What Is Bank-Owned Life Insurance?
Bank-owned life insurance (BOLI) is a form of life insurance purchased by banks where the bank is the beneficiary and also usually the owner of the policy. Such an insurance is used as a tax shelter for the financial institutions, which leverage its tax-free savings provisions as funding mechanisms for employee benefits.
Understanding Bank-Owned Life Insurance (BOLI)
BOLI contracts are primarily used by banks to fund employee benefits at a much lower rate than they might have to pay otherwise. The process works like this: The bank sets up the contract, and then makes payments into a specialized fund set aside as the insurance trust.
All employee benefits that need to be paid to particular employees covered under the plan are paid out from this fund. All premiums paid into the fund, in addition to all capital appreciation, are tax free for the bank. Therefore, banks can use the BOLI system to fund employee benefits on a tax-free basis.
As the U.S. Department of the Treasury's Office of the Comptroller of the Currency (OCC) explains, banks are allowed to purchase BOLI policies, "in connection with employee compensation and benefit plans, key person insurance, insurance to recover the cost of providing pre- and postretirement employee benefits, insurance on borrowers, and insurance taken as security for loans." OCC may also allow for, "other uses on a case-by-case basis."
Pros and Cons of Bank-Owned Life Insurance
As BoliColi.com, a firm that helps manage corporate-owned and bank-owned life insurance portfolios, notes, BOLI was traditionally combined with benefit plans for new senior executives. But more recently, "many banks have added BOLI in order to offset existing employee benefit expenses."
As noted, the advantages of BOLI included its tax favorability, and the ability to generate earnings that offset the costs associated with employee benefits programs. But BoliColi.com notes that there are disadvantages too.
For instance, "if a BOLI contract is surrendered by the bank the gains within the policy become taxable as well as a 10 percent IRS penalty on the gain similar to surrendering an IRA prior to age 59 1/2. If the policy is held to the death of each insured, the gain becomes part of the tax free death benefit and no tax is incurred."
Additionally, "the greatest concerns for most banks is the credit quality of the BOLI carrier. Most carriers in the market are of the highest quality, however, that can change over time. The second concern is the competitiveness of the crediting rate in comparison to the market."