Big Endowment – Positive or Not?

Top 10 Endowments Higher EducationOf course a big endowment is good and important.  BUT, it might not be so positive from your donors’ perspective.  Yesterday’s interesting meeting with a very special planned giving donor for a client really open my eyes again on this issue.

Stability, fiscal soundness, efficiency, consistency of leadership (in addition to mission, of course).  These were all factors this donor weighed (usually from the position as a board member – realize that your board members are possibly testing your organization for potential greater giving or not) in deciding which charities will make the cut into his estate plans (big gifts from glimmer in his eye!).

Endowment? Helps a long way towards his approach but be careful warned this donor. Too large of an endowment could send the wrong signal – is your charity in the business of saving lives or feeding hungry people today, or feeding salaries of the executives in the future?

What is the ideal level of endowment? Obviously depends on the organization, the immediacy of their mission and other organizational factors, but the general gauge that emerged from our conversation yesterday was 10 times the budget.  Your budget is $10 million – aim for a $100 million endowment.

Of course, this doesn’t mean you will keep everyone happy all of the time. I had a donor once contact me at a client looking for the 990 tax return to see how much we were paying our top people (he was looking at charities for a bequest). I knew this client well, and how little they paid, I thought we were in awesome shape. I sent it immediately and followed-up shortly after.  I get the man on the phone and he declares that this charity is not getting his bequest!  I was slightly dumbfounded – this was the most lean, efficient charity you could have imagined (less than 10% expenses to program ratio, very few employees, low salary for the executive director by any standard).

What was the problem? He saw the endowment figure – somewhere around $60 million.  Well below our 10 times revenue goal.  But, for this donor, it made no sense for him if the organization was sitting on that amount of money, what do they need his gift for?

Truth be told for that client – they held back a lot of money (primarily bequests) from disbursement to its prime mission (an overseas institution) over many years (an internal agreement between the two entities).  They just hoped no one noticed or asked about it.

So, the last lesson is about disclosure and proper messages. Don’t just hope no one notices that your organization has a huge war chest!  Be transparent! Explain why the endowment is so crucial. Explain how it works (i.e. reserves in case of emergency, annual income stream so staff can focus on mission, donor wishes, etc…).  And, sometimes distribute or use the funds – for your mission and related missions (if allowed, of course).



Watch webinar on Endowment follies!

Check out this 50 minute webinar presentation that is a follow-up to my previous blog post.

Endowment follies abound!

Throughout my 20+ year career in law and planned giving, I see various patterns that emerge that are sometimes frightening and clearly give us (nonprofit fundraisers) reason for concern.

One such area of frightening incompetence (as it turns out) is simple endowment management.

That includes the investment of “endowment” monies.  Sure, it is very troubling when institutional leadership violate every rule in the book regarding investment of endowment funds: over investing in hedge funds, allowing investment committee members to manage part of the pool, lack of independent oversight, etc… Yes, very troubling but not why I am writing this post.

My issue today is something even more basic: bookkeeping and record keeping and just following the law!

How hard are these tasks? Finance folks must be able to handle them?

Well, I have found in most cases the answer is that apparently bookkeeping and record keeping are not so easy – at least for those tasked with doing it!

Yesterday, I glanced at some endowment fund totals for a client going through an extensive entity merger that required filings with the attorney general, clarifications about which funds can have their restrictions released, etc… Actually, a very complex process in New York, by the way.

What did I see yesterday that has me all in a tilly?  I saw one endowment fund’s initial principal was around $500,000 and its appreciation was over $1.5 million.  Hmmmm.  A permanent endowment? Yes, probably close to 30 years old. Their supposed spending rate? 5% or more.  Hmmmm. Yes, this endowment pool was invested very aggressively (your draw would drop if you knew what percentage of this particular endowment had been in hedge funds going into 2008).  Ok, maybe it just grew tons, lost 50% of its value in 2008 and the winnings were still $1.5 million on their $500,000 principal?

I am not going to bother with the math.  There is something wrong with this picture.  If the organization actually withdrew any spending rate, it would be nearly impossible for the fund to more than triple in value, especially after they got killed in 2008 (and didn’t recover because hedge funds are probably not the best option for investment recovery).

My guess?  Maybe they withdrew the spending rate from other funds and didn’t subtract the distributions from the particular fund’s ledger page? Maybe they didn’t spend anything?

What else did I see? Some funds without any documents at all.  Numerous funds whose restrictions should have been released 20 years ago. A complete and utter disregard for the state’s legal requirements regarding managing those endowments (this is NY and NY has the most complex endowment management law).

