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What Is Bank-Owned Life Insurance (BOLI)?
Bank-owned life insurance (BOLI) serves as a tax-efficient tool for banks, helping them fund employee benefits through tax-free provisions. Banks purchase these policies on high-earning executives and board members, acting as the beneficiary themselves to safeguard against potential financial losses from the death of key personnel.
Key Takeaways
- Bank-Owned Life Insurance (BOLI) is used by banks as a tax-free method to fund employee benefits and provide financial protection for key personnel.
- BOLI policies are taken out on executives, and their tax-free death benefits are utilized to offset the costs of employee benefit programs.
- There are three types of BOLI: general, hybrid, and separate accounts, with each offering different investment and credit protection features.
- If a BOLI policy is surrendered and cannot be maintained, it becomes taxable and may incur a 10% penalty on gains.
- BOLI helps banks compete by allowing them to offer competitive benefits, even though the insured employee must consent to the policy.
Investopedia / Candra Huff
Understanding the Mechanics of BOLI Policies
Banks use BOLI contracts to fund employee benefits at reduced costs. In a typical scenario, the bank sets up the contract and then makes payments into a specialized fund set aside as the insurance trust. The policy is bought on an executive’s life.
All employee benefits that need to be paid to particular employees covered under the plan are paid out from this fund. All premiums paid into the fund and capital appreciation are tax-free for the bank. Therefore, banks can use the BOLI system to fund employee benefits tax-free.
As the U.S. Department of the Treasury’s Office of the Comptroller of the Currency (OCC) explains, banks are allowed to purchase BOLI policies “in connection with employee compensation and benefit plans, key person insurance, insurance to recover the cost of providing pre-and post-retirement employee benefits, insurance on borrowers, and insurance is taken as security for loans.” In addition, OCC may also allow for other uses, it says, “on a case-by-case basis.”
Tip
Banks can’t buy life insurance for regular employees. They can only insure employees whose death would cause the bank financial loss. This often means highly paid employees, or the top 25% of staff. Also, the insured employee must agree to the policy.
Exploring Different BOLI Account Types
Banks and corporations can choose from three types of BOLI accounts: general, hybrid, and separate. The general account is the most common and oldest. When banks invest in a general account product, it is mainly invested in bonds and real estate, the carrier of this type of insurance has a credit rating, which can change.
The bank’s investment deposit is used as a part of the carrier’s general account. The details of investments in a general account are shared in broad strokes rather than the in-depth view given with a separate account.
A separate account allows the insurance provider to separate the general account holdings into investments managed by fund managers. These managers provide the bank with details of the bank’s portfolio, and the credit rating of these accounts uses a yield-to-worst ratio. Still, there isn’t any guaranteed minimum credit rating as a general account.
A hybrid account combines aspects of a general and a separate type of BOLI. With a hybrid, banks and corporations receive a guaranteed credit rating and detailed information about investment holdings, like in a separate account. Separate and hybrid insurance are also isolated from creditors (unlike general insurance), which protects banks who take these types of BOLI out on their employees.
Important
Bank-owned life insurance is a kind of tax shelter providing funds (tax-free) to the bank to offset costs.
Weighing the Advantages and Disadvantages of BOLI
According to BoliColi.com, which helps manage corporate-owned and bank-owned life insurance portfolios, this type of insurance was traditionally combined with benefit plans for new senior executives but they are becoming more common as more banks purchase policies to offset employee benefit expenses.
Tax Benefits
As noted, the advantages of BOLI included its tax favorability and the ability to generate earnings that offset the costs associated with employee benefits programs. Another pro is that even if an employee leaves or is fired from the bank, the insurance policy stays in place, so funds from the policy can help the bank continue to pay for other employee benefits.
Surrendered Policies
One downside is that if a bank can’t keep up with premiums and surrenders the contract, the policy gets taxed, plus a 10% penalty on gains. In addition, the credit quality of a BOLI insurance carrier’s credit rating is essential.
In addition, because BOLI is an illiquid asset if a bank purchases a policy from a company with a poor credit rating, it exposes the bank to risk, especially if it isn’t purchased as a single-premium policy yields the most significant returns.
Why Do Banks Purchase BOLI?
BOLI offers banks a tax shelter and a way for them to fund benefit plans. Premiums paid into the fund, in addition to all capital appreciation, are tax free for the bank. Therefore, banks can use the BOLI system to fund employee benefits on a tax-free basis.
When Are Benefits Paid?
Since the policy is taken out on an executive’s life, tax-free death benefits are paid when the executive dies.
Can I Buy Bank-Owned Life Insurance?
No. Individuals cannot purchase bank-owned life insurance for themselves. It is only for banks and corporations, who purchase it for specific employees, often executives.
How Much BOLI Do Banks Own?
According to data reported to the FDIC, the total cash surrender value of all policies held by banks was $202.4 billion as of June 30, 2023.
The Bottom Line
Banks increasingly leverage Bank-Owned Life Insurance (BOLI) as a strategic tax shelter to fund employee benefit programs for high-value employees and board members. With BOLI, banks can maintain competitive employee benefits by offsetting costs through tax-free capital appreciation and death benefits. The policy remains with the bank, irrespective of the employee’s departure, ensuring sustained financial support for benefit plans. However, partnering with reputable insurers maintains benefits and insulates banks from potential credit risks associated with BOLI carriers. By strategically employing BOLI, banks can enhance their benefit offerings while efficiently managing associated costs.
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