Bank-Owned Life Insurance (BOLI) is an insurance product that has gained popularity among banks and financial institutions. It is a type of life insurance policy, similar to whole life policies used for Infinite Bank strategies, purchased and owned by banks on the lives of key employees. BOLI serves a dual purpose of providing a death benefit to beneficiaries and generating an investment return for the institution.
Banks and other financial institutions have invested in BOLI for several years. According to data from the National Association of Insurance Commissioners (NAIC), the total amount of BOLI owned by banks and thrifts at the end of 2019 was $198.2 billion, up from $190.7 billion in 2018. Additionally, the data showed that 72% of banks in the U.S. owned BOLI policies in 2019.
BOLI remains a popular investment option for banks and financial institutions. Its tax benefits and potential for high returns make it an attractive option for institutions seeking diverse investment portfolios.
What is BOLI?
When a bank purchases a BOLI policy, it pays premiums to an insurance company. A portion of those premiums go toward the death benefit, and the remainder becomes a cash value account. The cash value account earns interest, which is tax-deferred and grows over time. In addition, the bank uses the cash value as an investment vehicle.
In addition, the bank receives the death benefit in the event of the insured employee’s death. Banks often use the death benefit to offset the policy’s cost or provide a source of revenue. The beneficiaries of the employee also receive a payout from the policy.
One of the primary benefits of BOLI is the tax advantages it provides. The premiums paid by the bank are tax-deductible.
To illustrate, the policy’s cash value grows tax-deferred, meaning the bank only pays taxes on the interest earned once the policy is surrendered or matures. Additionally, the death benefit is received tax-free by the beneficiary.
Why Do Banks Buy Life Insurance for Employees?
There are several reasons why a bank might choose to invest in BOLI:
- Funding Employee Benefits – Employee benefits are a significant cost to any company. By purchasing BOLI, a bank creates a tax-free cash reserve funding employee benefits such as pensions, 401(k)s, and healthcare plans. This is because the bank is the beneficiary of the policy, and if an employee passes away, the bank receives the death benefit.
- Offsetting the Costs of Employee Benefits – In addition to funding employee benefits, BOLI also offsets the costs of these benefits. The policy’s cash value provides an additional source of income covering benefits costs. This reduces the overall cost of offering employee benefits.
- Tax Benefits – BOLI policies offer tax benefits for the bank. The policy’s cash value grows tax-deferred, and the death benefit is received tax-free. This makes it an attractive investment for banks looking to offset taxes.
- Predictable Returns – BOLI policies offer a low-risk, predictable return. Life insurance companies guarantee a certain return rate and regularly invest in safe assets such as bonds and money markets.
- Meets Reserve Requirements – Potentially the most important aspect of bank-owned life insurance is that it meets reserve safety requirements for banks. Because they use the best whole life insurance companies as banks to store assets, life insurance policy cash values count as reserves while also covering key employees.
How does BOLI differ from Individual Life Insurance?
Bank Owned Life Insurance (BOLI) and individual life insurance are two different types of life insurance policies, and they differ in several ways.
First, the beneficiary of a BOLI policy is almost always the bank that owns the policy. In contrast, with an individual life insurance policy, the beneficiary is usually a family member or someone designated by the policyholder. This is because BOLI is a product designed for banks to provide employee benefits. In contrast, individual life insurance provides financial protection for the policyholder’s dependents in the event of their death.
Second, BOLI policies are typically comprehensive policies purchased by banks in the name of their key employees, while individual life insurance policies are smaller, affordable policies purchased by individuals. BOLI policies allow banks to provide tax-free cash reserves to be used to offset the costs of employee benefits such as pensions, 401(k), and healthcare plans.
Whole life insurance policies also offer a range of financial benefits that can be valuable to policyholders. By combining a death benefit with an investment component, cash value whole life insurance policies provide policyholders with long-term financial security, asset protection, and potential for financial growth. Moreover, the tax advantages of these policies enable policyholders to reduce their tax burden while accessing the cash value for financial emergencies.
Finally, BOLI policies have some tax advantages for banks, with cash value growth being tax-deferred and the death benefit received tax-free. In contrast, the tax advantages of individual life insurance depend on the policyholder’s particular unique situation.
