Over the past two decades, banks have increasingly dabbled in BOLI, or bank-owned life insurance. While there are downsides to consider, experts say the benefits of these policies are two-fold: to generate income in the long term and to retain bank leaders.
By Beth Mattson-Teig
The cash surrender value of all U.S. bank-owned life insurance policies
Bank interest in bank-owned life insurance (BOLI) has been surging amid what some describe as a perfect storm of market conditions.
Two-thirds of banks in the U.S. hold BOLI assets, according to the NFP-Michael White BOLI Holdings Report for Q3 2020. The cash surrender value of those policies totals $182.2 billion. Banks with less than $10 billion in assets have, on average, approximately 14% of capital in BOLI.
BOLI has become one of the most common methods of financing the cost of employee and director benefits, including nonqualified benefit plans. It gained considerable traction in 2004 when the Office of the Comptroller of the Currency (OCC) released Bulletin 2004-56: The Interagency Statement on the Purchase and Risk Management of Life Insurance. “That really gave banks the green light to own BOLI and provided clear guidelines for pre-purchase analysis and risk management,” says Russell McMillan, director, business development at M Benefit Solutions in Portland, Ore.
That being said, there has been some cyclical ebb and flow in the demand since the OCC guidance was released. Because of the capital expense involved, BOLI competes with loans and other investments. If a bank is doing well making loans and its loan book is growing, BOLI will typically take a back seat to those loan assets, McMillan says. Over the past two years, demand for BOLI has spiked as interest rates dropped further, loan yields started to fall and yields in a bank’s permissible investment in securities portfolios started to decline.
One of the main reasons that BOLI is attracting more interest from bankers is that yields compare favorably with today’s alternative investments, says Ken Derks, a managing consultant at Nashville, Tenn.-based NFP Executive Benefits. The credit quality of general account BOLI is fairly high, and banks are getting a nice spread compared with other investments, he says, adding that in the current market, BOLI policies are generating tax equivalent net yields between 3% and 4%.
How does BOLI work?
Banks typically purchase BOLI policies for top executives or directors. The bank is both the owner and the beneficiary of the policy. BOLI is frequently used to help offset and recover the cost of employee benefits, as well as nonqualified benefit plan expenses, supplemental retirement and supplemental life insurance plans for officers and directors.
“Because the cash flows from a BOLI policy are generally tax-deferred income,” Derks says, “if the institution holds the policy for its full term, BOLI can provide attractive tax-equivalent yields to help offset the rapidly rising cost of providing employee benefits.”
“You hope that it is many days and years in the future, but one day that [bank-owned life insurance] policy will come back to benefit the bank.”
—Bill McCandless, Lone Star Capital Bank
San Antonio-based Lone Star Capital Bank bought its first BOLI policy about seven years ago and now holds policies on six of its executive officers. The $310 million-asset community bank has purchased single policies totaling about $5 million with proceeds that are tied specifically to funding benefits for each insured person.
“We have really used it to help offset the cost of a particular retirement plan for that person,” says chairman Bill McCandless. Although Lone Star Capital Bank provides 401(k) plans for all of its employees, it offers an additional retirement plan for those six executives as part of their overall compensation package. It’s an extra step to attract and retain key people, McCandless adds.
“You hope that it is many days and years in the future, but one day that policy will come back to benefit the bank,” he says, adding that the bank earns interest on the policy. The insurance company pays the bank a dividend, which accrues on the policy’s cash value. On the bank’s books, it’s treated as tax-free noninterest income even though it is not cash received. “So, I believe it has worked out very well for our bank,” McCandless adds.
Weighing pros and cons
Experts tend to agree that one of the main selling points of BOLI is its tax-favored treatment. “By far the biggest disadvantage is you pay for the insurance policy up front,” McCandless says. The premiums can be a sizable capital commitment that might range from $250,000 for an individual to upwards of $8 million for a group of 15 bank executives.
BOLI is an illiquid asset. It works well if the bank holds the policy until the death of the individual, which tends to make it a long-term asset. Banks can surrender the policy at any time for the cash surrender value, but they would be required to pay taxes on all gains received since they bought the policy. If it’s a modified endowment contract (MEC) policy, the bank would have to pay an additional 10% excise tax on those gains.
Banks should consider what they are doing strategically with their capital before committing funds to BOLI given its long-term nature, McMillan says. BOLI acts as an accounting offset, because it doesn’t generate cash flow. The cash render growth within the policy is an “other income” earnings. So, if a bank has a low cash flow or is in need of cash, BOLI may not be the right product. BOLI might also not be a good option for a bank that is in a negative tax situation, or if it has some carry forward losses, McMillan adds.
Regulators require banks to follow the interagency guidance on purchasing and maintaining BOLI, which includes vendor due diligence. It’s important to partner with a provider that can provide technical and compliance support, Derks says. Another important component is choosing a good insurance carrier.
“It is kind of like making a really long-term loan,” McCandless says. “You have to be very prudent in the insurance companies you choose to work with.”
Beth Mattson-Teig is a writer in Minnesota.