The Bank-Owned Life (BOLI) Insurance Market is Changing: Here’s How


BOLI-10-24-16.pngBank-owned life insurance (BOLI) has undergone a number of changes since it was first introduced in the early 1980s. The number of carriers offering BOLI was a handful in the 1980s, increased to 20 or so in the 1990s and 2000s, and since has decreased to 8 to 10 active carriers as a number of insurers have exited the market or are currently sitting on the sidelines due to the low rate environment.

As competition for attractive investments has increased due to low yields, many carriers have moderately increased duration. Interestingly, several carriers have reduced purchases of below investment grade securities as the yield spread available for them has decreased to the point where the investment return does not justify the increased risk.

On the sales front, in the first six months of this year, there was a 10 percent increase in the number of banks purchasing BOLI compared to a similar period in 2015. Despite the increase in BOLI purchases, there was a decline in the number of banks purchasing the hybrid separate account product as most banks opted for general account.

As the financial crisis passed and banks become more comfortable with the long-term credit quality of carriers, data shows that fewer banks selected hybrid account policies than in the past, which have a mix of variable and general account properties.

Some aspects of the market have, however, remained consistent over time: there have been steady annual increases in both the amount of BOLI assets held by banks and in the percentage of banks holding BOLI assets.

The focus of this article is to look more closely at the state of the market as of June 30, 2016, including changes that have occurred between June 30, 2015 and June 30, 2016 to help track market trends.

New Purchases of BOLI
IBIS Associates, an independent market research firm, publishes a report analyzing BOLI sales based on information obtained from insurers that market BOLI products. According to the IBIS Associates BOLI Report for the period January 1, 2016 to June 30, 2016:

  • During the first six months of 2016, 553 banks purchased BOLI. The 553 banks included institutions purchasing it for the first time as well as additional purchases by banks that already own BOLI. This was a 10 percent increase over the 502 banks that purchased BOLI during the same time period in 2015.
  • New BOLI premium from banks amounted to $1.78 billion as of June 30, 2016. During a similar six month period in 2015, the total was $2.10 billion or $320 million higher. The difference is attributable to one large variable separate account purchase in the first half of 2015 ($400 million).
  • General account purchases dominated the market during the first half of 2016. Of the $1.78 billion in new BOLI premium, $1.65 billion (92.8 percent) was invested in general accounts. Hybrid product purchases amounted to $75.8 million (4.3 percent) while variable separate account purchases (where the investment risk is held by the policyholders and investment gains flow directly to them rather than the insurance carrier) were only $51.4 million (2.9 percent).
  • During the period July 1, 2012 to June 30, 2014, 226 banks purchased a hybrid product while for the period July 1, 2014 to June 30, 2016, the number of banks with a hybrid product increased by just 42 banks.

The reasons cited by bankers for purchasing BOLI are that it provides competitive returns with superior credit quality. Current BOLI net yields are in the range of 3.00 percent to 3.75 percent which generates tax equivalent net yields of 4.85 percent to 6.05 percent for a bank in the 38 percent tax bracket. Income generated by BOLI can help offset the increasing costs of a bank’s benefit programs.

Status of Market
Based on a review of FDIC data, the September 2016 Equias Alliance/Michael White Bank-Owned Life Insurance Holdings Report, shows that as of June 30, 2016:

  • BOLI assets reached $159.0 billion reflecting a 3.8 percent increase from $153.1 billion as of June 30, 2015. Banks with between $1 billion and $10 billion in assets had the largest percentage increase in BOLI assets during this timeframe with 8.3 percent growth.
  • Of the 6,058 banks in the survey, 3,713 (61.3 percent) now report holding BOLI assets. This percentage has grown year after year. There is, however, a wide discrepancy in the percentage of banks holding BOLI by size category. For example, only 39.9 percent of banks with under $100 million in assets hold BOLI while 81.9 percent of banks with $1 billion to $10 billion in assets hold BOLI.

In summary, the positive trends in new purchases, growth in assets and usage of BOLI by banks continued in the first half of 2016.

