Valuable Assets | By Fabrizio D’Uva
Bank-owned life insurance (BOLI) can be a valuable asset for banks of all sizes, including community banks. Offered by most of the highly rated insurance carriers, BOLI is a single premium insurance policy in which the bank is the beneficiary and owner. While banks often utilize BOLI as a tax shelter, given BOLI’s status by the Internal Revenue Service (IRS) as a tax-free asset, it is also utilized to help offset the ever-increasing costs of employee benefit programs.
According to a recent report* released in June 2016, evidence of BOLI’s growth as an alternative asset strategy for financial institutions can be found in the following statistics: BOLI assets reached $157.6 billion as of March 31, 2016, reflecting a 4.4 percent increase from $151 billion at the end of the first quarter of 2015. And of the 6,122 banks in the survey, 60.9 percent reported holding BOLI assets in the first quarter of 2016, a two percent rise from the year-ago quarter.
The key factor to consider here is the policy’s return on investment. If a BOLI policy can be expected to appreciate in value at around 3 to 3.5 percent, remember that since that growth is tax-free, the actual returns on a tax equivalent basis are greater – more like 5 to 6 percent. Compare that with current returns on taxable fixed income investments.
Senior executives should consider BOLI as a means of driving more net income to the bank’s bottom line … especially in this current era of low interest rates. The additional earnings can be used to increase profitability; pay for the cost of providing certain benefits, including propping up the benefits structure of a 401k or pension plan; and/or finance new benefits programs.
BOLI can also be purchased for executives and officers as a way of offsetting financial losses incurred upon a given executive’s death. While some may find this practice objectionable – “I don’t want to put a price tag on my employees” is a concern I frequently hear – bear in mind that BOLI is, first and foremost, a life insurance policy. As such, it must include a death benefit … which the bank has the option of donating to a charity, perhaps in the decedent’s name. There are also ways of paying part or all of the benefit to the decedent’s beneficiaries and these design options include providing supplemental life insurance or replacing group term insurance thus delivering the insurance more efficiently via BOLI.
Of course, the bank should provide full disclosure to any employee it wishes to purchase BOLI upon; after all, the employee may be required to undergo a medical check-up before the insurance is issued. In addition, an employee has the right to decline the bank’s offer but, as explained above, if the policy’s financial benefits are fully explained to a long-vested employee, chances are good that he or she will ultimately agree.
It should be noted that the bank retains the policy on the employee’s life even if that employee retires. Most BOLI providers track plan participants on a quarterly basis via their Social Security numbers, and can therefore learn of the retired employee’s death within a reasonable time frame.
Another matter to consider is the upfront cost of purchasing BOLI. Additionally, as a long-term investment, BOLI may be viewed as “illiquid” in the short term. The policy can be surrendered at any time, but doing so will almost always involve significant tax consequences to the bank. However, the overall tax benefits – namely, that the growth of the cash surrender value is tax-deferred and the death benefits received are tax-free – can go a long way toward overcoming those concerns.
Other potential benefits of BOLI can easily be explained by a reputable financial services provider. If you have not already done so, I encourage you to begin exploring BOLI as soon as you can.■
Fabrizio D’Uva is a regional director, BOLI and non-qualified benefits plans for Pentegra’s supplemental benefits and bank owned life insurance (BOLI) business. *Source: Michael White BOLI Holdings Report