Bank Owned Life Insurance (BOLI) is institutionally designed life insurance policies purchased by a bank or bank holding company. The policies generally insure the lives of bank executives or other highly compensated employees. The bank pays the premiums, owns the policies and is the beneficiary of death benefit proceeds. The bank accrues revenue from investment earnings and bears the risk of investment losses. Although the death benefit is of significant value in a BOLI purchase, the primary benefit of the life insurance structure is the available tax efficiencies on the growth of assets within the policies. Income earned on the policies is tax-free for the bank, and when an employee dies, the cash payments the company receives are tax-free.
Since the early 1980s, banks of all sizes have added BOLI to their investment portfolios. Regulations do limit the amount of BOLI a bank may purchase. Still, premiums may range from thousands to many millions of dollars. While the products and reasons for purchasing BOLI are not new, the Federal Reserve Bank reports the overall use of BOLI at community banks, in particular, has been increasing.
Understandably, the industry’s regulatory environment contributes to an ongoing dialogue between community banks and regulators regarding BOLI. This brief overview highlights the appeal and features of this investment approach.
There are three types of BOLI policies: General Account, Separate Account and Hybrid Separate Account.
General Account BOLI is the most prevalent within banks of all sizes. The insurance company makes all investment decisions, and assets are a part of its general fund. Cash Surrender Value (CSV) is an unsecured obligation of the insurance company and is available to general creditors in the event of insolvency of the insurer. Interest rate risk is inherent in the policy’s crediting rate, a rate guaranteed by the insurer. The CSV fluctuates based on returns from the insurer’s general account.
Separate Account BOLI is less prevalent but still significant. The bank selects the investment style but cannot control the investments. Investments must be bank qualified. The insurer invests in assets that are segregated by state law and protected from general creditors. Interest rate risk is directly related to the performance of the specific investments in the separate accounts. The bank that owns the policy assumes the investment and price risk. Separate Account products may have Stable Value Protection (SVP) wraps to limit interest rate risk. CSV fluctuates based on the returns from the underlying investments supporting the policies. Without designed protections, the cash value could potentially be zero. SVP wraps can protect against some declines in CSV and can smooth fluctuations.
Hybrid Separate Account BOLI gives the bank benefits of separate account portfolios while the insurance company protects the bank from market losses, guaranteeing a minimum crediting rate.
BOLI Yields Contribute to Popularity
BOLI provides an attractive net yield. Current rates generally range from 2.9 to 3.75 percent after all expenses are deducted, depending on the carrier and the product. This translates to a tax equivalent yield of 4.83 to 6.25 percent, assuming a 40 percent marginal tax rate. The after-tax rates of BOLI are difficult to compete with when compared to the after-tax opportunity cost in a bank’s non-loan investment portfolio. The spreads are meaningful; BOLI yields have historically created spreads of 150 to 200 basis points. The current interest rate environment creates spreads that are historically at their highest levels, resulting in positive impact to the bank’s earnings.
Given these returns, the continued and growing popularity BOLI is hardly surprising. Just over 60 percent of all U.S. banks own BOLI. More than half of the 6,191 U.S. banking institutions own BOLI assets in excess of $1 million. BOLI purchases were $4.05 billion in 2015 by banks with total assets in excess of $1 billion. At of the close of 2015, there were $156 billion in BOLI cash values. That is an increase from 2014 of $6 billion or 4.7 percent.
BOLI was purchased at more than 600 banks nationwide in 2015, a first-time purchase for 127 of those banks. Commentators estimate that there is currently $200 billion in new BOLI capacity in the U.S. bank market.
Even with all the growth and potential in the BOLI marketplace, it is prudent to note that BOLI is not without risk. Its purchase should be aligned with the objectives of bank management, director-approved risk guidelines and the bank’s risk profile. Bank management must understand both the benefits and risks of its insurance decisions to effectively identify, quantify and actively manage all risk. Diversification between carriers and vetting plan administrators may be a worthwhile consideration. And, of course, because of the complexities of life insurance, bank management should seek qualified tax, insurance and legal advice when considering BOLI purchases.
For additional information about Bank Owned Life Insurance and other nonqualified plans, contact Greg Ochalek at (440) 591-8581 or firstname.lastname@example.org.