Understanding How Market Index Certificates Work Key to Members' Acceptance of Them, Experts Say

FLORHAM, N.J. – Nearly a decade since NCUA gave the green light for a pilot that would allow credit unions to offer index certificates tied to the performance of an equity market index, members have been attracted to their dividends and principal safety but some experts say they still may need more help understanding how they work. In general, market index certificates pay dividends based on the movement of a market index such as the Standard & Poor’s 500. Members can get stock-market like returns without risk to their deposits, said Shawn Gilfedder, vice president, fixed income risk strategist at RBC Dain Rauscher, Inc. “There is a competitive marketplace for this product and more depositories are looking to (them) to increase value to membership by offering a competitive product to mutual funds and equities, with principal protection and upside return potential of a market index,” Gilfedder said. In the early 1990s, CUNA Mutual Group through CUNA Service Group participated in an index certificate pilot. Today, its MEMBERS Market Index Certificate has $80 million in deposits through nearly 500 credit unions, said Bob Buckingham, CUNA Mutual vice president of asset accumulation products. “We’re working on making it more simple and straightforward to understand,” Buckingham said. “Some people may feel a little uncomfortable with not knowing what the return will be until maturity but the neat thing is compared to a typical security product, there’s an underlying guarantee that you get your principal back.” The MEMBERS Market Index Certificate has a zero-coupon portion and an index option portion. The zero-coupon portion is a credit union deposit and is treated like a traditional certificate with a 0% return. It guarantees that, at maturity, the deposit will be worth the amount of the original investment. The index option guarantees payment of the appreciation in the stock market. If a member establishes a $5,000 certificate, for example, instead of paying the member dividends, the credit union pays the present value of those dividends to the program’s financial vendor. This amount, called a premium, means the CU purchases a call option on the S&P 500 from the financial vendor. A call option allows the purchase of stocks in the S&P 500, for example, for a predetermined price. The gist is the member will earn a percentage of the increase in the S&P 500, called the participation percentage, which is set when the certificate is established, depends on the price of options and is affected by the volatility in the stock market and interest rates. When the stock market is very volatile, the price of options is relatively high and the participation percentage is relatively low. Conversely, when there is less volatility, the price of options is relatively low and the participation percentage is relatively high. Market index certificates still have risks. If the value of the S&P 500 goes down, the member will not earn any dividends on their initial deposit. Buckingham said CUNA Mutual is looking to launch another pilot that will come up with solutions for credit unions to present the Market Index Certificate in easier to understand language, including offering additional training and marketing tools. A “good evaluation” of the pilot may be determined by the end of the year, he added. [email protected]