bank owned life insurance
Bank Owned Life Insurance
Bank Owned Life Insurance (BOLI) consists of policies insuring the Bank’s officers and key employees, typically purchased with a one-time payment.
BOLI is an alternative asset that may enable the Bank to record attractive yields through tax-deferred cash value accumulation and tax- free death proceeds.
A typical BOLI purchase is immediately accretive to earnings per share with earnings increasing in future years due to the effect of compounding.
BOLI should be considered as a part of the Bank’s overall Asset/Liability Management (ALM) strategy.
The benefits being financed can include the following:
- Employer-paid Health Insurance
- 401(k) Matching Contributions
- Executive Benefit Programs
- Employee Disability and Group Life Plans
- Profit Sharing Contributions
The financing of employee benefits is the business purpose for BOLI
Regulatory guidance provides methodology to justify the amount of the BOLI purchased. Under the cost recovery method, the purchase is not excessive if the present value of the employee benefits is in excess of the present value of the gain from the life insurance death benefits.
The maximum amount of BOLI to be purchased is generally equal to 25% of the Bank’s Tier 1 Capital amount. Purchase amounts from any one insurance carrier should generally be less than 15% of the Tier 1 Capital amount.
It is not necessary to create new executive benefits to justify a BOLI purchase although BOLI is often implemented in conjunction with nonqualified benefit plans.
BOLI income is recorded as Other Income on the Bank’s income statement. This income and the policy death benefits are not subject to income tax if the policy is held until maturity.
BOLI policies that are surrendered for cash prior to the death of the insured create taxable income. This taxable gain is equal to the final policy cash value less the original premium amount. The gain on surrender may also be subject to a 10% MEC tax penalty.
BOLI has no legal impact on benefits provided by the Bank to its employees, nor does it impact their personal insurance programs.
The Bank is the beneficiary and sole owner of the policies; however, sometimes the insured individuals receive a portion of the excess death benefit.
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When reviewing the quality of the BOLI asset under consideration, the Bank should pay special attention to the following guidance from the 2004 Interagency Statement on the Purchase and Risk Management of Life Insurance.
“To achieve the tax benefits of insurance, institutions must hold BOLI policies until the death of the insured. Therefore, carrier selection is one of the most critical decisions in a BOLI purchase and one that can have long-term consequences.”
“…management should have a thorough understanding of how the insurance product works and the variables that dictate the product’s performance. The variables most likely to affect product performance are the policy’s interest-crediting rate, mortality cost, and other expense charges.”
“An institution should analyze the cost and benefits of planned BOLI purchases. The analysis should include the anticipated performance of the BOLI policy and an assessment of how the purchase will accomplish the institution’s objectives. Before purchasing BOLI, an institution should analyze projected policy values (cash surrender value and death benefits)…”
During the asset selection process, EBS works with the Bank’s management and Board of Directors to document that the above asset quality considerations have been reviewed.
- Determine/Quantify the need for insurance
- Vendor selection
- Insurance carrier selection
- Review the characteristics of the available insurance products
- Analyze the benefits of BOLI
- Determine the reasonableness of compensation provided to the insured employee if the insurance results in additional compensation
- Analyze the associated risks of BOLI and the Bank’s ability to monitor and respond to those risks
- Accounting considerations
Safe and sound banking practices:
- Complexity of the transaction
- Size of the transaction relative to the Bank’s capital
- Diversification of credit risk
- Financial capacity of the Bank
- Financial capacity of the insurance carrier
- Bank’s ability to identify, measure, monitor and control the associated risks
EBS provides the following ongoing administrative services to the Bank:
- Updates of the original census listing for employment status and last known address based on information provided by the Bank. The updated census will provide an insured status report based on the categories of active, inactive and deceased.
- Updates of insurance carrier ratings from Standard & Poor’s Corporation, Fitch Research, Moody’s Investor Service, and A.M. Best Company. In the event of a material change in ratings or condition, EBS will notify the Bank as soon as possible.
- Program Reviews with the Bank’s management and/or Board of Directors. This review includes historical performance of the program.
- Earnings projections to assist with financial budgeting.
- Annual cash value confirmations for each insurance carrier for the Bank’s auditors.
- Monitoring and Reporting for regulatory compliance and additional BOLI information as requested.
- Periodic updates of life insurance industry issues and other matters relevant to the BOLI program.
- Sweeps of the Social Security Administration’s Master Death File and other databases to assist with death claims for insured employees.
- Preparation of suggested journal entries for policy cash values and benefit expenses.
- Preparation of annual participant statements for applicable benefit plans.
- Preparation of an annual BOLI Board Reporting package.