Addressing Problems with SERPs in Benefit Plan Designs


SERPs-8-5-16.pngSupplemental Executive Retirement Plans (SERPs) are a valuable compensation tool that banks can use to attract and retain executive talent. SERPs are nonqualified deferred compensation arrangements that are non-elective, meaning the company is responsible for contributions to the plan. Unfortunately, improper design of these plans can result in significant expenses for banks without providing the intended retention value. As a result, SERPs have gained a lot of negative press (particularly during the economic downturn), but if used properly, they can be a powerful tool in compensation. Here’s what you need to know about executive retirement benefits and how banks can avoid the common issues that arise with SERPs.

SERPs have some lingering reputational issues, although this isn’t entirely fair. Many banks do their due diligence and pay close attention to the expenses they will incur as a result of their benefit plans, but this hasn’t always been the case. When SERPs rose in popularity, many banks entered into inappropriately designed plans without understanding their implications. A poorly designed SERP can accelerate vesting schedules in the event of early retirement or cause banks to pay benefits in excess of 100 percent of final salary. Problems also arise due to IRC Section 280G (which deals with golden parachutes) in the event of a change of control. Additionally, many of these SERPs were designed solely with the placement of Bank Owned Life Insurance (BOLI) in mind, ignoring the strategic purpose and future impact. Fast forwarding to 2016, we see a number of problems related to SERP plans. The primary concerns are the following:

  • Banks absorbing mortality risks for lifetime benefit plans.
  • Defined benefit structures whereby a SERP benefit is contingent upon a final pay calculation.
  • Not considering 280G excise tax concerns in the case of M&A activity.
  • Unreasonable benefit structures that are either too lucrative or conservative.
  • Equity-based SERP designs.

Many boards have been soured by a bad experience and vowed to never implement another SERP plan at their bank. From a strategic perspective, this is a mistake that will hinder the bank’s ability to retain and recruit the talent necessary to stay competitive.

The real problem isn’t SERPS—its poor design. A SERP isn’t the answer to all the retention or recruitment issues, but it is a tool that should be used to complement the other components of compensation. SERPS themselves are not the problem; poorly designed SERPs are. Let’s address a few key design considerations:

  • Know what your expense is going to be. The benefit should be fixed day one, plain and simple.
  • Understand the potential 280G impact, regardless of the probability of a change in control.
  • Know that financing tools exist to reduce plan expense and provide a lifetime benefit with a fixed cost through proven methodologies. Explore all financing options—BOLI is not the only tool available for bankers.
  • Understand the strategic purpose behind the benefit plan structure, and conduct peer compensation studies to ensure that the benefit and compensation are reasonable and competitive.
  • Make sure the bank is protected in the event of premature death, but don’t allow life insurance to drive the design of your plan.

If your plan does not incorporate some of these features, it’s time to take a hard look at your plan design. Although IRC 409A (which regulates the tax treatment for nonqualified deferred compensation plans) imposes limitations on plan design changes, there are a number of strategies to help reduce the general plan expense, mortality risk concerns, 280G exposure and other issues without violating IRC 409A. There are hedging vehicles in the market to generate efficiencies at the benefit expense level. Consult with a compensation professional to help you navigate these waters.

Many banks continue to use SERPs effectively. A bad experience should not deter you from exploring the plan’s positive benefits. That said, a SERP can be complex and should be designed objectively by compensation professionals. If you explore all financing tools to make sure the bank is getting the most efficient design, your bank will be in an excellent position to accomplish your goals.

Key Trends in the BOLI Market in 2016


BOLI-market-6-22-16.pngIn 2015, the percentage of banks with bank-owned life insurance (BOLI) increased, the majority selected a General Account (GA) product and the cash surrender value of policies rose.

