoring credit unions with periodic problems.
This would be done by using the Internet and timely reporting to provide information for both the insurer and insured institutions. Today data can be collected and displayed for hundreds of institutions in minutes rather than the weeks and months that it takes for NCUA to make data available. There is significant opportunity to create an information system to help credit unions react faster than any other organizations to market driven changes.
The new fund would increase insured coverage. Accountability for the Fund's priorities would be established through limited board representation. Pricing rebates can be used to both assess risk and to help enhance the mutual guarantee aspects of a cooperative system.
The insurance partner could establish flexible capital structures to recognize both the solvency and the liquidity risks of insurance. The fund would also be able to use different corporate structures to manage different parts of the risk.
In sum, credit unions would have an arm's length business partner whose first priority is the soundness of the whole system through proactive change and information sharing.

Next Steps
The most important part of change is to find credit unions who are willing to do the pioneering work of developing the ideal insurance structure. This team then needs to engage the primary players including the leagues and state supervisors to describe the benefits of a new model. Because many different jurisdictions are involved, multiple action units would need to be formed. Rolling implementations in different states would have to be accomplished.
Creating an insurance system that would be a more responsive source of external capital for the credit union system is the primary action item. However the ultimate issue is the viability of the credit union charter. As consumers move away from insured products and traditional banking services become commodities, finding new ways to deliver value through the cooperative is the most urgent challenge faced by credit unions. No one has the answer because no one knows what the multiple solutions will be. Establishing an environment to facilitate change is the only way to win this challenge. The key to accomplishing this is a new cooperative insurance model.

 

 

 

Aug. 21, 2000


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