Is Bank-Owned Life Insurance Right For You?

Bank-owned life insurance (BOLI) is a type of insurance where banks purchase coverage for key employees. The bank is both the policy owner and beneficiary, receiving the death benefit when the insured employee passes away. BOLI serves as a tax-efficient investment strategy for banks, as the policy's cash value grows tax-free and the death benefits are typically tax-exempt. While BOLI does not provide direct benefits to employees or their families, it can enhance overall financial and job security. This is a long-term, illiquid asset for banks, and proper management of associated risks is crucial.

Pros and cons of bank-owned life insurance

Bank-owned life insurance (BOLI) is a type of insurance that banks purchase for specific employees, often executives or other key personnel. While BOLI offers several benefits to banks, there are also some drawbacks. Here are the pros and cons of bank-owned life insurance:

Pros of Bank-Owned Life Insurance:

• Tax advantages: The cash value growth within a BOLI policy is tax-deferred, and the death benefits are generally income tax-free, providing banks with a tax-efficient investment strategy.
• Offsetting employee benefit costs: BOLI can help banks manage the costs of providing employee benefits. The death benefits received can be used to offset expenses associated with employee benefits packages.
• Stable return on investment: BOLI policies typically offer a steady and stable return on investment, which can be higher than returns from other types of investments.
• Improved financial performance: The tax advantages and stable returns from BOLI can contribute to improving the bank's overall financial performance and stability.
• Source of non-interest income: BOLI generates a steady stream of income for banks, as it remains in force as long as premiums are paid, benefiting the bank's bottom line.
• Employee benefits: BOLI enables banks to offer valuable benefits to key employees, such as executive bonuses, supplemental retirement income, or funding for employee benefit plans.
• Risk management: BOLI serves as a risk management tool, providing a death benefit to the bank upon the passing of a key employee. This can help offset the financial impact of losing a valuable employee.
• Diversification of investment portfolio: BOLI offers banks an alternative asset class that is not directly tied to market fluctuations, diversifying their investment portfolio.

Cons of Bank-Owned Life Insurance:

• Regulatory risks and compliance: BOLI is subject to regulatory requirements, and banks must ensure compliance with applicable laws and reporting standards, adding complexity to their operations.
• Interest rate sensitivity: BOLI returns are sensitive to interest rates. Prolonged periods of low-interest rates may result in lower cash value growth than expected.
• Costly surrender charges: If a bank decides to surrender the policy prematurely, they may face significant surrender charges, potentially eroding the cash value.
• Alternative investment opportunities: By allocating a significant portion of their assets to BOLI, banks may miss out on other potentially more lucrative investment opportunities.
• Policyholder risks: If the insured employee lives longer than expected, the bank may need to pay premiums for an extended period, impacting the overall returns on the policy.
• Credit quality of the carrier: The credit quality of the BOLI insurance carrier's credit rating is essential. A bank may be exposed to risk if the carrier's credit rating decreases over time.
• Liquidity concerns: BOLI is considered a long-term, illiquid asset. Withdrawing funds from a BOLI policy before the death of the insured may result in significant tax consequences and fees, limiting the liquidity of this investment.

In conclusion, while BOLI offers banks tax advantages and helps with employee benefit costs, it also comes with regulatory, financial, and liquidity considerations that banks need to carefully evaluate before deciding to invest in BOLI.

Types of bank-owned life insurance policies

Bank-owned life insurance (BOLI) policies come in three main types: General Account, Separate Account, and Hybrid Account. Each type has distinct features and benefits, and banks can choose the one that aligns with their strategic objectives and risk appetite.

The General Account BOLI is the most common and oldest type, where the policy's assets and liabilities are held in the insurance company's general account. The insurer's general account assets often back the policy's performance, and it offers a minimum interest rate guarantee.

Separate Account BOLI provides greater protection for the bank against the insurer's insolvency by holding the policy's assets separately from the insurer's general assets. However, it may also involve more investment risk.

Hybrid Account BOLI combines the features of General and Separate Account BOLI policies. It offers protection against the insurer's insolvency and provides a minimum guaranteed return.

BOLI is a strategic financial tool for banks to insure key employees, offering tax efficiency and supporting employee benefits programs. It is not available for individuals to purchase for themselves.

Why banks purchase bank-owned life insurance

Banks purchase bank-owned life insurance (BOLI) for several strategic reasons. Here are some common motivations for banks to invest in BOLI policies:

Tax-Efficient Investment

BOLI policies offer tax advantages that make them an attractive investment strategy for banks. The cash value growth within a BOLI policy is tax-deferred, and the death benefits are generally exempt from income tax. This allows banks to accumulate tax-free wealth over time.

