Should BOLI Be In Your Plans?

The most successful fi nancial institutions depend on generating non-interest income to solidify overall profitability. Did you know that bank-owned life insurance is one of the simplest and most effective methods that a bank can use to enhance its non-interest income?

Bank-owned life insurance is not new. Approximately one out of two U.S. banks own BOLI today. BOLI is simply an institutionally designed, key person life insurance policy; it performs like a tax-free investment. Th ough bank-owned life insurance may possess characteristics similar to that of a bond or a loan, the uniqueness of BOLI is that it is in fact life insurance, possessing a valuable protection component.

The bank typically purchases BOLI with a single-premium deposit, insuring a select group of offi cers or directors. Th e bank is the owner and benefi ciary of the BOLI asset. BOLI contains a savings element (cash value) and a protection component. Th e cash value includes the BOLI premium deposit plus accumulated interest.

Banks purchase BOLI for some or all of the following business purposes:

Reason #1 – As a tax-favored asset to increase earnings and off set rapidly rising costs of employee benefi ts (e.g. sky rocketing medical insurance premiums).

Reason #2 – As a means to protect (indemnify) the bank from the unexpected loss of skilled and valuable executives. Th is is often referred to as key man life insurance.

Reason #3 – As a vehicle used to fi nance the cost of providing a deferred compensation plan for key officers.

Reason #3.5 – Lastly, as a byproduct, BOLI enhances noninterest income.

Under GAAP, accounting for BOLI is based on the guidelines of FASB Technical Bulletin 85-4. Cash value is recorded as an “other asset.” The monthly policy income is booked as non-interest income. BOLI earnings are reported on the income statement and thus contribute directly to shareholder value.

Generally, there is no initial change in a bank’s balance sheet due to a BOLI purchase (no negative impact on retained earnings). The bank is merely trading one asset for another.

BOLI is carried on the balance sheet as an earning, long-term asset. If the BOLI purchase is for the purpose of fi nancing a deferred compensation plan for key officers, the bank must also account for the benefi t liability in addition to the BOLI asset.

BOLI may not make sense for some banks. If a bank is not profi table or has liquidity issues, a BOLI purchase may be inappropriate. Also, if a bank is not comfortable purchasing a long-term asset, then a BOLI program may not be suitable for that institution.

BOLI programs are primarily governed by guidelines issued in the Interagency Bulletin on Life Insurance OCC 2004-56. The guidelines assert that risk assessment and risk management are vital components of an effective BOLI program. In addition to conducting a thorough pre-purchase analysis, banks must monitor BOLI risks on an ongoing basis.

By working with a BOLI specialist, the details will be handled effi ciently with limited time required by the fi nancial staff of the bank. It is important for a bank to consider using an independent third party administration firm to handle the oversight of the ongoing regulatory due diligence and accounting work. Together, working with the BOLI specialist, checks and balances will be in place to satisfy the needs of the fi nancial institution and its regulatory authorities.

It has been proven that BOLI can play a major role in a bank’s success in capturing non-interest income. As the board and bank management periodically assess and evaluate their game plan, the bank may want to consider incorporating BOLI as a part of its strategy.

“Life Insurance holdings can serve a number of appropriate business purposes. Because the cash fl ows from a BOLI policy are generally income-tax free if the institution holds the policy for its full term, BOLI can provide attractive tax-equivalent yields to help off set the rapidly rising cost of providing employee benefi ts.”

– OCC 2004-56, Interagency Statement on the Purchase and Risk Management of Life Insurance

Granville Financial Group President and Managing Member William “Billy” Granville III is a chartered fi nancial consultant. Contact him at www.granvillegrp.com.