These are some of the conclusions drawn from the latest research from the Equias Alliance/Michael White Bank-Owned Life Insurance Holdings Report. Of the 6,182 banks in the U.S. operating at the end of last year, 60.5 percent now report holding BOLI assets. This percentage has consistently grown year after year. Further, the percentage of banks in each size category holding BOLI assets increased from the end of 2014 to the end of 2015 with banks in the $1 billion to $10 billion asset category having the highest percentage of BOLI at 82.5 percent.

BOLI assets reached $156.2 billion at the end of 2015, reflecting a 4.4 percent increase from $149.6 billion as of December 31, 2014. The growth in BOLI holdings is attributable to a variety of factors including an increase in the value of those holdings, first-time purchases of BOLI by banks, and additional purchases by banks already having BOLI on the books.

Holdings by Product Type
The highest dollar amount of BOLI assets continues to be held in Variable Separate Accounts (VSAs), where the investment risk is held by the policyholders and investment gains flow directly to them rather than the insurance carrier. VSA assets totaled $71.95 billion representing 46.1 percent of all BOLI assets as of December 31, 2015, down slightly from 47.6 percent at the end of 2014. At the same time, only 480 or 12.8 percent of all banks with BOLI reported holding VSA assets, down from 14.2 percent a year ago. Typically, only larger banks hold VSA assets because of the investment risk noted previously. The average amount of VSA assets held by these 480 banks is substantially larger than the average amount of General Account (GA) or Hybrid Separate Account (HSA) assets held by community banks due to the size differential between the banks.

The type of BOLI assets most widely held by banks in 2015 was GA. A GA’s cash surrender values are supported by the assets of the insurance company. Nearly 96 percent of banks with BOLI reported GA BOLI assets. In comparison to GA products, HSAs have not been available for purchase nearly as long. Since 2011, the number of banks using HSA products increased by 47 percent to 1,280. The above BOLI holding percentages exceed 100 percent since some banks have more than one type of BOLI product.

New Purchases of BOLI in 2015
According to a report from IBIS Associates, Inc., an independent market research firm, BOLI sales last year increased to $4.048 billion which were attributable to purchases by approximately 500 banks. This was 26 percent higher than the $3.214 billion reported in 2014 and was primarily due to a major increase in VSA premium which rose from $35.6 million in 2014 to $504.0 million in 2015. This was due, in part, to a few very large VSA purchases that may not be duplicated in future years.

Why BOLI Remains Popular
Feedback we have received from our clients suggests that the reasons BOLI remains appealing as an investment for banks has not changed in recent years:

  • It provides tax advantaged investment income not available with traditional bank investments, as well as attractive yields compared to alternative investments of a similar risk and duration
  • The growth in the cash value of the BOLI policies generates income for the bank and its shareholders
  • The bank receives the life insurance proceeds tax-free upon the death of an insured employee who elected to participate in the plan; and
  • The bank can use the income to pay for one or more non-qualified benefit plans to help attract and retain key executives, or use the income to help offset and recover employee benefit costs such as health care and retirement expenses.

Since BOLI currently offers a net yield ranging from approximately 2.25 percent to 3.75 percent, depending upon the carrier and product, BOLI remains a popular investment option for many financial institutions. For a bank in the 38 percent tax bracket, this translates into a tax equivalent yield of 3.62 percent to 6.05 percent.

Finally, based on our experience, banks owning BOLI policies remain very satisfied with their previous purchases and would consider making additional purchases in the future.

The Four Habits of Successful Bank Compensation Committees


compensation-committee-6-17-16.pngCompensation committees are responsible for setting the foundation of a bank’s compensation program, subsequently impacting the bank’s underlying culture. The banking industry is more competitive than ever, so attracting and retaining top talent should be the number one priority. With a compensation committee that is educated on industry trends and modern-day compensation best practices, your bank will be on its way to developing programs that attract and retain top talent. Here are the top four best practices a bank’s compensation committee should consider.

1. Committee Members Should Take Steps to Stay Educated
Your committee members are responsible for staying aware of compensation trends. They need to always be in-the-know of complications, IRS penalties, and other factors with unintended consequences or expenses that can impact both the bank and the executives. Committee members should regularly review market trends in executive compensation; staying aware of banking trends as well as trends in other industries will better position the bank for success in recruiting, rewarding, and retaining talent. Your board should also be educated by the committee regarding your compensation philosophy and how the committee functions.

