Florida Banking November 2023

BANCSERV ENDORSED PARTNER: NFP EXECUTIVE BENEFITS

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HAS BOLI LOST ITS LUSTER?

BY GLENN BLACKWOOD AND JOE SCHAEFER

W ith the rapid rise in interest rates in 2022 23, there is some line of thinking that Bank Owned Life Insurance (BOLI) has lost the attractive edge it has enjoyed over the years. It might be worthwhile to step back and look historically at BOLI and how it has performed since 2001, as interest rate cycles have ebbed and flowed. Over the last five years, the banking industry has experienced opposite ends of the spectrum, from excess liquidity in a low interest rate environment to constricted liquidity in a rapidly increasing rate environment. In both scenarios, because banks are in the business of effective use of their inventory (cash), banks were, and continue to be, on the hunt for yield. The intent of this article is to provide a history of how the Bank-Owned Life Insurance or BOLI asset has performed for the last 20-plus years, its structure and purpose on a bank’s balance sheet, and how it has served as a popular alternative asset to balance volatility for the long term. Let’s begin with the basics Unlike retail life insurance with annual premium payments, BOLI is a single-premium institutional cash value life insurance policy. When a bank purchases a BOLI contract, it maximizes its earnings potential from the full principal which earns compound interest from day one. Combined with book-value accounting treatment, the asset’s cash value will continue to grow steadily based on the earnings credited by the insurance carrier without experiencing the volatility of marked to-market adjustments. Because BOLI is a life insurance asset, it carries a death benefit in addition to its cash value, which adds to the asset’s positive balance sheet impact. The bank is the owner of the cash surrender value (bank asset) while also being the beneficiary of the life insurance proceeds. This is important because the death benefit protects the bank against financial costs when the death of a key person occurs. BOLI allows the bank to

efficiently obtain key-person protection by way of an earning asset, rather than through a term life insurance policy’s annual premium expense. The difference to retail life insurance does not stop at its premium frequency. Unlike a retail life insurance policy, intended to have maximum death benefit and minimum premium payments, BOLI is structured to have the smallest death benefit possible, while maintaining the tax preferred nature of a legal life insurance policy according to the Internal Revenue Code. This is important because the policy charges are a factor of the size of the death benefit. Thus, smaller death benefits minimize costs and maximize policy earnings for the bank. This is ideal when the goal is to create efficient use of cash. Why do banks own BOLI? The business purpose for a bank to own BOLI, as documented by Interagency Memo 2004-56, is to finance employee benefits expenses. Because the income generated from a BOLI policy is consistent and the asset is intended to be held for the long term, it matches up well against rising employee benefits expenses. The tax preferred nature and high credit quality of BOLI make the asset an attractive alternative to other high-quality taxable assets. While many banks earmark BOLI income to finance a specific benefit for key people, BOLI income may be used to finance all employee benefits, including 401(k) match, health insurance, etc. It is important to understand that a bank’s decision to purchase BOLI is for its long-term earnings potential and ability to ride the waves of rising and falling rate cycles. To provide an example, Figure 1 illustrates the performance of actual BOLI returns against the 10-Year Treasury and Fed Funds from 2001 to 2023. To generate a return, insurance carriers maintain a general portfolio comprised of multiple assets with varying degrees of maturity (including high-quality MBS, Corporate Bonds, and Private Placements). Many of the assets held inside the carrier’s general account cannot be directly owned by a bank. However,

14 — FLORIDA BANKING THE VOICE OF FLORIDA BANKING