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EXHIBIT 10.3
FIRST FARMERS AND MERCHANTS NATIONAL BANK
COLUMBIA, TENNESSEE
OFFICERS GROUP TERM REPLACEMENT PLAN
OWNER'S MANUAL
DECEMBER 18, 1996
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Introduction
Your bank has implemented an executive benefit plan designed by Bank
Compensation Strategies Group through David Shoemaker of our regional office in
Memphis, Tennessee.
Bank Compensation Strategies Group is a Minneapolis, Minnesota based company.
Our business is designing and marketing nonqualified compensation plans and
products for executives and directors of banks and other financial institutions.
This is our only business and our objective is to provide you with superior
advice and service and high quality products. We operate through a network of
Executive Benefits Consultants throughout the United States.
We are endorsed and recommended by the American Bankers Association, the
Tennessee Bankers Association, as well as 41 additional state banking
associations located throughout the United States.
We have prepared this Owner's Manual to provide the following:
- A plain "English" description of the plan which has been
implemented;
- Information concerning records you should maintain;
- Guidance concerning accounting procedures;
- A description of the type and frequency of correspondence you
should expect to receive; and
- Names of experienced contact people at our office if you
should have any questions.
Please do not hesitate to telephone us if we can be of assistance.
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Summary of Your Plan
Group Term Replacement Plan
Your bank has established a group term replacement benefit plan for the
following individuals:
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Name of Insured Retirement Number of
Amount of Post Benefit Payments
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Hickman, Waymon $450,000 One
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In a Group Term Replacement (GTR), the bank applies for and owns a life
insurance policy on the life of the executive. The bank is the owner and
beneficiary of the-policy. By way of a separate split dollar agreement between
the bank and the executive, the policy interests are actually divided between
the bank and the employee. The bank owns the policy cash surrender value,
including the accumulated policy earnings, and the "windfall" policy death
benefits over and above the policy cash surrender value are endorsed to the
executive and/or his/her beneficiary. In this situation the risk has been
entirely shifted to the insurance company. Since the bank has no promise to the
employee, no accruals are required on the bank's books in connection with this
type of plan. This plan is used as a supplement to or replacement of group term
life insurance which is often made available to all employees as a fringe
benefit. A plan which covers a group of executives is often called a "group
carve-out" plan because the participants are "carved out" of the group term
coverage and insured under Individually underwritten permanent e insurance
policies which may be more economical for the employer. me executives who
participate in the plan have no direct interest in the life insurance policies
which are owned by the bank.
The plan has some advantages to the executives as compared to group term
coverage because group coverage over $50,000 per person results in imputed
income for the estimated value of the insurance coverage to the executive which
is included in his/her W-2 tax form, which results in additional tax liability.
Also, group term coverage usually terminates at retirement.
The bank will be required to provide the retired executive with a 1099 tax form
which shows the estimated economic value of the split dollar insurance as
taxable income. The economic effect of this to the retired executive is to
permit him to "buy" the insurance coverage at a substantial discount. If the
retiring executive has no need for the insurance coverage, the policy can be
surrendered for the cash value or transferred to another executive. By
transferring the policy to another executive, additional front-end load charges
and surrender charges can be avoided.
Your bank has purchased life insurance on the following individuals in
connection with the plan:
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Initial Net
Policy Owner & Premium Insurance
Name of Insured Insurer Policy Number Beneficiary Payments Benefit
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Hickman, Waymon A. Hamilton 10199192 Bank 795,000 450,000
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The policies purchased by your bank are a form of flexible payment universal
life insurance which is paid for with seven annual payments.
The policy cash value is an earning asset for the bank which earns interest at a
rate that is linked to an index of interest rates on U.S. Treasury obligations.
The policy interest rate may be adjusted by the insurance company each year.
Each month the income is credited to the policy value and the
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insurance mortality cost is charged against the policy value. The policy income
typically exceeds the mortality costs and the policy equity value increases each
month.
Because of the favorable income tax treatment of life insurance polices, the
increase in the policy cash value through interest crediting is not current
taxable income to the policy owner, and if held to the death of the insured, the
accumulated policy income would be received tax free except for possible
alternative minimum taxes.
