Bank-Owned Life Insurance (BOLI)

BOLI Overview

Bank-Owned life insurance (BOLI), encompasses all life insurance that a bank purchases and either owns or in which it has a beneficial interest. For many years, banks have been purchasing life insurance on the lives of directors, officers and employees with the banks as the owners and beneficiaries of the policies. These policies have been typically acquired to recover all or a part of the costs of the bank’s employee compensation and benefit programs.

BOLI is most commonly designed as a single premium life insurance contract specifically designed to earn tax-free income. BOLI’s tax-free income is generated by the increase in cash value of the policy and insurance proceeds paid to the bank when an insured dies.

Most traditional bank investments create taxable interest income. In contrast, BOLI results in no current income tax liability for the earnings generated each year. Earnings are sheltered inside the life insurance contract and are therefore tax-deferred. When a death occurs, the bank receives life insurance proceeds tax-free. By reinvesting funds from traditional portfolio investments into BOLI, a bank can typically increase its yield by 100 to 350 basis points depending upon marginal tax rates, the size of the transaction, the type of policies selected and the demographics of the key employees to be insured.

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Regulatory Guidance

Recently issued guidance from federal banking regulators reasserts the fact that BOLI can “serve a number of appropriate business purposes” and specifically that “BOLI can provide attractive tax-equivalent yields to help offset the rapidly rising cost of providing employee benefits.” The referenced guidance is a joint interagency statement, OCC Bulletin 2004-56 (also cited as FIL 127-2004). Issued on December 7, 2004, by the federal banking regulators, the bulletin and first formal interagency statement on BOLI replaced and rescinded the previous guidance, OCC Bulletin 2000-23.

Like its predecessor, OCC 2000-23, OCC Bulletin 2004-56 discusses the risks associated with a BOLI purchase and establishes the supervisory expectations of both a pre-purchase analysis and the continuing post-purchase risk assessment. The guidance from OCC 2004-56 with respect to pre-purchase analyses of life insurance applies to all BOLI contracts entered into after the date of the bulletin (December 7, 2004). BOLI contracts entered into on or before December 7, 2004, would be subject to the prevailing guidance from an institution’s supervisory agency. The new post-purchase risk management guidance of OCC 2004-56 applies to all holdings of life insurance regardless of when the insurance was purchased.

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Risk Evaluation and Pre-Purchase Analysis

Bulletin 2004-56 introduces eight risk categories associated with BOLI including the newly identified “reputation risk” or the risk to earnings and capital arising from negative publicity surrounding the public perception of institutions owning or benefiting from life insurance on employees. The guidance suggests that an insured’s informed consent prior to the bank’s purchasing BOLI as well as the bank’s monitoring of the amount of insurance purchased on any one individual will mitigate this risk.

Management actions which Bulletin 2004-56 recommends for an effective pre-purchase analysis include:

• Identifying the need for insurance and determining the economic benefits and appropriate insurance type;
• Quantifying the amount of insurance appropriate for the institution’s objectives;
• Assessing vendor qualifications;
• Reviewing the characteristics of the available insurance products;
• Selecting carrier;
• Determining the reasonableness of compensation provided to the insured employee if the insurance results in additional compensation;
• Analyzing the associated risks and the bank’s ability to monitor and respond to those risks;
• Evaluating alternatives;
• Documenting the bank’s decision.

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Post-Purchase Risk Assessment

Bulletin 2004-56 asserts that “BOLI can be an effective way for institutions to manage exposures arising from commitments to provide employee compensation and pre- and post-retirement benefits.” Once implemented, management and the board of directors should continue to manage the life insurance holdings in a manner consistent with safe and sound banking practices.

The guidance identifies the risks which management and the board of directors should evaluate including liquidity, transaction/operational, reputation, compliance/legal and price risk. In the ongoing assessment of risk, Bulletin 2004-56 directs bank management to review the performance of the institution’s insurance holdings with its board of directors at least annually. Such post-purchase review would include at a minimum:

• A comprehensive assessment of risks discussed in the guidance;
• Identification of employees who are insured;
• Assessment of death benefit amounts relative to employee salaries;
• Calculation of percentages of insured persons still employed by the institution;
• Evaluation of material changes to BOLI risk management policies;
• Assessment of the effects of policy exchanges;
• Analysis of mortality performance and impact on income;
• Evaluation of material findings from internal and external audits and independent risk management reviews;
• Identification of the reason for, and tax implications of, any policy surrenders;
• Peer analysis of BOLI holdings.

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Assessment of Vendor Qualifications

Vendors generally represent banks in the vast majority of BOLI purchases as acknowledged by Bulletin 2004-56. The guidance reaffirms the importance of careful vendor selection. In choosing a vendor, consideration should be given to the adequacy of the vendor’s services, and its reputation, experience, financial soundness and long-term commitment to the BOLI marketplace. In addition, the guidance stresses the importance of “the vendor’s ability to honor its long-term commitments” and “the vendor’s commitment to investing in the operational infrastructure necessary to support BOLI”.

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BOLIStar™

With the introduction of OCC Bulletin 2004-56 in December 2004 (Interagency Statement on the Purchase and Risk Management of Life Insurance), the Federal Banking Regulators introduced a series of new requirements for the evaluation of purchases and holdings of BOLI. Among other issues, the Regulators now require banks to comprehensively evaluate the risk elements associated with the purchase.

One important component in the required analysis is an assessment of “reputation risk”. A key element of “reputation risk” is a peer review of BOLI holdings, comparing the bank’s BOLI holdings to those of its peers, to determine whether the bank is an outlier. Besides identifying this as a requirement, the Regulators provided no other definitional support or guidance.

To assist banks in conducting this peer review, NYLEX Benefits developed a proprietary system known as BOLIStar™, or Bank-Owned Life Insurance Statistical Analysis & Review.

BOLIStar™ is a unique program utilizing the Federal Government Thrift and Call Report database referred to as Statistics on Depository Institutions, or SDI. BOLIStar™ permits a bank to quickly assess its actual or proposed BOLI holdings against a wide range of its peers, classified by asset size, capital, geographic distribution, etc. The assessment is provided in graphical as well as text format. Additionally, BOLIStar™ provides a unique outlier report as it utilizes statistical data and correlation analysis to provide the bank with the most comprehensive review possible.

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BOLI Brochure

Click here to download our brochure about Bank-Owned Life Insurance.

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OOC Bulletins

• OCC Bulletin 2004-56 (PDF version) [effective 12/07/2004]
  (Also issued as FIL 127-2004, FRB SR 04-19, and OTS TB-84)
• OCC Bulletin 2004-10 (PDF version)
• OCC Bulletin 2000-23 (PDF version) [rescinded 12/07/2004]
• OCC Bulletin 2002-19 (PDF version)
• OCC Bulletin 95-7 (PDF version)
• OCC Interpretive Letter 848 (PDF version)
• OTS Regulatory Bulletin 32-16 (PDF version)