BOLI or Bank Owned Life Insurance continues to be a popular investment option for banks. As of 2019, in the third quarter, about 3800 banks own $190 Billion in BOLI policies.
While BOLI may cover a small part of a bank’s assets, the resulting financial failure from it can be impactful. This short guide will give you everything you need to know about investing in BOLI plans.
What is BOLI?
Bank Owned Life Insurance is a permanent life insurance policy, banks use this to offset liabilities with retirement benefits and recover costs of sustaining employee benefits. The cost to cover employee benefits is gradually rising. BOLI policies ensure that bank owners and CEOs provide these benefits to employees without a loss.
A Bank (Community, Regional, or National) or Credit Union purchases this policy to protect itself, the policy acts as supportive capital when dealing with other deferred compensation plans. Banks can earn a better return on Tier 1 assets and protect themselves against financial loss.
How Does BOLI Work?
When a bank invests in Boli, it’s usually a single premium universal or whole contract. The bank itself is the premium payer, beneficiary, and owner of the contract. So, the insureds are the employees of the bank.
The plan itself is an earning asset that banks can use to offset the existing benefit expenses on their employee’s benefit plans. These include any benefit expense that they can have for their entire population. These benefits can be offset through the income of a BOLI plan. This can include:
- 401(k) matching
- Vacation Days
- Sick Days
Several state and federal banking authorities enforce these regulations to make sure they uphold the contracts. It is not necessary for a bank to conduct medical tests if 10 or more employees agree to sign.
These policies are not represented solely as return investments. BOLI acts as a protective measure against financial failure when confronting compensation plans.
The Boli Process
Before purchasing the banks must get written confirmation of the buy from their employees. Local laws will provide details on who can or can not be insured.
According to The COLI Best Practices Act of 2006, all federal and state laws must be applied to the BOLI contracts. Insurable interest laws vary from state to state, so each establishment must ensure that all of its executives are insurable.
Once purchased, the bank insures a group of their officers. Most of these insurance policies are done through a guaranteed-issue structure. This means the bank doesn’t require medical tests or underwriting if there are 10 officers or more insured.
Once the contracts are created, the bank wires money to the insurance company. The insurance then invests that money either in their general account or in a segregated account. Then the carrier earns a return on those dollars.
They’re investing in assets some of which the bank buys. These can include:
- Mortgage Backs
- Private Placements
- Corporate Bonds
The carrier, through this process, will earn a return on their value. They will deduct their expenses for providing the contract. Also, they’re going to take out the cost of insurance specific to each contract.
After this insurance approval, the bank will receive a net return. That net return is tax-free. As a result, the bank will earn a greater return than what they will get on traditional assets in their portfolio.
BOLI does not work like several traditional individual life insurance contracts. Instead, these contracts remove the high values usually involved in these individual contracts.
BOLI is designed to have a high cash value and low insurance component. It is structured in such a way that you still receive tax benefits while qualifying as life insurance.
The premium advantage will lower the cost of insurance in the contract. This will allow for a cash value build-up in the contract which they’re recognizing tax-free. This creates a beneficial compounding effect for the bank.
This allows the bank leaders to have a general understanding of the contracts. As opposed to individual varying contracts that contain separate details.
Concerning Basel III, so far everyone believes that there’s known to be no impact regarding the tax-free nature of BOLI. This regardless of what the contract type is.
The general BOLI count assets were not expecting any change in risk weighting. But, the specialized accounts may see a change in risk weighting.
Upon Death, the insurance company is fully liable to pay out a policy’s death benefit. But, a policy may reach maturity without death, this is known as endowing. Should this occur, a BOLI consultant will guide executives through the process.
Generally, BOLI should be used to back the top 30% of a bank’s employee roster. This is to ensure that the bank is protected but not at a great loss of the bank’s assets.
Benefits of BOLI
The experience has been that banks have earned somewhere between one hundred basis points to two to three hundred basis points more than they would usually get on the other assets given on their portfolio.
There are many reasons why BOLI works well and why many state and federal regulators see it as a dependable policy. The policy is designed to be a performing asset to the bank.
The bank is not depending upon BOLI and the income from the life insurance to be where they get their benefit. It’s designed to deliver a return on an annual basis. That tax-free return compounds year by year.
One of the reasons why that works so well is that it’s designed to have a low cost of insurance relative to other insurance products. It’s meant to be a cost efficient way to provide these benefits while gaining returns.
BOLI—Is It Worth It?
Navigating around different contracts can be a hassle for any company. Through BOLI, you’ll get on the same page with your top employees. This can prevent any outcome that might result in an expensive type of compensation for a top-level employee.
An accident without proper protection won’t be cheap but you want to provide for your employees without breaking the bank. Find out more on how to protect your assets on our blog!