BOLI Carriers Prepare for COVID-19 Impact

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Purchases of bank-owned life insurance were strong in 2019 as bankers capitalized on its attractive yields relative to other investments available to banks.

What 2020 holds remains to be seen, given trends in the market and broader economy. Total BOLI purchases likely could be lower this year, as carriers are generally not willing to accept large premiums from a single policyholder. However, BOLI activity in the $10 million and under purchase size may be similar to 2019 levels. At the close of the first quarter, it is too early to know the full impact of COVID-19, but we have a few observations based on discussions with several major BOLI carriers:

  1. The carriers have not priced in any risk premium for potentially higher mortality rates and do not expect to do so. In addition, the carriers do not expect to tighten the requirements to obtain guaranteed issue underwriting. In a guaranteed issue BOLI case, the insureds answer several questions, but no physicals are required. Guaranteed issue underwriting can be obtained with as few as 10 insureds.
  2. It is virtually impossible for carriers to find fixed income investments that produce yields that approximate the yield on the existing portfolio, given that short-term interest rates have dropped to near zero and the 10-year Treasury declined from 2.49% on April 1, 2019 to 62 basis points a year later.
  3. While carriers continue to accept new BOLI premium, some are reluctant to take a large premium from any one customer to avoid diluting the portfolio for existing policyholders. Movements in the yield of the portfolio tend to lag the market because carriers’ portfolios are very large (often $50 billion to $200 billion) and generally have a duration of five to 10 years. For this reason, current crediting rates for several carriers remain above 3%.
  4. Several carriers indicated that they started reducing credit exposure and increasing asset diversification several years ago. While they did not anticipate a pandemic, the market had been good for so long and they thought it would be wise to start reducing the risk in the portfolio ahead of a potential downturn. In addition, credit spreads had also narrowed, so there was less reward for additional risk.
  5. Carriers primarily invest in fixed-income investments; a decline in the stock market has minimal impact on most carrier investment portfolios.

BOLI Growth In 2019
BOLI purchases totaled $4.3 billion in 2019, an increase of 147% over the 2018 total, according to IBIS Associates, an independent market research firm. The total represents the third-highest amount of BOLI purchases in the past dozen years.

It’s even more impressive when considering that most banks continued to have strong loan demand and less liquidity than in most previous years. At year-end 2019, BOLI cash surrender value (CSV) held on the balance sheets of U.S. banks totaled $178 billion, according to the December 2019 NFP-Michael White report.

Robust BOLI activity has been driven by attractive tax-equivalent yields, strong credit quality and leverage ($1 invested in BOLI typically returns $3 to $4 of tax-free death benefits). Banks can use BOLI as a way to retain key employees by providing life insurance benefits or informally funding nonqualified benefit plans; BOLI earnings can also be used to offset and recover health care and 401(k) or other retirement plan expenses.

According to the IBIS report, 77% of 2019 BOLI purchases were for general account, 22% for variable separate account and just 1% was for hybrid separate account. In general account policies, the general assets of the insurance company issuing the policies support the CSV. In variable separate and hybrid separate products, the CSVs are legally segregated from the general assets of the carrier, which provides enhanced credit protection in the event of carrier insolvency. The credit risk and price risk of the underlying assets remain with the policyholder in a variable policy, whereas the carrier retains those risks in a general account or hybrid policy.

Purchases of variable separate accounts dominated the market in 2006-07; since that time, general account BOLI has typically led the way. This is due to the simplicity of general account products relative to variable separate products as well as the increased product options, generally higher yields, and the high comfort level bankers have with the creditworthiness of mainstream BOLI carriers.

According to the IBIS data, 2019 general account BOLI purchases were at their highest level in the last 16 years. According to the NFP-Michael White report, 3,346 banks — representing 64.6% of all US banks — now hold BOLI assets. This is an increase from the 64.1% of banks that held BOLI at the end of 2018. Seventy-one percent of banks with over $100 million in assets hold BOLI; 77.3% of banks with over $300 million in assets do.

Key Trends in the BOLI Market in 2016

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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.

BOLI is Becoming an Increasingly Attractive Option for Banks

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4-24-13_Equias_Post.pngBank-owned life insurance (BOLI) has been available in the marketplace for over 30 years now. And yet, industry studies show that year after year, the number of banks and savings associations holding BOLI and the amount of BOLI assets held by such institutions continues to increase.

