This page is intended to give only a cursory overview of how BOLI works and some common features. In its present incarnation, BOLI is a highly complex, multifaceted topic, embodying numerous risk management challenges and requiring numerous articles to fully cover. We’ve addressed many of these sub-topics extensively in a series of articles, whitepapers and educational materials (literally hundreds of pages devoted to its history, uses, structure, risks and governance).
If you’d like to learn more about why banks use BOLI, you can do so here.
BOLI is the acronym for Bank Owned Life Insurance; a form of permanent life insurance owned by banks to offset the future costs of providing employee benefits. The insureds are employees, and the institution retains at least some interest in the death benefit proceeds.
There are several variations of permanent life insurance (e.g., whole life, universal life, variable life, indexed life, variable universal life) but for the discussion of BOLI, it mostly boils down to general account (GA) and separate account (SA)1.
With GA BOLI, the entire policy CSV is held within the insurance carrier’s general account, meaning that the principal and interest are direct obligations of the insurer. The main advantage of GA BOLI is that the insurance company takes all credit risk, interest rate risk and default risk associated with the portfolio of investments supporting the policy CSV. Accordingly, the bank can account for the policy CSV without any P&L volatility from reporting period to reporting period. The primary downsides of GA BOLI are a large, concentrated credit exposure to a single counterparty (for upwards of 7 decades) and very little influence over policy economic performance. GA polices are also generally opaque – a “black box”. Some policy charges/expenses and methodologies may be disclosed, but some are not.
In a SA Policy, the issuing insurance carrier establishes an account that is legally segregated from its general account. Premiums are invested in the separate account and the policyowner bears the investment risks. Policy expenses are more transparent and generally lower for SA than GA BOLI, however, SA BOLI is far more complex to manage. When accounting for SA BOLI, the bank must look through to the market value of the actual investments held in the SA. Therefore, interest rate risk causes market value fluctuations daily, resulting in P&L volatility (unless utilizing a stable value wrap).
SA BOLI does allow for additional investment flexibility. The policyowner can typically allocate the cash value to one or more “sub-accounts” or “investment divisions”, allowing diversification or targeted strategies.
As one may expect, hybrid BOLI products seek to combine elements of GA and SA. These non-variable products are invested in a duly established separate account with the objective of reducing direct counterparty/credit risk. However, the insurance carrier establishes and periodically adjusts a crediting rate and there is generally little, if any, ability to adjust allocation objectives over time. The National Association of Insurance Commissioners (NAIC) has expressed concerns about hybrid BOLI, noting that policyowners’ may achieve an advantageous status at the expense of GA policyowners – i.e., enjoying a minimum guaranteed crediting rate without the usual insolvency risk exposure borne by GA policyowners. At minimum, it raises questions about whether the fees insurance companies charge hybrid policyowners adequately compensates the insurance company.
Permanent life insurance can be either purchased as MEC (Modified Endowment Contract) or Non-MEC. Each have significantly different, death benefit, liquidity and tax treatment characteristics.
We cover the differences and corresponding implications of each in painstaking detail in our 3-part paper.
In pooled mortality or non-experience rated plans, the mortality risk charge, commonly referred to as cost of insurance (COI) charge is retained entirely by the carrier, which in turn is obligated to pay the portion of the death benefit exceeding CSV from its general assets. The amount above the CSV received by the bank when a claim is paid results in incremental earnings during that reporting period.
With experience rated policies, all but a small percent of the COI is accumulated in a mortality reserve used to pay claims; but unlike with pooled plans, this reserve is an asset of the policyowner, not the insurance company. Consequently, when a claim is paid, there is rarely a measurable increase in P&L earnings.
Stable Value Protection (SVP) is a mechanism which reduces investment volatility in SA BOLI. An SVP provider declares an initial crediting rate based on the yield to worst of the underlying portfolio(s), which is reset periodically (monthly or quarterly) according to a contractually set formula. The SVP provider is also contractually bound to bridge the gap between the stable, or “book,” value and the underlying market value of the assets upon a conforming policy surrender. This allows the policyholder to account for BOLI at “book” value.
We have published a series of whitepapers regarding SVP and have devoted a lengthy chapter to it in our “BOLI Basics” educational tome.
Although by no means a requirement, some BOLI is structured to pay a portion of the policy death benefit to the heirs of the insured employee. Adding a split dollar component adds complexity to an already highly complex process and should be pursued with great caution – the liability and accounting for split dollar can vary drastically from plan to plan.
We’ve introduced what BOLI stands for, what it is, how it works, and some common features. For more high-level information, you’ll find value in the following pages on our site: