BOLI: Bank Owned Life Insurance

Bank owned life insurance (BOLI) is life insurance purchased and owned by banks.  With the exception of term policies occasionally used to cover a borrower while a large debt remains outstanding, bank-owned policies are usually permanent life insurance, like whole or universal life.

The permanent policies accrue cash value, which earns tax-advantaged interest at competitive rates, and the wealth stored within a BOLI policy counts as an asset on the bank’s books.

Benefits of Life Insurance to a Bank

Life insurance policies can serve a wide range of important functions for a bank.

For example, a key person insurance policy covering a vital executive may be intended to protect the bank from the transition costs it will likely incur when recruiting and training a replacement.

Or, life insurance might insure against the risk of a borrower dying before repaying a large loan.

Deferred Compensation

A large number of banks have also implemented BOLI programs designed to fund and offset the administrative costs of long-term employee benefits and deferred compensation packages.

Though banks traditionally limited BOLI programs to highly compensated executives, the recent trend has been to extend BOLI coverage to a wider range of bank employees.

Because policies earn tax-advantaged growth, BOLI provides an excellent means of financing long-term obligations.

How is BOLI Structured?

When a bank acquires BOLI to finance long-term obligations, it will generally contract with one or more life insurance carriers for permanent policies covering key bank personnel.

With each BOLI policy issued, the bank is both the policyholder and the named beneficiary.

In most cases, the insureds (who must consent to the insurance) include directors, officers, executives, or other high-level employees.

Banks often purchase BOLI via a single premium or several annual premium payments over a few years, though policies are also available with premiums spread over a longer duration.

Like whole life insurance policies issued to individuals, BOLI policies pay out a death benefit when the insured person dies and have a steadily increasing cash surrender value.

Cash Value Growth

BOLI policies, though, are typically designed to place a greater emphasis on early strong cash value accrual.

For that reason, banks often favor universal life over whole life when acquiring BOLI.

As the policy ages, its cash value grows tax-deferred or tax-free—the former if realized through a surrender or partial withdrawal, the latter if received via the policy’s death benefit.

Because BOLI policies are designed to emphasize cash-value growth, earnings usually outperform comparable assets that a large institution might acquire to finance long-term obligations.

General Account vs Separate Account

Determination of cash-value growth rates depends on whether BOLI is “general account” or “separate account.”

With general account BOLI, policy funds are held within the insurer’s general account.  Interest rates credited vary according to performance of the insurer’s investments, though usually subject to a minimum return rate.

Separate account BOLI funds are held apart from the insurer’s general holdings and invested by an outside fund manager.

The bank has a say in the general nature of investments but can’t control individual allocations.

Earnings are based on investment performance, and the risk of loss is borne by the policyholder bank—though riders and corollary financial products are available to mitigate downside risk.

Non-taxed growth earned by BOLI is used by banks as a funding source for the administration and overhead costs associated with employee benefits and compensation plans.

In some cases, banks will provide covered employees an interest in the value of a BOLI policy as part of the employee’s compensation package.

Trust Account

Frequently, banks use a trust account to administer their BOLI programs.

The bank pays into the trust to cover the premium cost,

BOLI proceeds are placed in the account, and employee benefits and deferred compensation are paid out from the funds.

Tax Advantages of BOLI

As cash value accrues, BOLI policy growth is subject to neither current capital gains nor business income tax.

Returns continue growing and compounding year after year without any reduction for taxes, which significantly adds to the growth-potential advantage BOLI enjoys over comparable long-term, low-risk investments available to banks.

Though untaxed, policy growth nonetheless appears up on the bank’s balance sheet as it is earned.

Death Benefit Payout

When an insured employee dies, the life insurance carrier pays out the death benefit to the bank.

Because policy proceeds are received as a life insurance payout, the bank does not incur any tax liability on the funds, including funds attributable to growth.

Potential Downside

A downside of BOLI is that, if wealth held in a policy is accessed through a cash value surrender or partial withdrawal, funds attributable to growth qualify as taxable income to the bank.

The tax is assessed on the growth at the regular rate, plus an additional ten percent penalty.

Due to the significant tax hit involved with a cash surrender, BOLI is generally considered an illiquid asset, though most BOLI policies do not include surrender fees charged by the insurance carrier.