A few areas the compensation committee has direction over include equity grants, incentive structure, benefits, qualified plans, board compensation and other aspects of compensation. The directors should have a full understanding of structuring compensation plans, and if not, the committee should consult an adviser.

2. Establish the Duties and Responsibilities of Each Committee Member
In addition to staying educated, members of the compensation committee must have a framework for their efforts. This involves establishing the duties and responsibilities of each member, but before you begin, you’ll need to develop a compensation philosophy if you don’t already have one. Without an established compensation philosophy, your compensation committee will lack direction, clarity, and consistency regarding compensation practices. In addition to putting your philosophy in print, you should ensure that everyone on your committee understands it and is able to relay its message. The philosophy should be comprehensive as well as consistent with the culture of your bank, the interests of your shareholders and market trends.

3. Review the Committee’s Performance Quarterly
Quarterly, you should hold a meeting to assess the success of your committee. Check on what’s working and what isn’t with regards to committee function, meeting processes and other aspects. It’s important to look at whether you’re hitting benchmarks—and whether you’re attracting and retaining the talent you need to hit those benchmarks. There’s always room for improvement, so discuss what the committee may need to change in order for your bank to be more successful with recruiting and retention.

4. Engage Expert Consultants When Necessary
There’s a delicate balance that must be struck with compensation; it needs to be competitive enough to retain executives but as efficient as possible to drive shareholder value. With the increasing competition for talent and the rising costs of benefits like health care plans, many banks have been pre-funding benefits through plans such as bank-owned life insurance (BOLI). Choosing the best insurance carriers and structuring pre-funding plans is something that requires outside help from qualified consultants.

Professionals can help you determine competitive compensation packages and discern what investments will bring you the greatest return for the lowest risk.

If you don’t feel your compensation committee is hitting the mark, it’s time for something to change. Rewarding talent and funding those rewards is a complicated topic, so outside help from a compensation consultant who specializes in banking may be helpful to bring direction to your committee. If your committee follows these four best practices, you’ll be on a path to success applying your finest approach to compensation and benefits plans.

What Are the Best Ways to Fund Your Retirement Plans for Executives and Directors?


retirement-plan-4-20-16.pngNonqualified deferred compensation (NQDC) plans continue to be important tools to help banks attract, reward and retain top talent in key leadership positions. In order to retain their critical tax deferral benefits, such plans must remain unfunded. For tax purposes, a plan is “funded” when assets have been unconditionally and irrevocably transferred for the sole benefit of plan participants. Formal funding of qualified plans, such as a 401(k), does not subject the participants to immediate taxation—participants can defer taxes until they actually receive such income. However, qualified plans have limitations on the level of benefits that can be provided and these limits can lead to substantial shortfalls in expected retirement income for executives and other highly compensated persons. NQDC plans came about specifically to help offset those shortfalls.

The restrictions on funding NQDC plans leads plan sponsors to search for solutions to finance or economically offset the costs of providing enhanced benefits to NQDC plan participants. When you hear someone refer to “funding a NQDC plan,” this is what they mean. Economic, or informal, funding means that the bank acquires and owns the particular asset of that funding method and that at all times such assets are subject to the claims of the bank’s creditors. Our objective for this article is to review and compare the financial statement impact of various methods for economically funding such plans. In our examples we use a Supplemental Executive Retirement Plan (SERP) and the following funding methods: 1) unfunded; 2) bank-owned annuity contract; 3) bank-owned life insurance (BOLI); 4) a 30-year, A-rated corporate bond; and 5) a 30-year, bank-qualified municipal bond. The same investment allocation and same cost of money were used in scenarios two through five.

