Florida Banking November 2023

banks are able to experience the returns of these assets indirectly through BOLI. The smoothness of BOLI earnings is a result of the lag-effect of the general portfolios and the pace at which assets turn over into current interest rate earning instruments. In other words, as portions of the portfolio mature, the cash released is redeployed into assets that pull the portfolio in the direction of the market. In the Figure 1 case study, the heavy green line represents actual tax effected BOLI yields aggregated from multiple carriers but does not include the impact from tax-free death proceeds. From 2001 to 2002, the Fed Funds rate dropped rapidly. While BOLI yields also decreased, the lag effect tempered the drop in comparison. When the Fed Funds rate climbed steadily in the middle of 2004, BOLI rates stabilized as carriers attempted to reallocate portfolios from the downward trend in the prior months. Going forward to the economic crisis in 2008/2009, we all know what happened to interest rates as the economy was in turmoil and banks were failing. This is where BOLI carriers shined as they did their best to steady returns for the following 10 years. During that 10-year period, in many cases, BOLI was the highest earning asset on a bank’s balance sheet and served as a counterbalance to create income in a low interest rate environment. It is relevant to point out that not all BOLI carriers’ performance will be identical because each carrier manages their own general portfolio. Not only will there be variance in portfolio assets amongst carriers, but the duration of each portfolio will vary. Those with shorter durations will be more sensitive to rate fluctuations than those with longer durations. Because of this, many banks will use a blended approach of BOLI products to balance their risk and market rate sensitivity.

The point of highlighting that time frame is to take the focus away from the hunt for yield today and shine the light on the long term. The Fed’s fight against inflation has caused market rates to rise at a faster pace than the turnover in BOLI carriers’ general accounts causing under market BOLI returns. The recent uptick shows that BOLI is behaving exactly as predicted. Turnover creates a pull in either direction, but the tax-preferred status means that BOLI movements do not have to be as drastic to have the same impact. For example, in simplified terms, for every 100 basis points of movement in the market, a tax-preferred asset will only need to adjust by 75 basis points to have the same impact. This assumes a 25 percent tax rate and is an example to illustrate a point. It is also important to note that the BOLI yields in Figure 1 do not include the potential proceeds from the life insurance when a death occurs to one of the insureds. Howard Marks from Oaktree Capital often uses the phrase, “time over timing,” which is meant to urge investors against attempting to time the market but rather to focus on the long-term and reap the rewards of compound interest. The big picture tells us that over time BOLI continues to deliver consistent returns and serve its purpose, to offset the costs of employee benefits expenses and manage risk. Glenn Blackwood and Joe Schaefer are consultants with NFP Executive Benefits. To learn more, contact Blackwood at glenn. blackwood@nfp.com or Schaefer at joe.schaefer@nfp.com. Glenn Blackwood is a registered representative with Kestra Investment Services. Insurance services provided through NFP Executive Benefits, LLC. (NFP EB), a subsidiary of NFP Corp. (NFP). Securities offered through Kestra Investment Services, LLC, member FINRA/SIPC. Kestra Investment Services, LLC is not affiliated with NFP or NFP EB. Investor Disclosures: https://bit.ly/KF-Disclosures

Actual Case Study - BOLI Tax Equivalent Net Yields versus Treasury Yields, Fed Funds & MBS Index

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