BOLI INSURANCE – WHO BANKS CAN INSURE AND WHY

This article is intended to be an overview of why and how banks insure employees using BOLI or COLI. It does not cover all details or aspects. Details on topics like BOLI regulation and the history of BOLI/COLI are covered extensively in our other publications.

BOLI Insurance – What is BOLI?

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. When structured correctly, BOLI’s favorable assets/liabilities timing symmetry, its favorable accounting and its tax advantages can make it a valuable addition to a bank’s investment portfolios.

BOLI Insurance – Why would banks buy life insurance on their employees?

Banks as employers have many ongoing and future costs of employee benefits and liabilities, including general welfare employee benefits programs (e.g., medical plans, group life, 401(k) match, and other benefit plans) and non-qualified executive benefit obligations. BOLI has attributes that make it an efficient vehicle/asset for financing, hedging, or recovering some of these benefit obligations. When properly designed, BOLI is accretive to earnings – making for an attractive addition to the balance sheet. BOLI also possesses attractive accounting characteristics.

Employee benefit obligations typically have longer average durations than many other liabilities. When structured correctly, the timing of BOLI cash in-flows (tax free death benefits) is favorable for offsetting long term benefit liabilities (see chart below).

In short, using BOLI to offset portions of employee benefit costs can help banks to recruit talent by enabling them to maintain attractive benefits (which are not only costly today but are becoming increasingly more expensive to provide) in a hyper-competitive market.

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

While the history of COLI/BOLI is lengthy and encompasses many variations of the product, behavior by some corporations early on gave BOLI and COLI a sour reputation. WSJ articles in 2002 and 2003 generated negative perception regarding all COLI/BOLI (by failing to distinguish between tax-leveraged and non-leveraged versions and otherwise misrepresenting purpose and prevalence of certain practices). Consequently, several state laws were adopted, and onerous federal legislation was proposed. Among many others, two regulations are noteworthy for this article:

• 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), would 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 within the top 25%
  • 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 assiduously 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 they have an “insurable interest” in. Regulations restrict the insured to “highly compensated” employees (typically directors and above, or top 25%) 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.