Bank-owned life insurance (BOLI) is not new. In fact, most of the nation’s largest banks, as well of thousands of community banks, have purchased BOLI – a life insurance policy written on the life of an employee. The purchase of BOLI is considered “best practice” and a common strategy to manage the escalating employee benefit costs. BOLI has a track record of outperforming like investments such as US treasuries, mortgaged-backed securities and municipal bonds. However, even with today’s prevalence of BOLI and regulatory backing, objections to owning this asset still exist. Below is a listing of two common BOLI objections and areas of concern:
- The perception of BOLI’s liquidity; and
- Personal or philosophical beliefs.
BOLI is intended to be a long-term asset as gains are tax deferred. Furthermore, gains are tax-free if held until death of the insured. Rightfully so, are reluctant to surrender BOLI to increase liquidity as the gains would be subject to income tax and a 10% excise tax. Banks that have this concern surrounding liquidity though typically have strong loan demand and may have alternative plans for capital, such as branch expansions or acquisitions.
The more unsettling objection is philosophical in nature regarding the discomfort of receiving payment on the lives of either current or former employees. Reputation risk should always be considered, however it is imperative to understand the reason of implementing a BOLI programs, which may include the following:
- Generate tax-advantaged income to offset the liabilities and recover the costs of certain employee benefit plans, including healthcare plans, group term insurance, retirement plans and 401(k) contributions.
- Generate stable revenue from non-loan sources;
- Provide competitive returns with superior credit quality;
- Increase earnings per share and shareholder value; and
- Protect the bank from the death of a key management employee by reimbursing the bank for lost skills and knowledge and to fund the search for a replacement.
What is often forgotten, is that the “why” behind BOLI helps the insured executives as well. As an insured in a BOLI program, executives need to understand that ultimately the bank will receive funds at his or her death. However, they need to also understand that this allows the bank to increase profitability which in turn benefits all employees in the form of expanded benefits and profit sharing. Once both points are understood, executives realize the trade off and are willing to participant in properly designed BOLI programs.