  1. Unfunded
    A benefit plan is implemented and no specific assets are earmarked to generate income to offset the expenses. The bank accrues an accounting reserve for the benefit liability as required under GAAP and makes payments out of general cash flows. This method is simple and has often been used when the bank does not have additional BOLI capacity.
  2. Bank-Owned Annuity Contract
    The bank purchases a fixed annuity contract (variable annuities are not a permissible purchase for banks) on the lives of the plan participants. While the primary advantage of purchasing an annuity is that the cash inflows from annuity payments can be set to match the cash outflows for benefit payments, because corporate-owned annuities do not enjoy the tax deferral benefits of individually owned annuities, there is a mismatch of income taxation (annuity) with income tax deductions (benefit payments). Fixed annuity contracts with a guaranteed lifetime withdrawal benefit provide a specified annual payment amount commencing when the executive reaches a certain age (usually tied to retirement). Payments are made for the life of the annuitant. Fixed annuity contracts generally do not respond to movements in interest rates.
  3. Bank-Owned Life Insurance (BOLI)
    The bank purchases institutionally priced life insurance policies on eligible insureds to generate tax-effective, non-interest income to offset and recover the cost of the benefit plan. When properly structured and held to maturity, earnings on BOLI policies remain tax-free, eliminating the tax mismatch issue. The tax-free nature of BOLI earnings often allows the bank to exceed the yields on taxable investments on a tax-equivalent basis. Top BOLI carriers structure their products so that they do respond to market rate movements, albeit on a lagging basis.
  4. 30-Year, A-Rated Corporate Bond
    A 30-year, A-rated corporate bond is a simple and transparent investment vehicle. Because investment earnings are taxable as earned, and benefit payments are not deductible until paid, the tax mismatch is the primary disadvantage. Corporate bonds do respond to market rate movements, leading to potential volatility in market values.
  5. 30-Year, Bank-Qualified Municipal Bond
    A 30-year, bank-qualified municipal bond is similar to a 30-year corporate bond except the earnings are tax free.

In summary, key to the funding analysis is evaluating the best investment for the bank that will mitigate the impact of the plan expenses and liabilities on the bank’s financial statements with bank-eligible investments. The following table summarizes the projected net financial statement impact of the five methods discussed above in both today’s interest rate environment as well as the projected impact in a rising rate environment. As you can see, BOLI and a 30-year bank-qualified municipal bond offer some of the better ways of funding the plan over time.

Funding Your NonQualifed Deferred Compensation Plan

  Projected Life of Plan Net Income(Expense)*
Method of Funding Today’s Rate Environment Rising Rate Environment
Unfunded $(772,439) $(772,439)
Bank-Owned Annuity Contract $(164,229) $(439,597)
Bank-Owned Life Insurance (BOLI) $190,369 $1,598,371
30-Year A Rated Corporate Bond $(114,989) $(235,872)
30-Year Bank-Qualified Municipal Bond $221,007 $701,441

*Based on $500,000 single premium investment. Current rates are as of March 2016. For more detailed information as well as the relevant assumptions used, please contact David Shoemaker at dshoemaker@equiasalliance.com or 901-754-4924.

Equias Alliance offers securities through ProEquities, Inc. member FINRA & SIPC. Equias Alliance is independent of ProEquities, Inc.

Mitigating Risk When Choosing a BOLI Carrier for Your Community Bank


BOLI-3-9-16.pngIf your community bank is considering revamping your benefits offerings, you’ve probably thought about Bank-Owned Life Insurance (BOLI). Purchasing BOLI is one of the lowest risk ways for banks to fund the cost of their benefits, and for a community bank struggling to compete with commercial banks for top talent, this may be a strategic financial decision. While BOLI is a long-term investment, it generates tax-free interest, making it extremely appealing to community banks. As with any investment, the decision to purchase a BOLI portfolio must be carefully considered so you can get the most return with as little risk as possible. Here are some ways to ensure you choose the right BOLI carrier and get the most out of your policy.

