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4000 - Advisory Opinions
Deposit Insurance Coverage of Hybrid CD
FDIC--94-31
May 12, 1994
Douglas H. Jones, Acting General Counsel
This is in response to your letter of April 19th and our meeting of
April 26, 1994 concerning [hybrid CD], a new product which has been
developed by [company]. The [hybrid CD] combines features of a
traditional certificate of deposit together with certain payment terms
and tax advantages of an annuity contract. Initially, the [hybrid] CD
is being offered by a single bank [N] under a licensing agreement
with [company]. However, if the product is successful, it may be
licensed to other FDIC insured depository institutions.
Your letter, as well as certain news reports, raise the question of
whether the [hybrid] CD product is a deposit entitled to FDIC
insurance and, if so, the extent of such insurance. The Office of the
Comptroller of the Currency has also asked us to look into the
insurability of this product. Toward this end, we have reviewed the
promotional information, Account Terms and Conditions, Account Request
Form, and other pertinent information concerning the product offering
which you provided with your letter and during our meeting, along with
an advertisement placed by [Bank] in the Wall Street Journal.
It is our understanding that [Bank's hybrid] CD would function
along the following lines. Customers may open a [hybrid] CD account
with a minimum initial deposit of $5,000.
{{10-31-94 p.4872}}Subsequent deposits of not less than
$1,000 may be made once a year. When the account is opened, the
customer chooses a date ("Maturity Date") when the CD will
mature, but the minimum term of the account must be at least one year.
Upon opening the account, the customer also chooses his/her payout
options. Customers may choose to receive up to two-thirds of the
account balance (principal plus accrued interest) in a lump sum at
maturity. Any amount which the customer elects not to receive in a lump
sum at maturity will be used as the basis for the calculation of equal
monthly payments which will be made for the remainder of the customer's
life (or, in the case of a joint account, the survivor's life).
Customers may change their payout option at any time up to thirty days
prior to the Maturity Date. Unscheduled withdrawals prior to the
Maturity Date will incur substantial penalties, unless they are due to
the death or disability of the customer. Shortly after opening the
account, customers will be mailed a "certificate of deposit." It
is our understanding that the bank will record these funds on the
bank's books as deposit liabilities, pay deposit insurance assessments
on them, and use them in the normal course of its business. Insofar as
the [hybrid] CD is being characterized as an annuity for income tax
purposes, income taxes reportedly are deferred until the time of
withdrawal. The period of time from the customer's purchase of the
[hybrid] CD up until the Maturity Date is referred to as the
accumulation phase. The period of time after the Maturity Date is
referred to as the payout phase.
Due to the tax features of this account, it is reasonable to expect
that many, if not most, customers will choose a Maturity Date which
coincides with their retirement. The [hybrid CD] pays a fixed rate of
interest for up to the first five years, after which time the interest
rate is adjusted at the bank's sole discretion without reference to any
independent index. However, the issuing bank contracts that the
interest rate will never fall below three per cent per year. Interest
ceases being posted to the customer's account upon maturity. However,
the bank utilizes an "imputed interest rate" during the payout
phase to calculate the monthly benefit which the customer will receive.
If the account owner dies prior to the Maturity Date, his/her
beneficiary will receive the principal and all accumulated interest. If
the account owner dies after the Maturity Date, the beneficiary will
receive the principal and all accumulated interest up until the
Maturity Date, less any lump sum distribution and monthly payments
which have been made. The bank will charge a one time set-up fee of
$100 when the account is opened.
Interest (in the traditional sense) ceases being posted to the
customer's account at maturity, while the bank utilizes an "imputed
interest rate" during the payout phase. Thus, the value of a
customer's account after the Maturity Date which is payable to a
beneficiary upon the customer's death would be equal to all principal
plus accrued interest earned up until maturity minus any lump sum
distribution and monthly benefit payments. However, the "expected
value" of the monthly benefit payments which the bank has contracted
to make would generally be greater than the amount payable to a
beneficiary because of the imputed interest which the bank uses to
calculate the expected monthly benefit stream.
In reviewing the [hybrid CD], the FDIC has considered (1) whether
the [hybrid] CD is a deposit, as that term is defined in section 3(1)
of the Federal Deposit Insurance Act ("FDI Act"), 12 U.S.C.
1813(1); (2) if so, the extent to which the [hybrid] CD is covered by
FDIC deposit insurance; and (3) the adequacy of disclosures to
customers made in the issuing bank's promotional materials and
advertisements concerning the extent of FDIC insurance.
Section 3(1) of the FDI Act, in relevant part, defines a
"deposit" as:
"the unpaid balance of money or its equivalent received or
held by a bank . . . in the usual course of business and for which it
is obligated to give credit, either conditionally or unconditionally,
to a commercial, checking, savings, time, or thrift account, or which
is evidenced by a certificate of deposit. . . ."
12 U.S.C. 1813(1). Not all liabilities of a bank are deposits for
the purposes of the FDI Act. Whether a particular liability comes
within the definition is a question that turns upon all of the facts
and the intent of the parties.
{{10-31-94 p.4873}}
The first requirement is that there must be an "unpaid balance of
money or its equivalent." For example, if a bank is holding real
estate or some other non-monetary asset, this requirement would not be
satisfied. In the case of a [hybrid] CD, however, the bank's
obligation will be funded with cash or an instrument ordering the
transfer of cash funds and thus the CD clearly represents "the
unpaid balance of money or its equivalent."
Second, customer funds used to purchase [hybrid] CDs apparently
will be received and held by the bank in the usual course of its
business. There is no indication that the funds will be received or
held by a holding company, any subsidiary or affiliate of the bank, or
by any unrelated party. The bank intends to solicit the funds from
retail customers, as it solicits other types of deposits.
Third, in this case, the bank will be giving credit for the funds
received to an account established for the customer which will be
evidenced by a "certificate of deposit," which the bank has
indicated it would issue to each customer. Although the customer may
have limited rights to withdraw the funds, the bank will nonetheless be
obligated to repay all principal and interest accrued up to the
Maturity Date to the customer (or if the customer dies prior to full
repayment, to his estate or designated
beneficiary). 1
In addition, in order for there to be a "deposit" the parties
generally have to intend to create a deposit liability. In most cases,
the parties evidence their intent by including language in the
pertinent agreements indicating whether or not a particular liability
of the bank is intended to be a deposit liability as opposed to some
other type of general obligation of the bank. If the parties intend to
create a non-deposit liability, such as a bank note or other
subordinated liability, then generally a deposit is not created
(although the intent of the parties is not always determinative since
it is only one factor that is considered).
Based on the foregoing and subject to the limitations discussed in
the succeeding paragraph, we have concluded that the [hybrid] CD is a
"deposit," within the meaning of section 3(1) of the FDI Act,
because: (1) there is an unpaid balance of money or its equivalent
received and held by the bank in the usual course of business; (2) the
bank will utilize the funds received in the normal course of its
banking business (e.g. to make loans or investments); (3) the bank will
give credit for the funds received to an account evidenced by a
certificate of deposit; (4) the parties intend to create a deposit
liability, as evidenced by language expressing such intent in the
Account Terms and Conditions, Account Request Form and other
promotional material provided to us; (5) in the event of the account
holder's death, the bank will pay an amount equal to all remaining
principal and interest in the account to the customer's beneficiary;
and (6) we understand that the bank intends to treat the [hybrid CD]
like any other deposit liability, including booking it as a deposit for
accounting purposes, paying deposit insurance assessments on it and
maintaining the necessary reserves pursuant to regulations promulgated
by the Board of Governors of the Federal Reserve System.
With regard to the extent of FDIC insurance, we have concluded that
a [hybrid] CD will be insured for the same amount (up to a maximum of
$100,000) that would be payable to an account holder's beneficiary in
the event of the account holder's death. That is, in the event the
issuing bank were to fail prior to the Maturity Date, a [hybrid] CD
would be insured to the same extent as any other type of CD,
i.e., for principal and accrued interest up to the date of
failure. In the event that the bank were to fail after the Maturity
Date, the FDIC would pay a customer the balance of the account at the
Maturity Date (principal plus accrued interest) minus any lump sum
distribution and any monthly payments, up to a maximum of $100,000. We
also point out that a [hybrid] CD would not be insured separately
from any other individual or joint accounts, as the case may be, which
the depositor(s) may maintain at the same insured depository
institution. Under no circum-
{{10-31-94 p.4874}}stances would FDIC insurance extend to
the bank's commitment to make lifetime payments, as the value of such
payments is uncertain and may exceed the total account
balance. 2
The FDIC is aware that the insured amount would generally be less than
the expected value of the monthly payments which the bank agrees to
make. However, as we noted previously, the FDI Act Section 3(1)
definition of "deposit" contemplates a sum of money being held by
the bank on behalf of a depositor for which the bank is obligated to
give credit. The expected value of the contractually agreed-to monthly
payments does not reflect an account balance, i.e.,
principal deposited by the customer plus accrued interest posted
to the customer's account. Instead, the expected value (which you have
represented as being an ascertainable number) is derived from the total
value of the expected monthly payments. However, it is not reflected in
any account statement which is made available to the customer. In fact,
subsequent to the Maturity Date, the bank no longer produces [hybrid]
CD account statements. From that point in time on, the customer
receives only his/her monthly check and a IRS Form 1099R.
You should be aware that the manner in which an insured depository
institution advertises its deposits is subject to the proscriptions of
Federal Reserve Board Regulation DD, Truth in Savings, 12 CFR Part 230,
and section 709 of the United States criminal code, 18 U.S.C. 709. More
specifically, section 230.8(a) of Regulation DD provides that
"[a]n advertisement shall not be misleading or inaccurate and
shall not misrepresent a depository institution's deposit contract."
12 CFR § 230.8(a). 3
18 U.S.C. 709, a criminal statute, provides that it shall be unlawful
for anyone to "falsely [advertise] or otherwise [represent] by
any device whatsoever the extent to which or the manner in which the
deposit liabilities of an insured bank or banks are insured by the
Federal Deposit Insurance Corporation. . . ."
The FDIC is extremely concerned that customers understand what is
and is not covered by FDIC insurance. A recent survey has shown that
many customers who purchase mutual funds on bank premises are under the
erroneous impression that those investments are insured by the FDIC.
The federal financial institution regulatory agencies' concern about
depositors understanding exactly what is and is not insured is
reflected in the recently issued "Interagency Statement On Retail
Sales Of Nondeposit Investment Products."
The FDIC therefore strongly believes that all promotional materials,
advertisements, agreements and other customer materials concerning the
[hybrid] CD should clearly and conspicuously state that the lifetime
monthly annuity payments are not guaranteed by the FDIC. The bank
should also exercise care that the relative size of typefaces used in
promotional materials as well as the juxtaposition of statements could
not, in any way, be reasonably expected to create a deceptive and/or
misleading impression.
The FDIC has examined the [hybrid] CD promotional materials,
Account Terms and Conditions and Account Request Form, you provided to
us. The FDIC is concerned that consumers who may choose to open such an
account with the bank may be misled with regard to the extent of FDIC
insurance for such an account. For example, the bank's sample cover
letter to a prospective depositor states that "[o]nce your account
matures, you are guaranteed by the bank to receive a
monthly payment for the remainder of your life." (Emphasis in
original). One sentence later, that paragraph continues by stating
"Please note, FDIC insurance relates only to the account balance and
accrued interest." Shortly thereafter, however, the letter asserts
that "[i]f you are looking for. . .a guaranteed return and
federal insurance. . .then you should seriously consider a
[hybrid] CD." (Emphasis in original). We remain concerned that
the proviso concerning the extent of FDIC insurance is inaccurate and
that the juxtaposition of these two statements could mislead a
consumer. We suggest that the proviso be revised to read "Please
note, FDIC insurance
{{10-31-94 p.4875}}relates only to the principal (the
amount you contributed) plus interest accrued to maturity."
Similarly, the bank's one-page fact sheet states that "[Bank's
hybrid] CD is the first and only retirement account to
combine lifetime benefits, long-term tax-deferral, FDIC insurance and
flexibility." It also states that "FDIC insurance makes the
[hybrid] CD as safe as your savings account. . . ." The
bold-face caption immediately above this statement reads "Federally
insured up to $100,000." The paragraph immediately below this one is
captioned "Your payments are guaranteed for life." The paragraph
states that "[o]nce your account reaches maturity, the bank
guarantees monthly payments for the rest of your life." In this
case, the bank is analogizing its [hybrid] CD to a simple savings
account in terms of safety. Such is not the case. A customer's savings
account is fully insured by the FDIC up to a maximum of $100,000 such
that if the bank were to fail that customer would receive the full
value of the customer's account (principal plus accrued interest) up to
the $100,000 maximum. However, in the case of a [hybrid] CD, if the
bank were to fail after the Maturity Date and at a point in time where
the customer had already been paid the full value of the account
through a lump sum distribution and monthly payments, the FDIC would
neither insure nor continue to pay those monthly payments for the rest
of the customer's life. Once again, we are concerned that the
above-noted representations may be misleading. The bank's *****
advertisement in the Wall Street Journal raises similar
concerns to those expressed above. Any time the bank chooses to stress
FDIC insurance and guaranteed payments for life, consumers
can reasonably be expected to assume that FDIC insurance covers the
lifetime monthly payments.
