With the quick rise in interest rates over the past 18 months, a question many bankers ask is “When will my bank-owned life insurance (BOLI) yields increase?”
BOLI is a long-term investment for banks. Banks purchase BOLI as an asset intended to be bought and held on bank balance sheets, often for 30 years or longer, to optimize the tax and diversification advantages of life insurance. BOLI net yields are typically higher than yields on other taxable bank-eligible investments, especially when death benefits are recognized, according to the COLI Consulting Group’s BOLI Tracker in the first quarter. The account value of BOLI policies accumulates on a tax-deferred basis; the death benefit proceeds are generally income tax free.
Insurance carriers have long-term benefit obligations, including BOLI. To match the duration of their liabilities, they invest in long-term assets, typically resulting in intermediate-term portfolio durations. That means the increasing interest rates over the past 18 months have only recently begun to impact the average investment yields of carriers’ portfolios. If rates remain high, insurers’ portfolio returns will increase over time and crediting rates will increase on a lagging basis.
Banks should focus on the long-term structural characteristics of BOLI that allow it to outperform bank-eligible portfolios of similar credit quality over full market cycles. The ability of insurers to purchase assets unavailable to, and at a scale unachievable by, most banks is a key characteristic of BOLI. The long-term nature of BOLI provides an important hedge to reinvestment risk, which is especially important as many believe rates are nearing a high point in the cycle and reinvestment risk on shorter-term investments is material. Notably, investments in general or hybrid separate account BOLI incur no market value or accumulated other comprehensive income adjustment, or AOCI, unlike most alternate investments. That can be an attractive feature as higher interest rates have caused many banks to sustain significant reductions in equity capital due to AOCI adjustments to their bond portfolios.
Current BOLI Versus Higher-Rate New BOLI
While moving an insurance policy from one carrier to another can be accomplished with a tax-free exchange, provided all applicable state and federal regulations are complied with, policy owners should keep in mind:
- BOLI is a long-term investment and banks should not be overly swayed by higher new money rates. Sometimes, new money rates will exceed portfolio rates; at other times, portfolio rates will exceed new money rates. Long term, they trend toward equalization.
- The minimum interest rate guarantee for new BOLI products will likely be lower than the current BOLI policy’s minimum interest rate.
- Exchange charges, including market value adjustments, could significantly reduce the potential pickup in yield from moving coverage.
- To qualify as life insurance, the bank must have an insurable interest in each insured on a new policy’s issue date, and this requirement may not be as easy to meet with 1035 exchanged policies.
- Banks should be encouraged to look at the total return of their BOLI, including expected future death benefits proceeds, rather than solely focusing on cash value growth.
- Generally, a carrier won’t allow the bank to purchase additional BOLI in the future if the bank moves coverage, limiting the bank’s options for future purchases.
Exceptions where it may be appropriate to consider a 1035 exchange:
- Credit concerns regarding the current carrier.
- The carrier has exited the BOLI space and is not meeting customer expectations.
- Rates have been higher for several years and the carrier has not increased its rates.
With recent increases in interest rates, it’s tempting to expect rapid increases in yields on existing BOLI portfolios. However, BOLI is a long-term investment; crediting rates move up and down gradually, consistent with the duration of carriers’ portfolios. This gradual movement was much appreciated when rates moved down to near 0%, as many BOLI carriers continued to credit interest close to 3%.
Now that rates have increased and the yield curve has inverted, the lag in BOLI crediting rate movement may cause BOLI yields to temporarily be less than yields on some other available investments. But when held to maturity, BOLI typically produces more earnings than other bank-eligible investments. If your bank is considering a 1035 exchange of existing policies, be sure to evaluate the alternatives thoroughly and beware of pressured pitches to chase higher rates.
Insurance services provided through NFP Executive Benefits, LLC. (NFP EB), a subsidiary of NFP Corp. (NFP). Doing business in California as NFP Executive Benefits & Insurance Agency, LLC. (License #OH86767). 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
Life insurance products issued by Massachusetts Mutual Life Insurance Company (MassMutual) and its subsidiaries, C.M. Life Insurance Company (C. M. Life) and MML Bay State Life Insurance Company (MML Bay State), Springfield, MA 01111-0001. C.M. Life and MML Bay State are non-admitted in New York.