  1. Document every part of the process to ensure compliance. Regulations require careful attention, and national bank regulators provide a roadmap for the pre-purchase due diligence and ongoing risk management of BOLI. Before beginning the process of selecting a BOLI carrier, keep in mind that every step your community bank takes needs to be documented. From when you first purchase BOLI and throughout the life of your policy, documentation is absolutely critical for regulatory compliance, so you should frequently review reports of the performance of your BOLI assets. If any process isn’t documented, then in the eyes of regulators, it doesn’t exist. If you’re unsure of the proper protocol, working with a consultant who understands the regulatory process can help you with any issues that arise.
  2. Conduct a financial analysis of BOLI carriers. When choosing between BOLI carriers, you need to look at a variety of metrics to make the best decision. In the past, some banks’ decision making was reliant on ratings from independent agencies, and while ratings are still important, they are not the only thing you need to consider. By conducting a financial analysis of the carrier, you can get a clearer picture of whether the purchase will keep risk low while providing the yield your bank needs to fund competitive benefits. Here are financial metrics that can help you narrow down your options to a shortlist of low-risk choices:

    • Financial strength: Looking at the carrier’s balance sheet and income statement can help you determine the company’s financial strength, as can ratings from outside agencies.
    • Asset quality: By reviewing publicly available information about the carrier’s assets, you can identify any unusual trends and verify the carrier’s claims paying ability.
    • Risk-Based Capital: Review the carrier’s level of capital over time, compared to the regulatory required amount.
    • Investment philosophy: How does the carrier approach their investment portfolio; what techniques do they use for asset liability matching?
    • Experience in the BOLI market: How long has the carrier been active in the BOLI industry, and have they built a reputation for success in that time?
    • Ownership structure: Is there a parent company that could provide support in time of distress? Does the carrier have a stock or mutual ownership structure?
  3. If you need help, work with an executive benefits consultant. Choosing the right BOLI package for your community bank is an important decision and there are many compliance and regulatory issues that some banks just don’t feel comfortable navigating on their own. Working with an expert is the best way to make the most profitable, lowest-risk decision and to ensure regulatory compliance. Your consultant must understand the operating environment of your bank and your strategic interests in order to help you reach your financial goals and fund your benefits package. While selecting a BOLI carrier and deciding how to fund your purchase is complicated and may require outside help, it is an option that has enabled many community banks to offer more competitive benefits to employees.

Compensation for Privately Owned Banks: What to Know


incentive-plan-11-9-15.pngPrivately held banks, including Subchapter S banks as well as mutuals, are no different than publicly traded banks in their efforts to provide meaningful compensation plans for their key officers. Privately held banks must compete with public banks when attracting and retaining key officers and producers.

Publicly held banks typically offer restricted stock or incentive stock options to key employees. This is much more difficult for privately held banks due to a lack of available shares or illiquidity of the stock. Therefore, privately owned banks competing for talent often require more creativity.

While some privately held banks offer stock options, restricted stock or restricted stock units (RSUs), these types of plans are uncommon. Rather, privately held banks that want to provide rights of ownership to executives often use synthetic equity such as Phantom Stock Plans (PSPs) and Stock Appreciation Rights (SAR) plans. While these plans have an earnings impact to the bank, they do not have a per-share dilution as no actual shares are issued.

Competition for top talent is strong. Assuming the bank offers a competitive salary and an annual incentive plan, the challenge is the ability to offer a long-term incentive/retirement plan. The following types of plans are often used to attract and retain key executives and include:

  • Supplemental executive retirement plans (SERP) can be designed to address an executive’s shortfall that would result if the executive only had social security and the bank’s qualified plan to provide retirement income. Generally, under the terms of a SERP, an institution will promise to pay a future retirement benefit to an executive separate from any company-sponsored qualified retirement plan. The benefit is typically expressed as a fixed annual dollar amount or as a percentage of final compensation.
  • Deferred compensation plans (DCP) allow the bank to make contributions to the executive’s account using a fixed dollar amount, fixed percentage of the executive’s compensation, or a variable amount using a performance-based methodology. The DCP can also allow the executive to defer his or her current compensation.
  • Split dollar plans allow the bank and the insured executive to share the benefits of a specific BOLI (Bank-Owned Life Insurance) policy or policies upon the death of the insured. The agreement may state that the benefit terminates at separation from service or it may allow the executive to retain the life insurance benefit after retirement if certain vesting requirements are met.
  • Survivor-income plans/death benefit-only plans specify that the bank will pay a benefit to the executive’s survivors (beneficiaries) upon his or her death. The benefit may be paid in a lump sum or in annual payments over a specified time period. Typically, the bank will purchase BOLI to provide death proceeds to the bank as a hedge against the obligation the bank has to the beneficiaries. The benefits are paid directly from the general assets of the bank.