In yesterday’s meeting, I am estimating that the initial entity that brought in the endowments – and which has been suffering due to its endowment market losses – blew its chance at sorely needed budget relief to the tune of $100 million or more!  What I mean is that if finance/legal staff at that institution had been doing their jobs well, they could have seen that much or more cash flow into their operating expenses that were severely needed through proper endowment spending and freeing up of old/outdated funds.  Instead, they borrowed more money, sold more property and finally were forced into the merger situation that I’m peripherally advising on.

Of course, yesterday’s revelation was no surprise to me.  I have seen endowment managers who use laws that were out of date by 20 years or more. And, I have seen cases where magically an endowment fund kicks off the exact same dollar amount each year and they tell them the funds are there and invested. In fact, I can not recall seeing an endowment program managed properly – from bookkeeping, records, the law, etc.. – EVER.

This blog got a huge boost when New York finally passed its version of UPMIFA – in fact, that was the single largest day of viewers for several years.  So, I put together a great presentation on NYPMIFA and assumed plenty of NY nonprofits would need my help (as it was and is so clearly needed).  Well, I did not sell one NYPMIFA audit.  People tuned in, asked questions, and then went about their way of ignoring the law and screwing up their endowments further.

So, why did the above nonprofit have to actually clean up a mess?  They were going through a complex merger that involved moving of endowment funds from one entity to another.  And, lo and behold, they now have a major law firm helping them address the issues because there are so many.

What’s my point?  Maybe it is the nature of those tasked with simple bookkeeping and record keeping and following endowment law?  Maybe they are just stubborn and/or lazy or just uninformed?  Maybe it is human nature to wait until you are forced to address something?  New York, for instance, could put together a SWAT team of auditors and easily bring down over 90% of NY’s nonprofits for utterly spitting in the face of their law. Very, very few NY nonprofits follow NY endowment law but until the NY attorney general’s office decides to actively enforce NY state law, nonprofits will continually do themselves the major disservice of totally botching their endowments.

I guess my frustration is that virtually none of these nonprofits sought help in this area. Thousands checked out this blog, picked up all of the advice I flooded them with. But, none – zilch – actually took the step to even discuss fixing their problems.  At least not with me!  And, my guess is that very few actually implemented what they were supposed to.

Of course, by the time you are forced to address your endowment issues, you’ll likely be forced to hire one of those white shoe law firms who will easily charge 100 times more them me. Or, in this case, one entity will be left lamenting why they didn’t address their problems earlier – it could have actually help salvage their situation. Instead, a new entity is cleaning up (both literally and figuratively!).

When Financial Advisors Get Creative….

Quick Planned Giving lesson on Commercial Annuities

I couldn’t resist using this cartoon again but this time (to see previous post on commercial annuities – click here), I have a crazy scenario that just played out with a professional advisor who tried to foist a commercial annuity into a CGA on behalf of an unsuspecting intended charity.  See that previous post for more about commercial annuities – this post will just cover one of many disastrous scenarios that could occur.

Here are the facts as presented to me (with small changes to protect the innocent).  A friend (a planned giving director) calls last week with a nervous message, something about a donor giving them a commercial annuity (which I know doesn’t work).   What I find out when I get through to him is that the donor funded a commercial annuity that was somehow placed in the name of the charity but would pay lifetime annuity payments to the donor.  Really strange and my initial reaction was to direct him immediately to competent legal counsel.

After mulling this story over, and hearing a few more details, this is a must read post for planned giving professionals.

What happened here?  The planned giving director had given the professional advisor a CGA illustration on the donor.  Instead of finding out how CGAs work, the advisor decided to ask a really big insurance company (presumably one he is affiliated with) to somehow make the scenario work.  I am guessing that meant to get the donor his lifetime annuity payments and the advisor his commission!  Oh yeah, maybe a second thought about the charity’s remainder – NOT.

What did this multi-trillion dollar insurance company (one that took hefty bailout money just a few years ago for being too big to fail) come up with?  Their solution was to have the donor purchase on behalf of the charity a $100,000 commercial annuity that would pay the donor his CGA rate for his life.  All’s well that ends well, right?  Donor gets annuity and a $100,000 deduction (according to the advisor, at least), advisor gets his commission, charity gets remaining funds in the commercial annuity when donor passes (advisor even told the planned giving director that the remainder was a $100,000 guarantee to the charity – we’ll see about that!)

Your mind should be churning a bit here.  Let’s go through each problem.

