Community Banks: Insurance Essentials

Community banks have been increasingly investing in bank-owned life insurance (BOLI) since the 1980s. BOLI is a life insurance policy purchased by a bank to insure the lives of certain employees, often high-ranking ones. The bank is the beneficiary and receives the proceeds from the death benefit. This type of insurance is meant to protect the bank in the event of an unexpected financial crisis and give account holders the confidence to store their money in banks. The Federal Deposit Insurance Corporation (FDIC) insures deposits at member banks in case of a bank failure, protecting each credit union member for a maximum of $250,000.

Federal Deposit Insurance Corporation (FDIC) insurance

The Federal Deposit Insurance Corporation (FDIC) is an independent federal agency that insures deposits in US banks and thrifts in the event of bank failure. Created in 1933, the FDIC was established to maintain public confidence and encourage stability in the financial system through the promotion of sound banking practices.

The FDIC insures deposits up to $250,000 per depositor, as long as the institution is a member firm. This covers checking and savings accounts, certificates of deposit (CDs), money market accounts, IRAs, revocable and irrevocable trust accounts, and employee benefit plans. It is important to note that mutual funds, annuities, life insurance policies, stocks, and bonds are not covered by the FDIC.

The FDIC provides an essential safety net for depositors, ensuring that their money is protected even if a bank fails. This protection extends to different ownership categories, such as individual, joint, and business accounts, each with its own $250,000 insurance limit. For example, a couple with a joint savings account of $500,000 and an eligible retirement account of $250,000 would have their entire $750,000 covered by the FDIC.

The FDIC also offers resources and tools to help consumers make informed decisions and protect their assets. One such tool is the Electronic Deposit Insurance Estimator (EDIE), which helps depositors calculate how much of their bank deposits are insured and identify any amounts that exceed the coverage limits.

It is crucial for consumers to confirm whether their financial institution is FDIC-insured to ensure their deposits are protected. By doing so, depositors can have peace of mind knowing that their funds are safe and that they can access their insured money even in the event of a bank failure.

National Credit Union Share Insurance Fund

The National Credit Union Share Insurance Fund (NCUSIF) was established by Congress in 1970 to provide deposit insurance for member share accounts at federally insured credit unions. The fund is administered by the National Credit Union Administration (NCUA) and is similar to the deposit insurance coverage provided by the Federal Deposit Insurance Corporation (FDIC).

The NCUSIF provides insurance for individual accounts up to $250,000 and a member's interest in all joint accounts combined is insured up to $250,000. The fund also separately protects members' IRA and KEOGH retirement accounts up to $250,000 and provides additional coverage for members' trust accounts.

Credit union members are automatically enrolled in the NCUSIF when they join a federally insured credit union, and no credit union may end its federal insurance without first notifying its members. The NCUSIF is backed by the full faith and credit of the United States government, and no member of a federally insured credit union has ever lost any insured savings.

To ensure that their credit union is federally insured, members can look for the official NCUA insurance sign, which must be prominently displayed at each teller station and where insured deposits are normally received, as well as on the credit union's website. Members can also use the NCUA's Credit Union Locator tool to confirm federal insurance.

The NCUSIF does not cover all types of accounts or products. For example, it does not insure money invested in stocks, bonds, mutual funds, life insurance policies, annuities, or municipal securities, even if these products are sold at a federally insured credit union. It also does not cover safe deposit boxes or their contents, or digital assets such as cryptocurrencies.

Bank-Owned Life Insurance (BOLI)

There are three types of BOLI products offered to banks: General Account, Separate Account, and Hybrid Account. The General Account is the oldest and most common type, where the bank's deposit becomes part of the insurance carrier's general account, primarily invested in real estate and bonds. The Separate Account approach involves segregating the holdings from the carrier's general account into bank-eligible investments managed by fund managers. The Hybrid Account combines the benefits of both the General and Separate Account approaches, providing a guaranteed credit rating and detailed information about investment holdings.

BOLI is a long-term asset that offers banks a highly-rated investment option with significant tax advantages. The cash surrender values grow tax-deferred, providing the bank with monthly bookable income. The gains within the policy are only taxed if the contract is surrendered. BOLI also helps banks compete with other employers' benefit plans and provides a way to fund benefit plans for all employees.

While BOLI has traditionally been combined with benefit plans for new senior executives, it is becoming more common for banks to purchase BOLI policies to offset existing employee benefit expenses. BOLI allows banks to generate earnings that offset the costs associated with employee benefits programs and provides a tax shelter for financial institutions.

Key-person life insurance

The key-person life insurance policy provides a financial cushion for the bank, allowing it to cover the costs of recruiting, hiring, and training a replacement for the deceased person. The death benefit can also be used to pay off debts, distribute money to investors, provide severance benefits to employees, and close the bank in an orderly manner if necessary. This type of insurance gives the bank options other than immediate bankruptcy in the event of the loss of a key person.

The amount of coverage needed for key-person life insurance will depend on the size and nature of the bank and the key person's role. It is recommended to consider purchasing a policy that is eight to ten times the key person's salary or the monetary value of the key person. The cost of the insurance will depend on factors such as the health, gender, and age of the key person, the type of policy, and the amount of coverage.

Split-dollar life insurance

Types of Split-Dollar Plans

There are two types of split-dollar plans: economic benefit arrangements and loan arrangements. In an economic benefit arrangement, the employer owns the policy, pays the premium, and assigns certain rights or benefits to the employee. The employee can designate beneficiaries who will receive a portion of the policy's death benefit. On the other hand, in a loan arrangement, the employee owns the policy, and the employer pays the premium. The employee gives an interest in the policy back to the employer through a collateral assignment, which restricts what the employee can do without the employer's consent.

Advantages of Split-Dollar Plans

Split-dollar plans offer several advantages, including the use of corporate dollars to pay for personal life insurance, low-interest rates, and tax benefits such as options to minimize gift and estate taxes. Additionally, the employer can choose who receives the benefit, and there are fewer restrictions than with traditional plans. For employees, split-dollar plans allow them to build up their own cash value within the policy and provide tax-free income through loans and withdrawals.

Termination of Split-Dollar Plans

Split-dollar plans are typically terminated in two ways: at the employee's death or at a future date included in the agreement, such as retirement. If the employee passes away, the employer recovers the premiums paid, cash value, or the amount owed in loans, and the employee's beneficiaries receive the remainder as a tax-free death benefit. If the employee fulfils the terms of the agreement, all restrictions are released, or ownership of the policy may be transferred to the employee, depending on the type of plan.

Frequently asked questions