BOLI INSURANCE – WHO BANKS CAN INSURE AND WHY

BOLI Insurance – What is BOLI?

BOLI is an 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 highly compensated employees, and the institution retains at least some interest in the death benefit proceeds. When structured correctly, BOLI’s favorable assets/liabilities timing symmetry, accounting treatment and tax advantages make it a valuable balance sheet asset.

BOLI Insurance – Why are banks allowed to insure employees, and how do they choose which to insure?

Insurable Interest

As a general matter, an individual or institution seeking to purchase life insurance must have an “insurable interest” in the lives of the person(s) to be insured. Insurable interest is governed on a state by state basis and violating applicable insurable interest statutes could have severe federal tax consequences. While no states have an outright prohibition against BOLI, some states, including California, prohibit “classes” of employer owned life insurance. While there is a significant variance in how states have addressed the matter of insurable interest for employer owned life insurance contracts, the bulk of these differences can be placed into two overarching categories:

It is noteworthy that all state statutes require insurable interest in the covered life at the time the policy issues. It need not continue to exist thereafter – a policy on an employee that has retired or left the bank can remain in force with the original owner.

BOLI Regulations Overview

Among many others, two regulations are noteworthy:

• OCC Bulletin 2004-56 (December 7, 2004) – the comprehensive update of supervisory guidance for BOLI
• COLI Best Practices Act (COLI BPA) – signed into law as part of the Pension Protection Act of 2006 → amendment to IRC Section 101(j)

Requirements of IRC Section 101(j) include insuring only “highly compensated” or “key employees” and obtaining insured consent. However, compliance with the federal requirement on consent may not necessarily ensure compliance with a state’s requirement – both must be adhered to and carefully evidenced. For example, conforming to a state’s negative consent law requirement does not work because it fails 101(j)’s affirmative consent requirement. Conversely, meeting all of 101(j)’s requirements but purchasing an amount of insurance that fails to meet the state’s definition of permitted coverage (e.g., must, on a NPV basis bear a reasonable relationship to the NPV of future benefit liabilities), could also fail.

Who do Banks Pick?

Aside from providing consent, an employee must meet requirements as stated in the COLI BPA. The requirements include directors and highly compensated individuals.

• Highly compensated typically means
  • Highly compensated within the meaning of 414(q) (without regard to paragraph (1)(B)(ii) thereof)
  • Highly compensated within the meaning of 105(h)(5), except that ‘35 percent’ shall be substituted for ‘25 percent’ in subparagraph (C) thereof

COLI BPA also requires COLI/BOLI owners to maintain records necessary to prove the exemptions (e.g., that the insured employees met the definition of highly compensated employees, gave written consent, etc.).

Among many other requirements, OCC 2004-56 requires rigorous due diligence, including board approval, before BOLI can be purchased. Banks, along with consultants like MBSA, determine the insurable population and obtain and document all consent as part of a broad pre-purchase process.

Conclusion

Current regulations allow banks to take out life insurance on individuals for whom they have an insurable interest. Regulations restrict the insured to “highly compensated” employees (typically directors and above, or top 35%) and the insured must provide consent. If you have any questions about who banks can insure with BOLI or why, please contact one of our BOLI experts.