FDIC Law, Regulations, Related Acts
4000 - Advisory Opinions
Deposit Insurance Coverage of Hybrid CD
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. 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.
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- 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 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.
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