The insurance policy can be redeemed at any time for the net cash surrender
value. However, because of the particular characteristics of the type of
insurance policy your bank has purchased, there may be Income tax consequences
associated with redeeming the policy prior to death of the insured or borrowing
against the policy cash surrender value. Given the nature of a bank's assets, it
would appear that access to the policy values for liquidity purposes would be
most unlikely in the ordinary course of business. We recommend that you contact
us or consult with your tax advisor prior to any cash withdrawals or policy
loans.
Should an individual covered by the plan leave the bank's employ, the insurance
need not be surrendered. A policy on one individual can be transferred to one or
more of the banks other executives for a nominal cost; however, there would be
an adjustment to the mortality costs of the policy, depending on the age and
insurability of the new insured person. By taking advantage of this feature, the
bank can avoid any policy surrender charges. In Revenue Ruling 9-109, the IRS
ruled that an exchange of insureds in an insurance policy is a taxable
transaction, much the same as if the old policy was actually surrendered and a
new policy purchased.
The insurance policies purchased by your bank were issued by high quality, well
capitalized insurance companies and you will receive periodic financial data on
the insurer to enable you to monitor the insurer's financial condition and
performance. In order to minimize credit risk and achieve diversification, the
insurance policies purchased by your bank may have been issued by more than one
insurance company. In the event that you desire to reduce the banks financial
exposure to a particular insurer, an existing policy can be exchanged for a new
policy with another insurer on a tax free basis by way of an exchange under
Section 1035 of the Internal Revenue Code, which is similar in concept to an
Individual Retirement Account (IRA) roll over. This type of transaction would be
subject to the underwriting requirements of the new insurer and there would be
additional policy load charges on the new policy.
ACCOUNTING GUIDELINES
When your bank made the wire transfer of funds to purchase the insurance
policies to commence the plan, we sent a letter to you which provided the
initial accounting entries necessary to account for the plan on the bank's
books. This section of the manual will provide you with a general discussion of
the accounting principles concerning the insurance policies.
Accounting for the Insurance Policies
The accounting rules, Financial Accounting Standard Board Technical Bulletin No.
85-4, Accounting for Purchases of Life Insurance, provide that the amount that
could be realized under the insurance contract should be reported as an asset.
When your bank wire transferred funds for the purchase of the insurance
policies, a cash surrender value asset should have been recorded for the amount
of the premium deposit, less the policy load which was written off as an
expense. Each month thereafter, the insurance mortality costs should be reported
as an expense which reduces the cash surrender value and the policy earnings
should be
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recorded as income, which increases the cash surrender value asset. The
mortality costs and the policy income are recorded at the end of each month.
At the end of the calendar year, you will receive a year-end statement on each
individual insurance policy directly from the insurance company. The annual
statement will detail the income and expenses associated with each policy and
the year-end cash surrender value. You should use the year-end statements to
assure that your books balance to the insurance company's cash value figures.
Usually there are minor adjustments that have to be made.
Your policy was purchased from Alexander Hamilton Life. Each July you will
receive a letter from that insurance company for each policy. This letter will
advise you of any change in the policy interest rate and will contain a forecast
of the Income and expenses and policy equity values for the next 12-month period
(July to June). You should use the projections to adjust your monthly entries
for mortality costs and policy earnings for the next 12 month period.
On each annual anniversary of the insurance policy, you will receive a statement
of activity for each policy from the insurance company. This statement can also
be used to assure that your records are in balance with the insurance company's
records.
SUBSIDIARY ACCOUNTS
We recommend that you establish a subsidiary record for each individual
insurance policy to assure that your records properly reflect the carrying value
of each individual policy and to facilitate balancing your books with the
periodic correspondence from the insurance company.
SURRENDER CHARGES
The insurance contract contains a surrender charge of approximately 2 percent of
the original premium deposit which is imposed at the beginning of year 2 and
again at the beginning of year 3. From year 3 through year 10, the total 4
percent surrender charge remains in effect You will not actually incur this
charge unless you turn the policy in; however, because the accounting rules
(Financial Accounting Standards Board Technical Bulletin No. 854, Accounting for
Purchases of Life Insurance) require that insurance be carried on your books at
the cash surrender value, we recommend that you record the surrender charges and
reduce the cash value on your books in years 2 and 3. This accounting entry on
your books does not affect the actual "equity" value of the policy and there is
no reduction in the policy income. In the materials and statements from the
insurance company, the "surrender value" is me difference between the policy
equity value and the surrender charge.
Another way to handle the bookkeeping for the surrender charges is to establish
a separate general ledger or subsidiary account to record the surrender charges.
