WHAT IS BOLI? PART III – WHY BANKS USE IT

Introduction

This page is intended to give only a cursory overview of BOLI and why banks purchase it. 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). We revisit the topic in this abbreviated form primarily to dispel some of the more prevalent mischaracterizations and misunderstandings we’ve encountered.

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.

How does BOLI differ from COLI?

BOLI is a sub-category of COLI, or Corporate Owned Life Insurance. As explained below, banks can own both BOLI and COLI, whereas, life insurance owned by non-bank employers is generally referred to as COLI¹.

The key difference between BOLI and COLI is the type of employee benefit liabilities it is purchased to offset. COLI, which pre-dates BOLI by over a decade, is used to offset, hedge or finance executive benefit plans (most often referred to as non-qualified deferred compensation plans)². BOLI is used to partially offset general welfare benefit plan costs, including, but not limited to, the future cost of providing medical insurance, 401(k) matching contributions, other future pension plan costs, group term life insurance, group LTD, etc. So, BOLI is used to counteract benefits for all employees, whereas COLI is limited more narrowly to benefits only for highly compensated employees (bank officers, etc.). Because in both instances the liabilities and costs are extremely long in duration, permanent life insurance is more fitting than term insurance. The balance of this page focuses on BOLI.

When structured correctly, BOLI can be a valuable addition to a bank’s overall investments/assets. Currently, U.S. Banks collectively own ~$195 billion of BOLI. While there is no legal or regulatory barrier to non-banking employers using COLI to finance general welfare benefit costs it remains extremely scarce.

Why do Banks use BOLI?

While banks (and, for that matter, all employers) have no legal obligation to continue providing employees the aforementioned employee benefits programs (e.g., medical plans, group life, 401(k) match) they generally intend to. Whether motivated by a sense of paternalism (or maternalism as the case may well be) or competitive pressures, these benefits and their attendant costs appear inescapable. Even more inevitable is the escalating nature of the expense itself (medical inflation alone has risen 70% faster than the CPI over the past 20 years). Unlike most other types of corporations, banks are uniquely positioned to take advantage of BOLI as a means of financing a portion of these expenses.

Actuarial forecasts of general welfare expenditures, even under the most optimistic assumptions (i.e., showing lower than likely increases in costs), indicate huge, compounding cash outflows by employers over the decades to come. Permanent life insurance, unlike any other available investment, will produce cash inflows with a highly similar trajectory. While by no means perfect timing symmetry, the overall arc of likely in-flows from life insurance is better correlated to projected outflows than available alternatives.

The following chart is a redacted actuarial forecast of a bank’s after-tax benefit cash outflows juxtaposed against projected after-tax cash inflows from a BOLI plan along with corresponding net present values under a range of discount rates.

Even the longest maturity bonds fail to meet the ultra-long duration characteristics and holding a dedicated portfolio of bonds to maturity poses other risks that properly structured BOLI can mitigate.

BOLI has two additional attributes that can make it an effective vehicle for financing general welfare costs:

• Accounting for BOLI is favorable
• Growth of policy cash value is tax deferred

When coupling the favorable accounting with tax deferred growth, BOLI is immediately accretive to earnings and can make for an attractive, long-term balance sheet asset. That said, BOLI is by no means always the best choice and may be inadvisable when interest rates remain below historical norms, especially when taking into consideration its intrinsic illiquidity and other risk traits.