“Put simply, BOLI is attractive to the banks because it can produce better returns that the banks couldn’t otherwise achieve.”
– Fool.com, “Bank Owned Life Insurance: A Little Known Way Banks Make Money”
We introduced the phenomenon of BOLI, or bank-owned life insurance that has become a significant Tier 1 asset for many U.S. banks. We looked at how these plans work, the favorable returns and tax treatment compared to other cash equivalents, and how life insurance fits into Tier 1 assets held by banks.
Today, we’ll examine the impressive growth of bank-owned life insurance, the pros and cons of BOLI, and answers to common questions. Then we’ll look at what we can learn from the BOLI trend can be applied to our personal economies.
Banks have had the ability to purchase life insurance since early 1980’s, according to BankDirector.com. From nothing to many billions, it has grown steadily, often with double-digit annual gains in volume of cash surrender value (CSV). By 2008, the research of Barry James Dyke revealed a surprising fact: “According to the FDIC, banks are the largest purchasers of cash value life insurance in the United States.”
Immediately before and after the subprime crisis, both the number of banks purchasing life insurance and the amount of life insurance held by these banks increased dramatically. According to official BOLI holdings reports, BankInsurance.com, and other sources that report numbers from FDIC filings, BOLI assets held by banks and thrifts totaled $65.8 billion by the end of 2004. Two years later, at the end of 2006, the number had skyrocketed to $103.90 billion. By the end of 2011, BOLI assets had reached $143.67 billion. And in another five years, at the end of 2016, CSV of BOLI policies held by banks and savings associations reached a new high of $161.8 billion. (Assets represent both new policies and cash value growth of existing policies, subtract claims paid, and do not include the value of death benefits.)
Today, over 62% of banks hold BOLI assets, according to reports based on regulatory filings. And as you can see on the chart below from the most recent Equias Alliance / Michael White BOLI Holdings Report, over 74% of banks with assets exceeding $300 million report owning bank-owned life insurance:
Most of the largest financial institutions in the US have used BOLI for many years. In recent years, thousands of community banks and thrifts have also jumped on the BOLI bandwagon, often looking for ways to fund the ever-rising cost of employee benefits, such as healthcare costs.
Who are the top holders of BOLI? The list below shows the top 20 banks and savings institutions in the U.S., measured by volume of CSV reported at the end of 2015:
As detailed in last week’s article, banks hold an average of 13-19% of their Tier 1 assets in life insurance contracts, and up to 25% is within regulatory guidelines.
The Benefits of BOLI
Why are many of the largest banks putting billions into cash value life insurance? Writing for Fool.com, Matthew Frankel names what may be the main benefit, “BOLI… can produce better returns that the banks couldn’t otherwise achieve.” However, as with traditional whole life, bank-owned life insurance provides many benefits that add up to much more than an anticipated rate of return.
Some key advantages of BOLI include:
- Superior returns to other safe investments, cash equivalents, and typical bank products.
- Low risk and high liquidity qualifies as Tier 1 capital, which is both required and essential to a bank’s stability and ability to lend.
- Cash value grows tax-deferred, and is never taxed if held until death.
- BOLI diversifies the bank’s investment portfolio.
- BOLI cash values do not need to be marked down if interest rates rise.
- Some policies offer minimum guarantees for cash value performance.
- Gains can efficiently offset costs associated with employee benefits programs.
- Tax-free death benefits indemnify the bank in the case of loss of a key employee.
- “Split-dollar” policies can provide valuable protection benefits for an executive’s heirs.
- Employee benefits funded by BOLI (such as healthcare and retirement benefits) allow a bank to attract and retain quality employees.
- There are broad and well-defined guidelines for permissible usage.
- As single-premium “MEC” policies, the cash surrender value is high.
- Policies have no surrender charges (although there may be tax consequences if policies are surrendered prematurely).
- Cash values are backed by the highest rated insurance companies in the nation.