Picking the right plan design is only part of the process. Striking the proper balance between making the plan attractive to executives but not excessively expensive to the company are also significant factors when designing the benefit plan. Nonqualified plans can be customized to each executive, avoiding a cookie cutter approach by allowing flexibility in the amount of the benefit, vesting schedule, non-compete provisions, timing of payments and duration of payments. For example, assume you provide a substantial retirement benefit to a 40-year-old executive, but provide no vesting until age 65. The executive will likely not see it as a valuable benefit since most 40-year-olds think they will retire long before age 65. Likewise, if the executive is fully vested at age 55, the executive may not be motivated to stay past that age.

The plan must also provide a fair benefit upon death, disability and change in control. The payment terms can be customized to fit the needs of the executive while remaining in compliance with IRC Section 409A of the tax code. A properly designed nonqualified plan can enhance the bank’s bottom line by attracting and retaining top talent, but doing so in a way that is cost-efficient to the bank.

With over 30 years of history, BOLI has proven to be an effective tool to help offset and recover benefit expenses. While many public banks purchase BOLI to recover the cost of general benefit liabilities only, many privately held banks purchase BOLI for the same reason, but also include recovering the cost of nonqualified plans. BOLI is a tax-advantaged asset whereby every $1 of premium equates to $1 of cash surrender value (CSV) on the bank’s balance sheet. The CSV is expected to grow every month and earnings are booked as non-interest income on a tax preferred basis. From a cash flow perspective, BOLI is a long-term accrual asset that will return cash flow to the bank upon the death of the respective insured(s). BOLI is an investment asset that currently generates a return in the range of 2.50 percent to 3.50 percent after all expenses are deducted, which translates into a tax equivalent yield of 4.03 percent to 5.65 percent (assuming a 38 percent tax bracket).

Summary
Privately held banks must compete with all types of organizations for talent. Their future is dependent on their level of success in attracting and retaining key executives. The use of nonqualified plans, when properly chosen and correctly designed, can make a major impact on enhancing long-term shareholder value.

Equias Alliance offers securities through ProEquities, Inc. member FINRA & SIPC. Equias Alliance is independent of ProEquities, Inc.

BOLI Administration: What Comes Next?



Setting up the right Bank-Owned Life Insurance (BOLI) policy is only part of the story. What happens over the life of the policy is important, too. In this informative video, Jim Calla of Meyer-Chatfield explains how proper maintenance and reporting can make the most of this product.

  • Why is proper BOLI administration an important issue for banks?
  • What are the characteristics of a good BOLI administrator?

The Impact of Rising Interest Rates on BOLI


BOLI-7-9-15.pngSince the Great Recession of 2007-2009, the Federal funds rate has been held near zero to help spur the U.S. economic recovery. However, with the decline in the unemployment rate, strong jobs growth in the second quarter of 2015 and low inflation, the Federal Reserve may begin to raise short-term interest rates before the end of this year.

Although no one can predict exactly when interest rates will rise or by how much, we all understand it will occur at some point. Because we have been in a low interest rate environment for so long, the natural question is how will higher market interest rates impact the credited interest rates on bank-owned life insurance (BOLI) policies?

