Life Insurance And Banks: A Partnership For Customer Benefits

Banks have been purchasing life insurance policies for their executives and key employees since the early 1980s. This type of insurance is called bank-owned life insurance (BOLI). It is a tax-free way for banks to fund employee benefits and shore up balance sheets with reliable assets that can be used as collateral.

BOLI is an attractive investment for banks because it offers guaranteed growth, tax advantages, and favourable loan terms. The death benefit from a BOLI policy is also tax-free.

While individuals cannot purchase BOLI for themselves, they can use a similar strategy called infinite banking. Infinite banking involves overfunding a permanent life insurance policy so that the policyholder can borrow against its cash value. This provides easy access to funds and flexible loan terms, all while maintaining life insurance coverage.

Banks can use life insurance as a tax shelter

Additionally, bank-owned life insurance (BOLI) is a type of life insurance that banks use as a tax shelter. In this arrangement, the bank is the policy beneficiary and owner. BOLI is often purchased for high-earners and board members, and the bank pays for the policy and benefits after the insured individual's death. The death benefits and any growth in the cash value of the policy are tax-free for the bank. BOLI helps banks fund employee benefits and compete with other employers' benefit plans while also providing a tax shelter.

Infinite banking is another strategy that can be employed, where individuals overfund their permanent life insurance policies and borrow against the cash value. This allows individuals to become their own bankers, accessing funds tax-free and avoiding the need to qualify for traditional loans. While this strategy is more commonly used by individuals, it is based on the same principle that banks use – leveraging the tax advantages and cash value of life insurance to create a tax shelter.

Life insurance can be used to fund employee benefits

Group life insurance is attractive to employers because it helps them attract and retain top talent. It demonstrates a commitment to employee well-being and can be a valuable addition to the overall compensation package. The premiums paid by employers for group life insurance are also tax-deductible, reducing their financial burden while providing valuable benefits for employees.

For employees, group life insurance provides access to financial protection for their families in the event of their death. It often serves as the first life insurance coverage for many workers, offering a foundation of financial security. Employees with pre-existing medical conditions or higher health risks may still be eligible for coverage without the need for extensive medical examinations. Enrollment is also convenient, as it is often part of the onboarding process when hiring new employees.

Group life insurance benefits both employers and employees by offering cost-effective coverage, tax advantages, simplified administration, and financial protection. It represents a win-win situation, boosting the competitive edge in recruitment and providing peace of mind for employees and their loved ones.

Life insurance can be used as collateral

Here's how to apply for collateral assignment of life insurance:

• Know the requirements: Lenders generally require an active life insurance policy with cash value. This means that a term life insurance policy may not qualify. However, exact requirements vary by lender.
• Fill out a life insurance application: Apply for a life insurance policy that will meet a lender's loan requirements. You will likely need life insurance with cash value. Check with the lender to ensure the policy you're approved for qualifies for a life insurance collateral assignment.
• Fill out a collateral assignment form: Once you've signed your life insurance contract and paid your first premiums, complete a collateral assignment form with your insurer. You'll need to fill in your lender's contact details so your insurer can designate them as a collateral assignee while your loan is outstanding.
• Sign and submit the form: After completing the collateral assignment form, you and your lender must sign it. Your insurer may be able to provide electronic versions of the documents and e-signature capabilities to streamline the process. Wait for your bank to confirm that your insurer has made them the collateral assignee, and then apply for your chosen loan.

Using your life insurance policy as collateral may impact your beneficiaries if you default on the loan or pass away with an outstanding balance. In such cases, the death benefit payout to your beneficiaries could be reduced.

Collateral assignment of life insurance is most common in small business lending. Since most entrepreneurs sink all their savings into their ventures, they might not have many remaining sources of equity to tap. A collateral assignment ensures that the lender will be repaid the funds they lent, even if the borrower dies.

If you're trying to use the value of a life insurance policy to help secure a mortgage or other type of personal loan, the lender might prefer if you have a whole or permanent life policy with accrued cash value. This is because the cash value makes the policy a tangible asset, like a building or vehicle.

It's important to note that you are required to keep current on the premiums of the life insurance policy for which the lender is an assignee. Staying up-to-date on the premiums is a condition of the loan, and the lender will likely check.

When the loan is fully repaid, the life insurance policy is no longer used as collateral, and the lender will need to provide documentation confirming this.

A common mistake is to make a lender a beneficiary of a life insurance policy, rather than an assignee. With a collateral assignment, the lender gets first dibs at the death benefit money up to the amount of the outstanding debt, and any remaining funds go to beneficiaries. If the lender is the beneficiary, they would be entitled to the entire death benefit, which could leave the policyholder's heirs with nothing.

Life insurance can be used to offset the costs of employee benefits

The bank pays for the policy and benefits from the insured individual's death. The death benefit is tax-free, and the cash value of the policy can be used to fund employee benefits such as healthcare, 401(k) programs, and vacation days.

BOLI offers banks several advantages, including tax benefits and the ability to generate earnings that can offset employee benefit expenses. The policy remains in place even if the employee leaves or is terminated, allowing the bank to continue funding employee benefits.

BOLI can also help banks meet their capital requirements and compete with other employers' benefit plans. As of June 30, 2023, the total cash surrender value of all BOLI policies held by banks was $202.4 billion.

Life insurance can be used to protect against the unexpected loss of key people

BOLI is a tax-free way for banks to fund employee benefits. It is a tax shelter, and the tax-free benefits can be used to offset the costs of employee benefits, such as healthcare, 401(k) programs, and vacation days. It can also help banks meet their capital requirements.

BOLI is an attractive option for banks because it offers benefits that their own products and institutions do not. Bank products have low rates and are taxable, whereas life insurance offers guaranteed growth, tax advantages, and the opportunity to strengthen balance sheets with a highly reliable asset.

BOLI policies produce far superior returns than traditional bank investments. The growth in the cash value of the policies, as well as any death benefits paid out, are completely tax-free. This favourable tax treatment has a sizable impact on returns.

BOLI assets are considered robust capital profiles. Since the policies are considered somewhat liquid due to their cash-surrender value, they can be counted as Tier 1 capital under new capital requirement rules. This means that Cash Surrender Values (CSV) can provide up to 25% of a bank's top-shelf capital.

Life insurance companies invest for long-term stability and do not employ leverage, making bank-owned policy cash value a high-quality, low-risk asset. This makes life insurance an attractive option for banks to protect themselves from the unexpected loss of key people.

Frequently asked questions