Industry Studies

Each year, IBIS Associates, Inc., an independent market research firm located in McLean, Virginia, publishes a report analyzing BOLI sales based on information obtained from the insurance companies that market BOLI products. According to the IBIS Associates BOLI Report for 2013:

  • Life insurance companies reported that over 1,100 BOLI cases were sold in 2012 representing approximately $4.4 billion in assets. The 1,100 cases included banks purchasing BOLI for the first time as well as additional purchases by banks that already have BOLI on their balance sheet.
  • Of this $4.4 billion in assets, approximately $2 billion was attributable to one very large sale.
  • Excluding this large case sale, the average premium per case was approximately $2 million last year.

Based on a review of FDIC data, the Equias Alliance/Michael White Bank-Owned Life Insurance Holdings Report for 2013 shows that:

  • Of the 7,083 banks and savings associations in the U.S., 3,782 or 53.4 percent report held BOLI assets in 2012.
  • Banks increased their BOLI holdings (i.e., cash surrender values) from $131.95 billion in 2011 to $137.95 billion last year.
  • Although the largest portion of BOLI assets was held in variable separate account polices (where the bank assumes the investment risk rather than the insurance company), more banks added hybrid separate account policies (that combines the best features of a general account and variable separate account product) in 2012 (10 percent) than any other policy type.

Attractiveness of BOLI

Some have asked why BOLI is still such an attractive asset choice for banks. Briefly, the tax-deferred interest generated by a fixed income BOLI policy is typically substantially higher than a bank can earn on other investments with a similar risk profile. The higher earnings from BOLI can be used to:

  • Help offset the rising cost of employee benefits such as healthcare and retirement programs through use of the tax-deferred income from BOLI assets. For instance, BOLI provides a competitive yield, currently in the range of 3.25 percent to 3.50 percent after all expenses are deducted, which translates into a tax equivalent yield of 5 percent to 5.4 percent. *
  • Increase a bank’s earnings as well as shareholder value. For example, if a bank in the 38 percent tax bracket were to hypothetically invest $5 million in a BOLI fixed income account with a net yield of 3.25 percent, it would generate $162,500 in income. A similar investment of $5 million in a 5-year government agency bond yielding .93 percent would generate $46,500 in income, before taxes. Thus, the investment in BOLI would generate more than $116,000 in additional income for the bank which would enhance return on assets, return on equity and shareholder value. *
  • Help diversify the bank’s balance sheet by investing 2 percent to 3 percent of its assets in a BOLI policy since investment in the general assets of an insurance company through a BOLI policy would be a new asset class for most banks.

In addition to these benefits, a BOLI policy can enable a bank to earn tax-free income and receive death proceeds from policies when they are held to maturity. A bank may also decide to share a portion of the life insurance coverage with its key executives and directors.

Over the years, BOLI has proven to be a valuable asset since now more than 50 percent of the banks in the U.S. have BOLI on their balance sheet.

Pre-Purchase Analysis

What does a bank need to consider in deciding whether to purchase BOLI? The joint banking regulatory Interagency Statement of 2004 identified the factors a bank should consider in making such a decision including why the purchase is being made, the qualifications of the vendors (financial ratings, BOLI experience), the key risks (liquidity, credit, interest rate, etc.), an evaluation of the policy types available (variable separate account, hybrid separate account, general account) and a review of the bank’s capital position as well as risk tolerance.

Market Trends

For the reasons shown above, the number of banks purchasing BOLI for the first time or making an additional purchase of BOLI continues to grow year by year. Hybrid separate account and general account polices (where the general assets of the insurance company support the policyholder’s cash surrender value, but are not protected from claims on the insurer), have been the most popular BOLI product in recent years.

Although BOLI is not suitable for all banks, the statistics show that an increasing number of banks appreciate the benefits it does offer and are making it a part of their investment portfolio.

Additional Equias articles on BOLI:
The Impact of Rising Interest Rates on BOLI
Report on the Market: BOLI Assets Continue To Have Strong Growth

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

*The projected yield is based on an average of the interest rates offered by three carriers in the BOLI market as of April 1, 2013 and assumes the bank is in the 38 percent tax bracket.

Ken Derks is a registered representative of, and securities are offered through, ProEquities, Inc., a Registered Broker/Dealer, and member FINRA and SIPC.   Equias Alliance is independent of ProEquities, Inc.