The FDIC is also concerned about [Bank's] explanation of deposit
insurance in the Account Terms and Conditions. The text states that
"[t]he deposits of each depositor are insured by the Federal
Deposit Insurance Corporation for up to an aggregate amount of one
hundred thousand dollars ($100,000)." However, once again, this
document does not make it clear to customers that under no
circumstances will the FDIC be responsible for continuing to pay
monthly benefits during the payout phase. This section of the Account
Terms and Conditions goes on to state that "[f]or insurance
purposes, jointly owned accounts are considered to be held by one
depositor." We consider this statement to be misleading. Pursuant to
§ 330.7 of the Corporation's deposit insurance rules and regulations
(12 CFR § 330.7), joint accounts are aggregated with other joint
accounts and insured separately from individual accounts.
Section 230.8(c) of Regulation DD provides that if an annual
percentage yield is stated in an advertisement for a time deposit, the
advertisement shall clearly and conspicuously include a statement that
a penalty will or may be imposed for early withdrawal. We note that the
bank's one page fact sheet which states the annual percentage yield for
a three and five year initial term [hybrid] CD at the bottom includes
no such required disclosure. The FDIC is concerned that potential
customers be made aware of the substantial penalties for early
withdrawal from a [hybrid] CD in circumstances other than death and
disability.
We also call your attention to the aforementioned "Interagency
Statement on Retail Sales of Nondeposit Investment Products" which
sets forth guidelines that insured depository institutions should
follow when selling nondeposit investment products, such as mutual
funds and annuities, to retail customers. While we have concluded that
the [hybrid CD] is an insured deposit, with some limitations, it
nonetheless also possesses certain characteristics which make it quite
similar to an annuity. We think that some of the same concerns
discussed in the Interagency Statement with regard to nondeposit
investment products may be applicable to the [hybrid] CD.
Insured depository institutions offering the [hybrid] CD product
should also keep in mind that the FDIC's brokered deposit regulation
(12 CFR 337.6) may be applicable under certain circumstances.
We are unable to comment concerning the question of how a [hybrid]
CD would be treated in a bank failure that is resolved via the use of a
purchase and assumption transaction. The precise nature of these
transactions differs on a case-by-case basis.
{{10-31-94 p.4876}}
Finally, the issue of the safety and soundness of any bank's
participation in offering the [hybrid] CD will be subject to review
by the appropriate regulators and the FDIC as back-up supervisor. The
FDIC may have substantive concerns with regard to how a bank manages
funds received in this program. Where the issuing bank is an insured
state nonmember bank and thus within the FDIC's supervisory
jurisdiction, these issues should be discussed with the FDIC's Division
of Supervision. The FDIC's Legal Division takes no position with regard
to any safety and soundness concerns which may be raised by the
[hybrid] CD product. Similarly, the Legal Division is not expressing
any opinion with regard to the tax status of the [hybrid] CD. Our
opinion relates solely to the insured status of the [hybrid] CD and
is based upon the facts as we understand them as outlined above.
Different facts or circumstances may alter our opinion.
Our willingness to respond to your request for an opinion as to the
insurability of the [hybrid] CD product should in no way be
represented or construed as an endorsement or approval by the FDIC of
the product. To the contrary, the FDIC expressly disclaims any such
endorsement or approval.
If you have any questions concerning this letter, please feel free
to contact Claude A. Rollin, Senior Counsel, or Jeffrey M. Kopchik,
Counsel, at (202) 898-3985 or (202) 898-3872,
respectively.
1Once a [hybrid] CD matures, the customer does not have the
option of receiving all principal and interest in one lump sum. At a
minimum, one-third of the account balance can only be paid to the
customer in monthly installments over the remainder of the customer's
life, similar to an annuity. Thus, the CD appears to be hybrid. It
possesses certain features which are characteristic of a deposit, while
other features resemble an annuity. Go Back to Text
2We note that the FDIC's conclusion with regard to the extent
of deposit insurance to be afforded a [hybrid] CD is in accord with a
written legal opinion you provided to us issued by a private law firm
at your request. Go Back to Text
3Section 230.8 also prescribes specific disclosures in
advertisements which solicit deposits concerning the terms and rates
that are being offered. Go Back to Text
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