In recent years, bank-owned life insurance has emerged as an attractive investment option for banks and financial institutions. As an investor, it is important to understand the basics of bank-owned life insurance, including its investment value, risks, and strategies. Bank-owned life insurance, also known as BOLI, refers to life insurance policies purchased by banks on their employees. The bank is both the policy owner and beneficiary of these policies. BOLI provides banks with tax-advantaged growth of assets and can also be used to indemnify key employees. However, there are risks such as credit risk, mortality risk and liquidity risk. When evaluating BOLI as an investment, investors should assess the financial health of the issuing insurance carrier, analyze the expected returns, and ensure the bank has proper risk management procedures in place. Overall, with appropriate due diligence and risk control, BOLI can be a stable long-term investment that generates both cash value growth and insurance benefits.
BOLI provides benefits like tax-advantaged growth and employee retention for banks
As the policy owner and beneficiary of BOLI, banks can grow their assets in a tax-advantaged manner. The cash value growth in BOLI plans is tax-deferred. Banks are also not taxed on the death benefit payout when an insured employee passes away. Additionally, the death benefits received are income tax-free. BOLI plans are structured to maximize these tax benefits. Banks can use the tax savings to reinvest and further grow their balance sheet. Another benefit of BOLI is employee retention. Banks can provide BOLI plans as a supplement to employee benefit packages to attract and retain key personnel. The death benefits can be used to offset the costs of replacing essential employees or funding non-qualified employee retirement plans.
Mortality, credit, and liquidity risks exist with BOLI investments
While BOLI offers benefits, there are also investment risks to consider. Mortality risk refers to the uncertainty of when an insured will pass away, which affects the timing of receiving the death benefits. Credit risk stems from the financial strength of the issuing life insurance carrier. If the insurer defaults, the BOLI plan may lose value. Liquidity risk arises because accessing BOLI cash values usually incurs surrender charges and transaction costs. Since BOLI plans are often buy-and-hold investments, banks need to be aware of these risks.
Proper due diligence includes evaluating insurers’ creditworthiness and expected returns
Investing in BOLI requires rigorous due diligence as banks take on insurance carrier credit risk. The credit rating, financial leverage, and risk management policies of the insurer should be analyzed. Higher rated insurers generally have better ability to fulfill their policy liabilities. The projected returns of BOLI plans should also be evaluated under different interest rate scenarios, incorporating assumptions about cash value growth, mortality rates, and carrier credit spreads. Comparing expected returns across insurers enables the selection of a plan that maximizes tax-advantaged growth potential.
Banks should implement risk controls like exposure limits to manage BOLI risks
To mitigate the risks of BOLI investing, banks should implement proper risk governance and controls. Limits can be set on the maximum BOLI exposure as a percentage of capital, forcing diversification. Diversification across insurance carriers also reduces concentration risk. Strict underwriting procedures ensure only qualified employees are insured under BOLI plans. Ongoing monitoring of carrier credit risk allows timely detection of any changes. With prudent risk management, banks can tap into the benefits of BOLI while controlling the investment risks.
In summary, bank-owned life insurance can provide attractive tax-advantaged growth and employee retention benefits to banks. However, investing in BOLI also carries risks like mortality, credit, and liquidity risk. Performing due diligence on insurers’ financial strength and expected returns, along with implementing strong risk governance, are key success factors when investing in BOLI.