Bank-owned life Insurance is a specialized financial instrument that has gained popularity among banks as a tool for managing employee benefit expenses and generating tax-advantaged income.
While it is a niche concept, the role it plays in the banking sector is critical for offsetting rising operational costs. What’s more, by leveraging BOLI effectively, banks can support their operational goals and maintain a competitive edge in the financial industry
What Is Bank-Owned Life Insurance?
Abbreviated and known as BOLI, this insurance is a type of life insurance mainly purchased by banks on the lives of their employees, like executives and key personnel.
The bank pays the premiums and is both the policy owner and beneficiary. In return, insured employees receive indirect benefits, such as enhanced retirement plans or compensation packages funded by the policy’s earnings.
Furthermore, banks use this strategy as a financial management tool to offset the costs of employee benefits. The earnings from these policies, grow on a tax-deferred basis and provide a steady income stream to the bank.
Additionally, it enables them to manage liabilities associated with benefit programs.
How Bank Owned Life Insurance Works
Here’s how it works:
Policy Purchase
The bank starts by purchasing life insurance policies for select employees, usually those in leadership or executive roles. These policies are structured as permanent life insurance plans, such as whole or universal life insurance, to accumulate cash value over time.
Premium Payments
The bank funds the policy premiums, either as a single payment or through periodic contributions. Also, these payments are considered assets on the bank’s balance sheet.
Cash Value Accumulation
The policy’s cash value grows over time on a tax-deferred basis. This growth is often linked to a guaranteed interest rate or the performance of an underlying investment portfolio. However, it depends mainly on the type of policy purchased.
Death Benefit Payout
When the insured employee passes away, the bank receives the death benefit, which is usually tax-free. What’s more, this payout can be used to cover benefit obligations or other financial needs.
Employee Participation
Although the employee is the insured party, they do not own the policy. However, they may receive indirect benefits, such as enhanced retirement or compensation plans funded by the BOLI earnings.
Types Of Bank-Owned Life Insurance
Here are the different types associated with this bank insurance:
General Account BOLI
The funds are invested in the insurer’s general account, which provides a guaranteed interest rate. It has the benefits of low risk and predictable returns.
Separate Account BOLI
Funds are invested in a segregated account, which allows for customized investment strategies. What’s more, it offers greater potential for higher returns, tailored to the bank’s risk tolerance.
Hybrid Account BOLI
This account combines elements of general and separate accounts to balance risk and return. It also provides flexibility with some level of guaranteed returns.
Benefits Of This Insurance For Banks
Here are the advantages gained from purchasing a policy in this insurance model:
- The cash value growth and death benefits from BOLI policies are typically tax-deferred or tax-free, making it an efficient financial tool.
- If properly managed and the policies align with banking regulations, it offers a compliant method for asset growth and expense management.
- By investing in BOLI, banks can build a stable asset base that generates predictable returns, contributing to overall financial health.
- The earnings can offset expenses associated with employee benefits, such as healthcare, retirement plans, and bonuses.
- BOLI allows banks to fund attractive compensation and benefits for key employees, helping attract and retain top talent.
Risks And Challenges Of BOLI
Despite the advantages one gains from this, here are some of the challenges that one may also face:
Initial Cost: The policies of this bank insurance require a large upfront investment, which might strain the bank’s finances in the short term.
Regulatory Scrutiny: The policies are subject to strict regulatory oversight. What’s more, banks must adhere to guidelines for disclosure, accounting, and use of policy proceeds.
Interest Rate Fluctuations: The changes in interest rates can impact the growth of the policy’s cash value and the overall return on investment.
Credit Risk: The performance of this insurance depends on the financial stability of the insurance provider. If the insurer faces solvency issues, the bank could experience financial losses.
Reputational Risk: Mismanagement or perceived misuse of BOLI funds could harm the bank’s reputation, especially if employee beneficiaries feel unfairly treated.
Frequently Asked Questions
What Is The Primary Purpose Of BOLI?
The main purpose of it is to offset the costs of employee benefits and create a tax-advantaged income stream for the bank.
Can Any Bank Purchase BOLI?
Yes, but these banks must conduct due diligence and ensure compliance with regulatory requirements before purchasing BOLI policies.
Do Employees Benefit Directly From BOLI?
Employees do not directly benefit from their policies. However, they may receive enhanced compensation or retirement plans funded by the policy earnings.