Banks, particularly community-owned ones have been purchasing Bank Owned Life Insurance Policy (BOLI) for several business purposes since 1980s. According to IBIS Associates Inc. life insurance companies sold approximately 1,200 new BOLI cases in 2013 that were 12 percent more than the corresponding numbers in 2012. The common reasons behind taking BOLI are as follows:
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Let's read more about the different types of BOLI, what's trending in BOLI holdings in community banks and unique risks associated with it.
What's BOLI
BOLI is a life insurance policy bought by a bank or bank holding company for insuring life of some of the key employees who could be - highly compensated employees or officers. Then again, banks can purchase BOLI for any employee. Since, BOLI is owned by the bank, it has legal right over the proceeds from death benefits and revenue from investment earnings. Also, the entity is responsible to bear the risk of investment losses.
Bank often pays a single premium to purchase BOLI insurance and the premium amount might range from thousands to millions of dollars. One of the prime benefits of BOLI is that the income earned on the policy is tax-free for the bank and after demise of the employee; the cash payment it receives is also tax-free.
Types of BOLI
Two primary types are:
Whereas general account is easy to understand, separate account can be a bit complicated. Let's discuss the two in detail:
In general account, the insurance company makes all the investment decisions and the assets received are part of the general fund. On the contrary, in the separate account, bank has the freedom to select investment style; however, it has no control over the investment.
CSV for a general account, is an unsecure obligation of the insurance company and available to general creditors in case the issue of life insurer's insolvency arrives. Whereas, in case of separate account, the assets are segregated by state law and also protected by general creditors.
For general account, the interest rate is same as guaranteed by the insurer. Whereas, for separate account, interest rate is related to how specific investments perform in separate accounts.
Also, an interesting thing to notice is that the likelihood of a community bank holding BOLI assets increases with its size.
BOLI Risks
Before investing in any sort of insurance, a person needs to analyze the plus and minus points of any policy to avoid distress at a later stage. So, here are a few risks associated with BOLI insurance you need to take into consideration.
Credit Risk
The performance of any life insurance contract depends greatly on the financial condition of the insurance company that guarantees or underwrites it. Also, the company's capability in adhering to the payment terms of the contract is another fact to consider. Since, most insurance contracts are long-term; you need to analyze the financial condition of the insurance company and its ability to pay for the cover before taking a decision. Thorough analysis is a major part of the credit risk assessment process.
Market Risk
The market risk depends on the type of the BOLI insurance taken. In general account BOLI, the investments are held in the general account of the insurance company and since the maturity of the assets in the account is often on a long term basis, the investment value may vary with the change in the long-term interest rates.
Whereas in case of separate account BOLI, the rate of interest is directly related to the investments in the separate account. So, it is more difficult for the management to control the risk because separate account assets cannot be controlled. A common way of mitigating some risk is by purchasing SVP wrap that will protect the bank against any sort of decline in the value of the account asset due to interest rates change.
Liquidity Risk
One of the least liquid assets in a bank's balance sheet is the cash surrender value of Bank Owned Life Insurance Policy. In most cases, a bank does not receive any cash flow from BOLI until the death of the insured employee. If it wants to extract liquidity from the policy before death, there are two ways to follow:
Both the ways will bring with them significant tax consequences and fees.
Summing It Up
Although BOLI offers many benefits to community banks, it does come with risks. It may provide compensation to a company after an insured executive's death or offer tax advantage; however, it should be purchased only after carefully considering all the aspects and discussion with the management. As it is a complex insurance, banks are recommended to seek the advice of a qualified insurance agent and get in touch with a reputable insurance company to avoid any unwanted loss in the long run.
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- To recover from the losses associated with death of a key person
- To recover from the cost of providing pre and post retirement employee benefits
- To provide direct employee benefit
Let's read more about the different types of BOLI, what's trending in BOLI holdings in community banks and unique risks associated with it.
What's BOLI
BOLI is a life insurance policy bought by a bank or bank holding company for insuring life of some of the key employees who could be - highly compensated employees or officers. Then again, banks can purchase BOLI for any employee. Since, BOLI is owned by the bank, it has legal right over the proceeds from death benefits and revenue from investment earnings. Also, the entity is responsible to bear the risk of investment losses.
Bank often pays a single premium to purchase BOLI insurance and the premium amount might range from thousands to millions of dollars. One of the prime benefits of BOLI is that the income earned on the policy is tax-free for the bank and after demise of the employee; the cash payment it receives is also tax-free.
Types of BOLI
Two primary types are:
- General Account
- Separate Account
Whereas general account is easy to understand, separate account can be a bit complicated. Let's discuss the two in detail:
In general account, the insurance company makes all the investment decisions and the assets received are part of the general fund. On the contrary, in the separate account, bank has the freedom to select investment style; however, it has no control over the investment.
CSV for a general account, is an unsecure obligation of the insurance company and available to general creditors in case the issue of life insurer's insolvency arrives. Whereas, in case of separate account, the assets are segregated by state law and also protected by general creditors.
For general account, the interest rate is same as guaranteed by the insurer. Whereas, for separate account, interest rate is related to how specific investments perform in separate accounts.
Also, an interesting thing to notice is that the likelihood of a community bank holding BOLI assets increases with its size.
BOLI Risks
Before investing in any sort of insurance, a person needs to analyze the plus and minus points of any policy to avoid distress at a later stage. So, here are a few risks associated with BOLI insurance you need to take into consideration.
Credit Risk
The performance of any life insurance contract depends greatly on the financial condition of the insurance company that guarantees or underwrites it. Also, the company's capability in adhering to the payment terms of the contract is another fact to consider. Since, most insurance contracts are long-term; you need to analyze the financial condition of the insurance company and its ability to pay for the cover before taking a decision. Thorough analysis is a major part of the credit risk assessment process.
Market Risk
The market risk depends on the type of the BOLI insurance taken. In general account BOLI, the investments are held in the general account of the insurance company and since the maturity of the assets in the account is often on a long term basis, the investment value may vary with the change in the long-term interest rates.
Whereas in case of separate account BOLI, the rate of interest is directly related to the investments in the separate account. So, it is more difficult for the management to control the risk because separate account assets cannot be controlled. A common way of mitigating some risk is by purchasing SVP wrap that will protect the bank against any sort of decline in the value of the account asset due to interest rates change.
Liquidity Risk
One of the least liquid assets in a bank's balance sheet is the cash surrender value of Bank Owned Life Insurance Policy. In most cases, a bank does not receive any cash flow from BOLI until the death of the insured employee. If it wants to extract liquidity from the policy before death, there are two ways to follow:
- Surrender the policy
- Borrow against the policy.
Both the ways will bring with them significant tax consequences and fees.
Summing It Up
Although BOLI offers many benefits to community banks, it does come with risks. It may provide compensation to a company after an insured executive's death or offer tax advantage; however, it should be purchased only after carefully considering all the aspects and discussion with the management. As it is a complex insurance, banks are recommended to seek the advice of a qualified insurance agent and get in touch with a reputable insurance company to avoid any unwanted loss in the long run.
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