What Is Bank Owned Life Insurance (BOLI) and How Does It Work?

What Is Bank-Owned Life Insurance (BOLI)?

Bank-owned life insurance (BOLI) is a product where the bank is the policy beneficiary and usually the owner. Such insurance is used as a tax shelter for the financial institutions, which leverage its tax-free savings provisions as funding mechanisms for employee benefits.

This permanent life insurance policy is often purchased for high-earners and/or board members of a bank, which pays for the policy and benefits after the insured individual's death. Banks do not take out bank-owned life insurance for every employee working for them, but only those key players whose death could cause the bank to lose money.

Bank-owned life insurance is a type of life insurance created to benefit a bank, not the insured or their beneficiaries. Bank employees may be offered a traditional at-work life insurance plan to cover their loved ones if they die as part of a workplace benefits package.

How Bank-Owned Life Insurance (BOLI) Works

Banks primarily use BOLI contracts to fund employee benefits lower than they might otherwise pay. In a typical scenario, the bank sets up the contract and then makes payments into a specialized fund set aside as the insurance trust. The policy is bought on an executive's life.

All employee benefits that need to be paid to particular employees covered under the plan are paid out from this fund. All premiums paid into the fund and capital appreciation are tax-free for the bank. Therefore, banks can use the BOLI system to fund employee benefits tax-free.

As the U.S. Department of the Treasury's Office of the Comptroller of the Currency (OCC) explains, banks are allowed to purchase BOLI policies "in connection with employee compensation and benefit plans, key person insurance, insurance to recover the cost of providing pre-and post-retirement employee benefits, insurance on borrowers, and insurance is taken as security for loans." In addition, OCC may also allow for other uses, it says, "on a case-by-case basis."

3 Types of BOLI Accounts

There are three types (general, hybrid, and separate) of BOLI insurance available to banks and corporations. General is the most common (and oldest) product of the three types. When banks invest in a general account product, it is mainly invested in bonds and real estate, the carrier of this type of insurance has a credit rating, which can change.

The bank's investment deposit is used as a part of the carrier's general account. The details of investments in a general account are shared in broad strokes rather than the in-depth view given with a separate account.

A separate account allows the insurance provider to separate the general account holdings into investments managed by fund managers. These managers provide the bank with details of the bank's portfolio, and the credit rating of these accounts uses a yield-to-worst ratio. Still, there isn't any guaranteed minimum credit rating as a general account.

A hybrid account combines aspects of a general and a separate type of BOLI. With a hybrid, banks and corporations receive a guaranteed credit rating and detailed information about investment holdings, like in a separate account. Separate and hybrid insurance are also isolated from creditors (unlike general insurance), which protects banks who take these types of BOLI out on their employees.

Pros and Cons of Bank-Owned Life Insurance

According to BoliColi.com, which helps manage corporate-owned and bank-owned life insurance portfolios, this type of insurance was traditionally combined with benefit plans for new senior executives but they are becoming more common as more banks purchase policies to offset employee benefit expenses.

Tax Benefits

As noted, the advantages of BOLI included its tax favorability and the ability to generate earnings that offset the costs associated with employee benefits programs. Another pro is that even if an employee leaves or is fired from the bank, the insurance policy stays in place, so funds from the policy can help the bank continue to pay for other employee benefits.

Surrendered Policies

There can be downsides. For example, if a contract is surrendered because they can't keep up with the premiums, that policy will be taxed, and there is a 10% penalty on any gains. In addition, the credit quality of a BOLI insurance carrier's credit rating is essential.

In addition, because BOLI is an illiquid asset if a bank purchases a policy from a company with a poor credit rating, it exposes the bank to risk, especially if it isn't purchased as a single-premium policy yields the most significant returns.

The Bottom Line

Banks using BOLI as a tax shelter and vehicle for funding benefit plans for all employees are on the rise. This permanent life insurance policy allows banks to cover high-value employees and board members and use the funds to offset benefit programs.

BOLI can help banks compete with other employers' benefit plans, and even if a BOLI-covered employee leaves or is terminated, the policy stays within the company. As long as banks use reputable insurers with strong credit standards, the use of BOLI can be beneficial for the employees and the bank itself.