BOLI vs. COLI
While Bank-Owned Life Insurance (BOLI) and Corporate-Owned Life Insurance (COLI) share some similarities, the two have several differences.
BOLI and COLI are valuable financial tools that enable banks and corporations to enhance employee benefits and improve their financial positions. While BOLI is tailored explicitly towards banks and their needs, COLI serves the interests of corporations, aiding in the funding of employee benefit plans. With their tax advantages and ability to generate additional income, BOLI and COLI play significant roles in the financial strategies of these institutions.
The main differences include:
Who Purchases the Policy
The first difference between BOLI and COLI is who purchases the policy. BOLI is a policy purchased by a bank on the lives of its key employees, while COLI is a policy purchased by a corporation on the lives of its key employees.
Purpose of the Policy
The second difference between BOLI and COLI is the purpose of the policy. BOLI policies are designed to provide long-term executive benefits and offset the cost of employee benefits such as pensions, 401(k)s, and healthcare plans. COLI policies, on the other hand, usually fund employee benefits as well as other corporate initiatives such as buy-sell agreements and deferred compensation plans.
Is BOLI Regulated?
The regulation of BOLI varies depending on the jurisdiction and the specific aspects of the policy.
States regulate BOLI as a form of life insurance. State insurance departments oversee the sale and administration of BOLI policies, ensuring compliance with local laws and regulations.
Further, these regulations may cover various aspects, such as licensing requirements for insurance companies, agents, and brokers, financial solvency standards, policy terms and benefits, and disclosure requirements.
BOLI is also subject to federal regulation. The Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted in 2010, introduced federal guidelines for using BOLI policies by banks. Under this act, the Federal Reserve Board is responsible for establishing standards for compensation arrangements and risk management practices, including those related to BOLI policies.
Critical Benefits of BOLI?
Several key benefits make it an attractive option for banks.
- 1. Executive Benefit Plan Funding – One of the primary benefits of BOLI is its ability to fund executive benefit plans. Banks can provide valuable benefits to key employees by purchasing BOLI policies, such as deferred compensation or retirement income. According to a survey by the American Bankers Association (ABA), 85% of banks reported using BOLI to fund executive benefit plans.
- 2. Tax Advantages – BOLI also offers significant tax advantages for banks. The cash value growth within BOLI policies is tax-deferred, meaning that banks accumulate earnings on the policies without incurring immediate tax liability. This provides a valuable source of tax-efficient income for banks. According to a report by Deloitte, tax-advantaged cash flows are one of the key factors driving banks to consider BOLI.
- 3. Balance Sheet and Earnings Enhancement – BOLI enhances a bank’s balance sheet and earnings. The cash value of BOLI policies is considered an asset on the bank’s balance sheet, which enhances its financial position. Additionally, the income generated from BOLI investments is typically tax-free. This tax-advantaged income boosts a bank’s earnings, offsetting some costs associated with employee benefits and improving overall profitability. According to a study by Michael White Associates, BOLI contributed an average of $161,100 to each bank’s net income among the 200 largest U.S. banks.
- 4. Risk Mitigation – Another crucial benefit of BOLI is its ability to mitigate risk for banks. In the event of the unexpected death of a key employee, the bank receives a tax-free death benefit payout. This payout offsets the financial impact of losing a key employee and provides recruitment and succession planning resources. BOLI acts as a risk management tool, protecting against key person risk. It ensures bank operations continue and maintain stability in challenging times.
- 5. Diverse Investment Options – BOLI policies often offer a range of investment options, allowing banks to diversify their portfolios and earn higher rates of return. Banks select from various investment strategies, such as fixed income, equity, or alternative investments, depending on their risk appetite and investment goals. This flexibility in investment options allows banks to tailor their BOLI policies to align with their overall investment strategies.
Understanding Bank Owned Life Insurance
There are several reasons why banks purchase BOLI, including to fund executive benefit plans, gain tax advantages and balance sheet enhancements, mitigate risks, and diversify investments. While BOLI may not be for every bank, it has provided many benefits to those banks that have incorporated it into their overall investment strategies.
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