To understand the impact of rising interest rates on BOLI carriers offering fixed-income products, it is first necessary to understand the carriers’ investment philosophies, portfolio compositions and interest crediting methodologies. Although the investment philosophy of each BOLI carrier differs, there are generally some common threads. The investment objective of most BOLI carriers is to build a diversified portfolio of securities across and within asset classes with a long-term orientation that optimizes yield within a defined set of risk parameters. The portfolio strategy often targets investment grade securities, both public and privately issued, with cash inflows that reasonably match the projected cash outflows of their projected liabilities. Corporate bonds are usually the largest holding in the portfolio along with commercial mortgages/mortgage backed securities, private placements, government/municipal bonds and other holdings. The duration of these portfolios is typically four to ten years.

Insurance companies use different interest crediting methodologies for BOLI business. Some carriers use a portfolio approach while others use a new money rate approach. In most cases, the carriers who use a new money rate approach blend it into the portfolio over time. The crediting rate in products from new money rate carriers is based on the carrier’s expected rate of return on premiums received currently. The crediting rate in products from portfolio rate carriers is based on a combination of the rate of return from new premiums as well as the balance of the general account assets of the company or the assets of the specific BOLI portfolio.

Rising interest rates will affect both new BOLI cases as well as existing BOLI policies. As noted above, insurance companies invest heavily in bonds. When market interest rates rise, yields on new bonds will increase while prices on existing bonds will decline. In anticipation of rising interest rates, some carriers shorten the duration of their portfolios or pursue a hedging strategy to manage risks.

Carriers using the new money approach will see a more immediate and positive impact on their initial credited rate for new BOLI policies as their rates, for newly issued policies,  are based on current investments yields. Assuming a modest increase in rates, carriers using the portfolio approach may see little or no immediate change in their rate, but will likely see an increase in their credited interest rate over time. This will occur as the portfolio turns over and as new premium that is received is invested at a higher rate.

For existing general account and hybrid separate account BOLI policies, whether a new money or portfolio approach was used, there is no mark-to-market risk as the insurance company, not the policyholder, bears the price risk. For new money products, the interest rate credited to a new purchase is not likely to increase for several years after purchase since the underlying investments supporting the new money purchase typically have durations of four to ten years. Assuming slow and steady interest rate increases, both new money and portfolio products will likely increase over time with the portfolio products expected to increase more rapidly than the new money products. This is because the portfolio products will receive more new cash flows to invest at the higher rates.

A significant interest rate increase over a short period of time may cause most new premium to be placed in new money products, thereby reducing the new premium received into a portfolio product and slowing the time period it takes for the crediting rate to grow to market levels. If this were to occur, the crediting rates on portfolio and new money products would be expected to increase at about the same pace.

Please also bear in mind that it is important for directors and senior management of a bank to monitor not only changes in credited interest rates, but also the net yields. The net yield reflects the actual credited rate less mortality charges and, in some cases, policy fees or other administrative expenses. Accordingly, it is possible for one carrier to have a higher interest rate than another, but a lower net yield.

Many BOLI service providers will meet with their clients at least once a year to discuss the status and performance of their policies. At that meeting, it is vital for board members and senior management to review, among other things, the net yield earned on their policies to determine whether those yields are competitive in light of the type of policy purchased (new money, portfolio, blended portfolio) and current market conditions. Your service provider is well positioned to help you with that analysis and discussion of options, if changes are needed.

In conclusion, rising interest rates will occur at some point, but are likely to have a favorable interest rate impact on both new and existing BOLI clients using a fixed account over the long-term.

Equias Alliance offers securities through ProEquities, Inc. member FINRA & SIPC. Equias Alliance is independent of ProEquities, Inc.

What Is Bank-Owned Life Insurance (BOLI)?



You may have heard the term BOLI before, but what is Bank–Owned Life Insurance? How can it benefit your bank?

In this insightful video, Charlie Hicks of Meyer-Chatfield explains what BOLI is, how it works and breaks down the ins and outs of this investment product.

  • What is BOLI?
  • What are the benefits of BOLI?
  • How does BOLI work?
  • Is there information on how the tax-free status of BOLI will be impacted by BASEL III?