Offsetting Employee Benefit Costs

Banks often provide a range of benefits to their employees, such as health insurance, retirement plans, and other perks. BOLI policies help banks manage these costs by providing funds to offset the expenses associated with offering employee benefits. The death benefits received from a BOLI policy can be used to cover these costs, improving the bank's financial health.

Stable Return on Investment

BOLI policies typically offer a steady and reliable return on investment, which can be higher than returns from other types of investments. This stable ROI contributes to the financial performance and stability of the bank.

Risk Management

In addition to providing a financial benefit, BOLI policies serve as a risk management tool. They provide a death benefit to the bank upon the passing of a key employee, helping to protect the bank from financial losses associated with the death of a valuable employee.

Improved Financial Performance

The tax advantages and stable returns offered by BOLI policies can contribute to the overall improvement of a bank's financial performance and health. This, in turn, can enhance the bank's competitiveness and ability to attract and retain key personnel.

Risks associated with bank-owned life insurance policies

Bank-owned life insurance policies (BOLI) are a type of insurance that banks can take out on key employees. While BOLI policies offer several benefits to banks, they also come with certain risks and challenges. Here are some of the risks associated with BOLI policies:

• Departure of Key Employees: If a key employee leaves the bank, the BOLI policy may still remain in place, but the bank may lose out on the potential death benefit. This could result in a financial loss, especially if the bank has already paid significant premiums. Employee retention is, therefore, an important consideration.
• Long-term Commitment: BOLI policies are long-term investments, and early withdrawal may result in penalties and taxes on any gains, impacting the bank's liquidity.
• Regulatory Compliance: Banks must comply with various regulatory requirements when purchasing and maintaining BOLI policies. Failure to adhere to these regulations could result in penalties and a loss of tax benefits.
• Insurer Financial Health: The bank's return on investment is dependent on the financial stability of the insurance company. Financial distress or insolvency of the insurer can adversely affect the policy's returns. Therefore, assessing the insurer's financial health is crucial before committing to a BOLI policy.
• Credit Risk: BOLI policies expose banks to credit risk, especially in the case of separate account and hybrid policies. The credit quality of the insurance carrier is essential, and a poor credit rating can increase the bank's risk exposure.
• Market or Interest Rate Risk: The interest rate risk inherent in BOLI policies, particularly those held in separate accounts, can lead to fluctuations in the value of investments.
• Liquidity Risk: BOLI policies are considered illiquid assets, and early surrender or borrowing against the policy may result in adverse tax consequences and fees.
• Operational Risk: The complex structures of BOLI contracts introduce operational risks. Separate account and hybrid policies, in particular, involve multiple parties and variables, making them more complex than general account policies.
• Legal and Compliance Risks: BOLI purchases introduce a range of legal and compliance risks due to the involvement of employment law, tax law, and state insurance laws.
• Reputational Risk: Banks owning BOLI policies may face potential perception issues as they benefit from the death of their employees. Proper consent and communication with employees are essential to mitigate this risk.

Considerations for employees covered by bank-owned life insurance

If you are an employee covered by a bank-owned life insurance (BOLI) policy, it's important to understand certain aspects of this arrangement to effectively navigate your employment benefits and personal insurance needs. Here are some key considerations:

• No Direct Benefit to You or Your Family: As the bank is the beneficiary of the BOLI policy, neither you nor your family will receive any death benefits directly from the policy. This means that a BOLI policy does not replace the need for personal life insurance. It serves the bank's interests, not yours or your family's.
• Insurability Information and Privacy: The process of obtaining a BOLI policy involves the bank gathering information about your insurability. This may raise privacy concerns. However, it's important to know that your consent is required. The bank must obtain your written consent to the policy, and you have the right to refuse if you do not agree. This consent ensures transparency and respects your privacy and choice.
• Limited Coverage: BOLI policies are typically purchased by banks for specific key employees whose loss could significantly impact the bank's operations. Not all employees will be covered by these policies, and the selection is often based on the potential financial impact of an employee's death on the bank.
• Impact on Overall Financial and Job Security: While you may not receive direct benefits from a BOLI policy, its presence can enhance overall financial and job security. The financial stability gained by the bank through BOLI policies can positively impact the work environment and the bank's ability to offer stable benefits packages.
• No Direct Cost to You: As an employee covered by a BOLI policy, you are not responsible for paying any premiums or costs associated with the policy. The bank bears all the expenses.
• Understanding Personal Insurance Planning: Being covered by a BOLI policy highlights the importance of having your own personal insurance planning in place. It's essential to recognize that BOLI serves the bank's interests, and you should ensure that you and your family have adequate personal life insurance coverage to meet your needs.

Frequently asked questions