What is bank-owned life insurance? Bank-owned life insurance (BOLI) is a financial tool that many banks use to manage employee benefits, and costs, and enhance their financial stability.
Banks gain tax-advantaged earnings by purchasing life insurance policies for their employees. And this helps to fund various benefits programs.
Banks usually purchase BOLI policies on a group of key employees. And the bank is both the owner and the beneficiary of the policies.
The cash value of these policies grows tax-deferred, providing banks with a steady source of income. Upon the death of an insured employee, the bank receives the death benefit, which is also tax free.
Furthermore, BOLI serves two main purposes: it helps banks offset the rising cost of employee benefits and serves as an additional income stream.
This makes it an attractive financial strategy for banks looking to improve their overall performance while supporting a long-term employee benefit program.
How Bank-Owned Life Insurance Works
Bank-owned life insurance (BOLI) is a financial strategy that helps banks manage employee benefit costs while building a stable income source. To understand how BOLI works, let’s break it down step by step.
Policy Purchase
The process begins with the bank purchasing life insurance policies for select employees, usually those in executive or leadership positions.
These policies are designed as permanent life insurance plans, such as whole life or universal life insurance, which accumulate cash value over time.
Premium Payments
The bank pays the premiums for the policies. These payments are made either as a lump sum or through periodic contributions.
Unlike regular expenses, these premiums are recorded as assets on the bank’s balance sheet, increasing the institution’s financial strength.
Cash Value Accumulation
Over time, the cash value of these policies grows. This growth is tax-deferred, meaning the bank does not pay taxes on the earnings as they accumulate.
The growth is determined by the type of policy. It may have a guaranteed interest rate or be tied to an investment portfolio’s performance.
Death Benefit Payout
When an insured employee passes away, the bank receives the policy’s death benefit. This payout, which is usually tax-free, can be used to offset employee benefit costs, fund other obligations, or strengthen the bank’s financial position.
Employee Participation
While employees are the insured individuals, they do not own the policies. However, employees may benefit indirectly through compensation or retirement plans funded by the earnings from BOLI.
Types of Bank-Owned Life Insurance
There are three main types of BOLI policies that banks can choose from. They include:
General Account BOLI
With this type, funds are invested in the insurance company’s general account. It offers a guaranteed interest rate, providing low-risk and predictable returns for the bank.
Separate Account BOLI
This option involves investing funds in a segregated account. It allows banks to customize their investment strategies, offering the potential for higher returns based on their risk tolerance.
Hybrid Account BOLI
A hybrid account combines features of both general and separate accounts. It provides flexibility with investment options while maintaining some level of guaranteed returns.
Benefits of Bank-Owned Life Insurance for Banks
BOLI policies offer several advantages, making them a valuable financial tool for banks:
Tax Advantages
The cash value growth and death benefits are usually tax-deferred or tax-free, improving the bank’s financial efficiency.
Asset Growth
Properly managed policies provide a stable method for increasing assets while adhering to regulatory guidelines.
Expense Management
The earnings from BOLI can offset the costs of employee benefits, such as healthcare, retirement plans, and bonuses.
Employee Retention
Banks can use BOLI earnings to fund competitive compensation and benefit packages, helping to attract and retain top talent.
Predictable Returns
The policies contribute to financial stability by generating consistent returns over time.
Risks and Challenges of Bank-Owned Life Insurance
While BOLI provides significant benefits, it also comes with potential risks that banks must carefully manage:
Initial Costs
Purchasing BOLI policies requires a substantial upfront investment, which could strain the bank’s finances in the short term.
Regulatory Compliance
Banks must follow strict regulations related to disclosure, accounting, and the proper use of policy proceeds. Non-compliance can lead to penalties or reputational damage.
Interest Rate Risks
Fluctuations in interest rates can affect the cash value growth and the overall return on investment.
Credit Risk
The performance of BOLI depends on the financial health of the insurance provider. If the insurer faces financial difficulties, the bank could incur losses.
Reputational Risks
Mismanagement or perceived misuse of BOLI funds could harm the bank’s reputation, especially if employees feel the policies do not serve their interests.
Frequently Asked Questions
What Is the Primary Purpose of Bank-Owned Life Insurance?
The main purpose of BOLI is to help banks offset employee benefit costs while generating tax-advantaged income to strengthen their financial stability.
Can Any Bank Purchase BOLI?
Yes, any bank can purchase BOLI policies. However, they must conduct thorough due diligence and ensure compliance with all regulatory requirements before doing so.
Do Employees Directly Benefit from BOLI?
Employees do not directly benefit from these policies, as the bank owns and is the beneficiary of the policies.
However, employees may enjoy enhanced compensation or retirement benefits funded by the earnings from BOLI.
