As 2017 comes to a close, bank-owned life insurance (BOLI) continues to be an attractive investment alternative for banks, based on the increasing percentage of banks holding BOLI assets and the high retention rate of existing BOLI plans. Through the first half of 2017, BOLI carriers reported receiving almost $1.4 billion in new BOLI premiums, according to the market research firm IBIS Associates. Assuming an annualized production level of $2.8 billion, this is only slightly behind the actual full-year new premium results of $3.2 billion received in 2016.
In 2016, 91 percent of new premiums were invested in general account products, and through mid-year 2017, the results were very similar, with 84 percent of new BOLI premiums going to that product type. Cash surrender value of BOLI policies held by banks stood at $164.5 billion as of June 30, 2017, reflecting a 3.5 percent increase from $159 billion as of June 30, 2016, according to the Equias Alliance/Michael White Bank-Owned Life Insurance (BOLI) Holdings Report™. Further, the percentage of banks holding BOLI assets increased in that time period, from 61.3 percent to 62.8 percent. With that in mind, what can we expect of the BOLI market in 2018, given today’s economic and legislative landscape?
Impact of the Economy on BOLI in 2018
Overall, the economy generated some very positive results in 2017. Unemployment declined to just over 4 percent, the stock market hit several new highs, and wage growth increased, albeit slightly. However, banks and other financial institutions continue to operate in a low interest rate environment with no significant market change expected in 2018, based on a November 2017 informal survey that Equias conducted of major BOLI carriers.
To understand the impact of continued low interest rates on BOLI carriers offering fixed-income products, it is important to understand the carriers’ investment philosophies and portfolio compositions. The investment objective of most carriers is to build a diversified portfolio of securities with a long-term orientation that optimizes yield within a defined set of risk parameters. The portfolio strategy often targets investment-grade securities. Corporate bonds are usually the largest holding in the portfolio, along with commercial mortgages and mortgage backed securities, private placements, government and municipal bonds, a small percentage of junk bonds, and other holdings. Some of the carriers in our informal survey stressed they will be allocating more of the portfolio to higher quality bonds in 2018 to guard against any potential downturn in the economy in 2019 or 2020.
Continued low market interest rates will somewhat affect the credited interest rates offered by carriers on both new BOLI sales as well as existing BOLI policies. Credited interest rates and net yields (defined as the credited interest rate less the cost of insurance charges) on new BOLI purchases are currently expected to remain stable in 2018. As a result, new BOLI purchases are, once again, expected to be in the $3 billion to $3.5 billion range in 2018. We also anticipate that approximately 80 to 90 percent of new premiums will be directed to general accounts with higher interest rates.
For existing general account and hybrid separate account BOLI policies, credited interest rates are likely to remain level or decrease slightly, unless market interest rates begin to rise at a faster clip than we have seen in recent years.
Impact of Federal Legislation on BOLI in 2018
One of the key proposals under the Tax Cuts and Jobs Act, passed recently by both houses of Congress, is to reduce the corporate tax rate from 35 to 20 percent. If this were to occur, the taxable equivalent yields on BOLI policies would be slightly lower. For instance, if the net yield on a new BOLI policy was 3.5 percent, then the taxable equivalent yield on that policy would be 5.38 percent at the current federal tax rate of 35 percent, due to the favorable tax treatment that life insurance policies receive.
With the lower federal corporate tax rate under the proposed legislation, the tax equivalent yield for a 3.5 percent net yield BOLI policy would be reduced to a still attractive 4.38 percent. If the corporate tax rate ends up at 25 percent, as some predict, the tax equivalent yield would be 4.67 percent.
Looking ahead to 2018, the continuation of low interest rates and a possible reduction in the corporate tax rate may have some minor impact on BOLI sales and existing BOLI policies, but neither should result in any material impact on the BOLI market.