Frequently Asked Questions on BOLI

Financial institutions face a wide range of ever-increasing benefit costs. These benefit plans range from qualified plans such as pensions to group health benefit plans and supplemental benefits designed to attract and retain key personnel. BOLI provides a tax-efficient tool with favorable tax-equivalent yields versus other investment alternatives to help offset benefit costs.

Well-designed BOLI can provide the following benefits:
Provides favorable tax-equivalent yields versus other investment alternatives
Increased tax-free income from BOLI can help to offset the cost of existing and/or new employee benefit expenses (including health insurance, 401(k) contributions, etc.)

Provides tax-free death benefits to protect the bank against the loss of a key employee while also protecting and increasing shareholder value
BOLI cash values do not need to be marked down if interest rates rise (i.e., no “Unrealized Loss” exposure that the securities portfolio has)
Cash Values are backed by the highest rated insurance companies in the nation
Annual time commitment and staff involvement for BOLI is minimal

Most of the largest financial institutions in the nation have used BOLI for many years. More recently thousands of banks and thrifts as well as community banks throughout the country have purchased BOLI to help finance benefit costs.

The bank purchases life insurance on a select group of management including officers or other key personnel. The bank is the owner of the policies, pays all premiums (typically a single, lump-sum premium) and is the beneficiary of the insurance proceeds. Some banks may choose to share a portion of these proceeds with plan participants.

During the life of the policy, the growth of the cash surrender value is tax-deferred. Ultimately upon mortality, the death proceeds are received tax-free. This combination of economic benefits makes BOLI an excellent tool to offset a variety of existing or new benefit costs.

Insurable interest laws vary by state. However, Executive Benefits Network advocates obtaining positive, written consent from every employee to be insured even if doing so is not required by law. Section 101(j) outlines the Notice & Consent requirements.

As BOLI usage has become more common, many bank officers have become aware of the viability of this financing option, and realize the value BOLI provides to help the bank manage its benefit costs. The Executive Benefits Network can assist you in designing enrollment materials that may help ensure understanding and participation.

Employees are never required to participate. We believe that the more an employee understands about the uses and benefits of BOLI, the more likely they are to participate. There is no cost to the employees, and for larger plans there typically is no medical underwriting required.

Executive Benefits Network will analyze the overall performance of the BOLI and educate on possible alternatives to improve performance.

The bank retains the policy on the retiree’s life since the economics of BOLI are most effective when BOLI is held for the long-term. Carriers utilized by Executive Benefits Network will track the Social Security numbers of plan participants on a quarterly basis. When an insured dies, this tracking system provides information necessary to gather appropriate documents from the bank in order to file a death claim with the insurance company.

The greatest value of a BOLI plan is the tax-deferred growth of the cash surrender value. While the bank receives death proceeds when an employee dies, it loses the potential tax-deferred growth of that contract. In addition, many banks choose to share a portion of the ultimate death benefits as an additional benefit to employees’ beneficiaries through a split dollar agreement.

Because of our conservative approach, Executive Benefits Network typically recommends diversification when making BOLI purchases. There are three basic categories of BOLI products:

• General Account: These products typically provide minimum interest rate guarantees. Current interest rates are typically credited on a quarterly or annual basis. The net rates credited reflect the overall earnings of an insurance company’s general account, as well as any expenses associated with the policies. The policies are backed by the general account of the insurance company; therefore, the credit quality of a potential carrier is a critical issue to potential buyers.
• Separate Account: The returns of these policies reflect assets in a segregated account that are not subject to the general creditors of the insurance company. Plan returns are subject to market fluctuations. With a separate account product, the policy owner bears the risk of default of assets in the separate account.
• Hybrid Account: Hybrid products have separate accounts to hold funds. The crediting rate is based on the underlying yield of the assets held in the overall portfolio. Similar to Separate Account options, these products typically have various investment portfolios to choose from, and each invests in securities and other assets according to specific investment objectives and guidelines. Many Hybrid products offer lower Risk-Based Capital weightings and have greater product transparency when compared to General Account products.

Most of the major insurance carriers have BOLI products. Like its industry peers, Executive Benefits Network has access to most major insurance carriers.

There are two primary interest crediting methods used by carriers. “New money” product returns reflect current interest yields available at plan inception. Over time, the underlying assets, or a proxy portfolio that reflects them are tracked to determine future crediting rates. “Portfolio” products typically reflect the returns of assets backing a broad group of policies and provide the same rate for all policies. The differences in renewal crediting rates between the two crediting philosophies can be substantial in early plan years, but tend to diminish over time.

BOLI can be surrendered at any time for its cash surrender value. However, doing so may cause adverse tax consequences to the bank. Therefore, in order to receive the full economic benefits of BOLI, it should be considered a long-term asset.

Any gain above the premium that the bank paid would be taxed at the normal rate. In addition, most BOLI policies are classified as Modified Endowment Contracts. These types of policies allow for the most efficient cash surrender value growth possible, but any gain is subject to an additional 10% penalty tax if the policies’ cash values are accessed. However, even with this penalty tax, the net BOLI returns may compare favorably to other financing alternatives over the same time period.

The bank should do a thorough review of the credit worthiness of any potential carrier as part of its due diligence. Executive Benefits Network can provide you with updated credit information over the life of your BOLI coverage.

BOLI’s current tax benefits have been unsuccessfully challenged over the years. There are strong bank regulatory guidelines for proper use of BOLI. If the tax treatment is changed, existing plans may be grandfathered. However, if existing policies are not grandfathered, they may be surrendered for their cash surrender values.

The OCC has been the lead regulator in this area. There are two basic tests: one based on benefits and one based on capital. The OCC has indicated that the gains from BOLI cannot exceed the costs they are intended to offset. Executive Benefits Network can help you in determining conservative parameters for the purchase of BOLI. In addition, the OCC says that as a general rule, a bank should not invest more than 25% of its Tier I capital plus 25% of the allowance for loan and lease losses in BOLI as a whole, and no more than 15% of its Tier I capital with any one company. The OCC views these as guidelines, while the OTS regards them as stricter limitations.

BOLI is governed by FASB Technical Bulletin 85-4. This bulletin states that BOLI should be recorded on the balance sheet as an “other asset” and that both the cash surrender value growth and ultimate net insurance proceeds should be recorded as “other income.”