You've heard of life insurance and homeowners coverage, but have you ever heard of bank-owned life insurance? By the time you finish reading this article, you'll know what bank-owned life insurance is, how it works, who buys it, and why.
What is a bank-owned life insurance policy (BOLI)?
Bank-owned life insurance (BOLI) is a type of insurance coverage purchased by banks. Frequently, a BOLI policy is taken out in the name of a key employee, executive, or board member. Every BOLI program is closely regulated. For example, the federal banking agencies issued guidelines to ensure that each bank uses safe banking practices and focuses on risk management when using a BOLI transaction to fund their employee benefit program.
If that sounds confusing, stay with us. Here are the key facts to remember:
- BOLI can only be purchased by banks and is not available to individual investors.
- BOLI is a type of life insurance policy purchased in the name of a key employee.
- The bank owns the policy and is named the beneficiary.
- The bank benefits from the tax-free or tax-deferred nature of the policy.
- If the employee dies, the bank is the beneficiary of the death benefit on the policy. These funds are also tax-free.
- Money earned from the death benefit or cash surrender value is earmarked to pay for employee benefits.
- In addition to supporting employee benefit plans, a BOLI allows financial institutions to diversify their portfolio.
Why do banks buy bank-owned life insurance?
Banks buy BOLI because life insurance policies offer tax-free benefits that banks cannot provide. For example, interest earned through a banking product is taxable, while interest earned investing in a life insurance policy is not. Banks do not offer guaranteed rates on any of their banking products, while many permanent life insurance policies do. In short, life insurance is the most practical, efficient way a bank can invest money and know with a degree of certainty it will pay off.
How does BOLI work?
A bank buys permanent life insurance policies for its top-tier employees and board members. The bank owns each policy and is named as the sole beneficiary. Part of each premium the bank pays goes toward building cash value.
Everything, from premiums paid to the cash value growth, is tax-free. In addition, if a key employee dies, the bank receives the life insurance payout tax-free. Those tax-free funds help offset the cost of employee benefits, like medical plans, 401(k) matches, and group life insurance.
Pros and cons of bank-owned life insurance
Here’s a quick rundown of the pros and cons associated with bank-owned life insurance:
Pros of BOLI
- Cash value grows tax-free if held until the death of the person insured. If it's cashed before the person dies, it is tax-deferred.
- Death benefits are tax-free.
- Proceeds are used to fund employee benefits.
- There are no surrender charges attached to a BOLI, saving banks money.
- Investment risks within the life insurance policies do not exceed standard business risks.
- Using a BOLI as an asset adds diversity to a bank's portfolio.
Cons of BOLI
- There's a lack of liquidity. Unlike some other investments, a bank does not have immediate access to the funds tied up in a life insurance policy.
- If a policy is surrendered before the insured dies, all gains are taxed and the bank is required to pay a 10% penalty.
- Banks are exposed to greater risks when a policy is purchased through an insurance carrier with a less-than-stellar credit rating.
Is bank-owned life insurance a good investment?
For banks, it's a great investment because the bank can invest money tax-free (or tax-deferred) and receive a payout if an employee dies. More importantly, a BOLI allows a financial institution to cover employee benefit costs.
