This page is intended to give only a cursory overview of how BOLI works from beginning to end. 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’re looking for information on why banks use BOLI, you can read here.
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 it work?
Banks purchase life insurance (typically from carriers with good credit quality) on the lives of officers and other highly compensated employees and not only remain the policy owner but are generally also the designated beneficiary1. Prior to purchasing BOLI, banks obtain written consent from the executives they intend to insure and do not purchase policies on those employees opting not to consent. State law governs who can buy insurance (known as “insurable interest”) on whom, whether prior notice must be given to the proposed insured and whether consent must be affirmative and in writing. Because insurable interest laws vary considerably from state to state, with uneven employee protections, federal law was enacted that augments all state statutes and has applied to all COLI/BOLI purchased since August 17, 2006 (“The COLI Best Practices Act”)2.
If you’d like to learn more about consent and who banks can insure with BOLI and why, you can read more here.
If you’d like to learn more about the pre-purchase process for BOLI, you can read more here.
Permanent life insurance includes a savings account component referred to as “cash value”. The Cash Surrender Value (or “CSV”) is the cash value net of any applicable surrender charges. If a policy does not have any surrender charges (which is common in BOLI), the Cash Surrender Value is synonymous with cash value and often used interchangeably. The bank treats this CSV as an asset on its books and periodic changes in the carrying value are recorded in earnings (accretive to earnings when it has increased during the period, a hit to earnings during periods when CSV has decreased).
BOLI cash value earns interest on a tax-deferred basis. A portion of this inside growth offsets the insurance risk cost, known as cost of insurance or “COI”, within the policy (the COI is based upon the difference between the policy cash value and the amount payable upon death. This difference is known as the net amount at risk, or “NAR”).
Banks are required to report aspects of their BOLI programs in their quarterly statements of financial condition (i.e., “call reports”).
Upon death, a policy’s death benefit is payable in full by the insurance company. Permanent Life Insurance death benefits are generally the sum of the Cash Value and the NAR. Depending on the mortality design, the NAR portion of the benefit can come from a special type of reserve owned by the policyholder (revenue neutral to the P&L), or from the insurance company’s reserves/surplus (incremental P&L earnings in the reporting period equal the NAR paid).
A policy may also reach maturity without the insured dying (this is known as “endowing”). Some examples include:
- When the Cash Surrender Value equals the death benefit – this must, according to the IRS definition of a life policy, occur by a specified age (generally between ages 95-100, but depends on when the policy originally issued among other factors). This highly depends on mortality design)
Of course the policy might not last until it endows or results in a death claim if the policy owner elects to surrender it for the cash value, converts the policy CSV into an annuity or allows the policy to lapse (the causes and risks associated with policy lapsation are a topic covered in another article).
Want to know more about BOLI?
We’ve introduced what BOLI stands for, what it is and how it works. For more high-level information, you’ll find value in the following pages on our site:
- What is BOLI Part II – Common Types and Features
- What is BOLI Part III – Why Banks Use It
- BOLI Insurance – An overview of who banks can insure with it and why
As always, if you have any questions or would like to speak to a BOLI expert, please contact us.
1 Some policies may be owned by a trust established by the bank and/or such trust may be the named beneficiary.
2 Most employers have always obtained employee consent prior to purchasing COLI/BOLI; but because some notable exceptions made headlines and were the subject of numerous misleading and salacious articles, pressure mounted for federal legislation to close state law gaps.