Tier One: What is Boli?
In my recent article, The Promise & The Path: An Introduction to Non-Qualified Deferred Compensation, I discussed how companies informally fund executive benefit plans using cash value life insurance. Whether a handful of policies or hundreds are purchased, the economics are the same: the timing of when the company should either take tax-free policy loans or expect to receive income tax-free death benefit proceeds presents the most efficient asset for liquidity to pay for a variety of benefits.
Banks are no different in their desire to leverage the benefits of life insurance to shore up their balance sheets when providing benefits for just a handful of senior executives or a broader category of essential employees.
What is different about Bank-Owed Life Insurance (“BOLI”) is the additional scrutiny the Treasury Department applies when financial institutions choose to purchase life insurance. The Treasury’s Office of Comptroller of the Currency (“OCC”) has the job of ensuring a safe and sound federal banking system for all the United States and, in carrying out this mission, provides guidance on how much and into what assets a bank can invest. More on this later.
First, there are many potential benefits of BOLI:
Protect against the increasing costs of employee health and welfare ERISA plans.
Provide the ability to recover the expenses from executive compensation and benefit plans.
Create a hedge by holding an asset with a value highly correlated to the changing value of a liability.
Safeguard against the economic loss of a key employee’s premature death.
In a BOLI transaction, a bank will allocate capital toward the premiums for the life insurance policies it wishes to purchase. The bank is both the policyholder and the named beneficiary. Generally, the insureds will be officers, executives or other senior level employees who consent to having life insurance coverage purchased on their lives.
The premium can either be a single premium, resulting in a Modified Endowment Contract, or a series of annual premiums which usually result in a non-Modified Endowment Contract, permitting the policies’ cash value to be accessed tax-free in the future. Most BOLI is purchased for the death benefit that is paid out at the death of the covered employee; though, the structure may also utilize the access to tax-free cash value loans during the life of the covered employee. The larger the number of insureds, the easier it is to actuarially predict mortality and the receipt of a policy’s proceeds.
Types of BOLI
There are generally three types of BOLI plans: General Account, Separate or Segregated Account or Hybrid Plans.
A General Account Plan is where a bank makes an investment, and that investment is held within the life insurance company’s general account. These are often fixed rate investments and interest rates assigned by a carrier vary according to the performance of the carrier’s portfolio. Usually there are minimum rates of return.
In Separate or Segregated Account BOLI, the most common type, the investments are held outside of a life insurance company’s general account and directed by an outside manager. These investments are kept separate from the claims of any creditors to the general account. Even though a bank cannot directly control the investments in these plans, returns are based on performance of the underlying investments and the bank, as the policyholder, bears the risk of loss. Many policies in this space have riders or other benefits which can mitigate the downside.
Decreasing in popularity due to regulatory scrutiny is the Hybrid Plan– a mix of the general account and separate or segregated accounts. The general account is used to provide some stability to the volatility of the separate or segregated account.
In 2004, the OCC, the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation issued an “Interagency Statement on the Purchase and Risk Management of Life Insurance” to provide specific guidance on BOLI and deferred compensation agreements within banks.
Specifically, the OCC has indicated that the gains from BOLI cannot exceed the costs they are intended to offset and, as a general rule, a bank should not invest more than 25% of its Tier I capital plus 25% of the allowance for loan and lease losses in BOLI as a whole, and no more than 15% of its Tier I capital with any one company.
Despite all of the many benefits of BOLI, it is not without risk. BOLI may fund executive benefits, provide contingent liquidity to a bank at the death of an executive and offer tax advantages not generally available in other investment alternatives. However, a bank’s management should understand the inherent market, credit and liquidity risks of BOLI which can impact a bank examiner’s consideration when assessing a bank’s overall financial condition and risk profile to assign supervisory ratings.
Banks considering BOLI should seek qualified tax, life insurance and legal advice. At Life Insurance Strategies Group, we do not sell products and can therefore offer independent and unbiased advice in this area to financial institutions seeking to learn more about BOLI.
Read our companion Tier One Interview with Tyler Furger by clicking here.
Since its inception, Life Insurance Strategies Group has solely focused on the individual high net worth life insurance market. We do not sell products. This allows us to offer unbiased, pragmatic advice. Visit us at www.lifeinsurancestrategiesgroup.com.