  1. Income tax deduction – The donor basically transferred to the charity $100,000 and immediately invested it (on behalf of the charity) into this commercial annuity.  Lot’s of problems here.  #1 donor control of investment is a no-no, meaning no deduction, zero, zilch.  Let’s say the charity had acquiesced retroactively.  Basically, the donor created his own CGA – at best the donor might be entitled to the appropriate CGA deduction.  Advisor’s claim that donor should get $100,000 deduction showed how completely ignorant he is on these matters.
  2. Commission – Let’s say charity said fine, we have a CGA here and the charity agrees that this investment is fine (which it probably is NOT for the NY State Dept. of Insurance – who would probably have forced this entire thing to be reversed if it ever got to their attention).  A big problem is that the advisor basically took a commission on the issuance of a CGA – a violation of the Philanthropy Protection Act (the Act that exempted CGAs, among other vehicles, from SEC regulation).
  3. Remainder – The advisor’s guarantee that the charity was guaranteed a full $100,000 was a complete untruth.  In fact, when the planned giving director inquired of the insurance company about what happens to the remainder, they told him that it basically extinguishes around the end of the life expectancy of the donor.  Nothing, zilch, for charity if donor lives to life expectancy.  Talk about chutzpah!
  4. NY Dept. of Insurance (NY-DOI) – Hate’em, yes, if you have to deal with them but in this case, there is no way they would have let this go (which is a good thing).  I know one scenario where an advisor had a CGA program reinsure all of its CGAs (a NY charity) and didn’t follow NY’s rules (which are particularly strict on reinsurance).  They forced that nonprofit to undo all of the transactions.  Not fun. This one would have been killed sooner or later (probably at the expense of the pg director’s job).

Let’s add it all up. Extremely doubtful deduction, illegal commission, horrific investment choice, NY-DOI will make you pay dearly.  I have probably even missed a few problems.

Why do such disasters happen?  Ironically, the worst planned giving disasters (besides the Huguette Clark estate) almost always involve attempts to  use commercial annuities in planned giving contexts.  Besides the reinsurance disaster mentioned above (that was about purchasing commercial annuities to cover CGA payments), I’ve dealt with disastrous use of commercial annuities as investments in CRTs several times and I just keep asking myself WHY?  Why in the world do advisors do such stupid things like this?

The answer, which my planned giving director friend also agreed with, was the drive to get a commission.  Yes, it comes down to dollars and cents.  Advisors need commissions – preferably cash upfront.  That is their lifeblood, their inspiration.  And, even though commercial annuities don’t pay the great commissions that life insurance policies do (which are insanely huge), they are probably enough for the advisor to sleep well at night.  Of course, if your prime focus is how you can benefit from this gift (you meaning the advisor), you might not pay too much attention to small details like any remainder for the charity.

I had an advisor once defend a case where donor/client put up $25,000 in insurance premiums for the first five years of a policy and by the 6th or 7th year, the policy was already lapsing for nonpayment.  The donor had wanted to give $25,000 to get a $100,000 policy (and leveraged naming gift).  But, the policy needed another 20 years of premiums or more.  Charities almost never pay premiums, certainly not mine at that time.  The advisor skipped that issue when setting up the policy – what should he care?  He got his commissions from the first payments.  I confronted him (and even had pro-boon counsel ready to make his life miserable) and he didn’t show the slightest feelings of guilt. It dawned on me then that singular focus by advisors on their commissions is a dangerous thing.

Back to our story.  Luckily for all involved, there is a 30 day “get out of jail free card” when buying commercial annuities.  The whole thing is being undone.  Somehow the donor isn’t angry, advisor came up with some excuse, and the charity will issue a CGA after all.

Ironically, if this advisor had any clue, he could have advised the donor to set up a CRT and continued to manage the money and continued to get some commissions.  Of course, he probably did better with the immediate commission from the commercial annuity in the short term.  Now, he get’s nothing, which should make us all feel a  little better about this story.

And, sadly, this story confirms how insurance companies are utterly ignorant of this stuff.  How could a room full of guys (who all drive BMGs and Porches) be so stupid? I would love to train advisors but they will have to learn to change their outlook to get a clue on planned giving.  It can’t be about your silly $2 commission.  It has to be about finding the best options for your clients!  And, they might have to actually use their brains a bit.

Anyway, the bottom line with commercial annuities in a planned giving context is this: They never work (except for simple beneficiary designations) and are actually very dangerous from a tax standpoint (to the donor and the charity).  In other words, stay away from them if an advisor is trying to slip one into a planned giving situation.