Rather than credit the cash surrender value asset account directly to reflect
the surrender charges, credit the separate surrender charge account. The credit
balance surrender charge account would be carried on the asset side of the
balance sheet, and netted out against the cash surrender value asset account
similar to the balance sheet handling of the allowance for loan losses account.
Since the periodic account statements and projections from the insurance
companies reflect gross policy "equity" values, carrying the surrender charges
separately should facilitate periodic balancing of the bank's books to the
statements from the insurance company.
After year 10, the surrender charges no longer apply and the cash value of the
policy will be equal to the equity value of the policy. At this point, your cash
surrender value asset account can be increased by the amount of the surrender
charge with a corresponding credit to income. Although the accounting guidelines
for life insurance policies are as outlined above, many CPAs have taken the
position that the surrender charge need not be booked because it is not a
material item with respect
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to an institution's overall financial position. Please feel free to consult your
independent accountant concerning accounting for the surrender charge or any
other accounting matter concerning this plan.
INCOME TAXES AND DEFERRED INCOME TAXES
The insurance premiums paid are not tax deductible and the death benefits are
received tax free except for possible alternative minimum taxes.
The annual increase in the insurance policy cash surrender value is not included
in taxable income unless the insurance policies are cashed in or surrendered.
Depending on the date of the policy, a cash distributor or withdrawal from an
insurance policy may also result in taxable income.
With respect to alternative minimum taxes, a portion of the annual net increase
in the policy cash surrender value will be included in "adjusted current
earnings" when calculating alternative minimum taxes. If the alternative minimum
tax is greater than the regular income tax, the taxpayer must pay the
alternative tax; however, the difference between the alternative tax and the
regular tax becomes a minimum tax credit that can be carried forward
indefinitely to future years as a tax credit against regular income tax. This
discussion of alternative minimum taxes is based on proposed regulations issued
by the Internal Revenue Service on May 2, 1990.
With respect to deferred taxes, Statement of Financial Accounting Standards
(SFAS) No. 109, Accounting for Income Taxes, has superseded SFAS No. 96 for
fiscal years beginning after December 15, 1992. SFAS 109 does not require a
financial institution to recognize a deferred tax liability on the cash
surrender value in excess of cost if you expect to hold the life insurance
payment policy until the death of the insured and if the receipt of the death
benefit is not taxable income under the then current U. S. tax law for the
regular tax system. Provided that your tax planning strategy is to hold the
policy until the death of the insured and there has been no change in the
regular tax law regarding equity values on life insurance policies, there is no
need to record deferred taxes on the buildup of cash value within the policy.
REGULATORY REPORT TREATMENT
The instructions for the Consolidated Reports of Income and Condition ("Call
Reports") indicate with respect to Schedule RC--Balance Sheet, that the cash
surrender value of life insurance policies be reported in Other Assets. With
respect to Schedule RI--Income Statement, the insurance policy income should be
included in "Other non-interest income" Expenses associated with the insurance
policies (load, mortality and surrender charges) should be included in "Other
non-interest expense."
Documentation and Approval of Your Plan
The purchase of insurance on the lives of the banks executives should have been
approved by your banks board of directors or by an appropriate committee
thereof.
Accounting for the Benefit Plan
Provided that the SI/DB plan does not continue beyond normal retirement, no
accruals are required. If the plan is converted to a split dollar plan at
retirement, no accruals are required because the payment obligation has been
shifted to the insurance company.
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Regulatory Issues
Bank examiners and the various bank regulatory agencies will expect: that your
bank account for the insurance policies consistent with generally accepted
accounting principles; that the amounts of insurance purchased is reasonable and
justified in your minutes; that you are dealing with a high quality insurance
company; that you maintain current financial data on the insurance company(ies)
and that the amount of cash surrender value of insurance with any one company is
reasonable in relation to your banks capital and reserves. Policies purchased
must comply with Banking Circular No. 249, Bank Purchases of Life Insurance,
which was issued by the Comptroller of the Currency in 1991. Policies owned
which predate the effective date of the circular are not grandfathered. A state
bank holding a policy which does not conform to the circular must apply to the
FDIC for permission to retain the policy.
Please feel free to refer any questions from bank examiners to us.
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Contact People in our Company
Norm Moody Compliance Supervisor
Bank Compensation Strategies Group
3600 West 80th Street, Suite 200
Minneapolis, MN 55431
612-893-6767
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