Bank Owned Life Insurance - BOLI

Executive Concepts

What is BOLI?

Bank Owned Life Insurance (BOLI) is an allowable transaction that serves the bank as a competitive tax-free investment. BOLI has its roots in Corporate Owned Life Insurance, which has been used by large corporations for decades to offset employee benefit plan costs and other liabilities.

Sophisticated financial institutions are using BOLI to:

• Earn a high tax-free yield on their investment
  BOLI yields are significantly higher than Treasury yields
  BOLI creates an increase in Net Income and Earnings per Share


• Finance existing or new employee benefit plan costs
  BOLI is not a new employee benefit plan, but is a strategy for financing these costs

Uses for BOLI

The benefit plans which can be financed with BOLI are:

• Current medical and Post-Retirement Medical
• Life Insurance Benefits (including BOLI premiums)
• Deferred Compensation Plans (non-qualified)
• Qualified Retirement Plan Benefits (including 401(k) matching contributions, defined benefit plans etc.)

BOLI is the perfect vehicle for offsetting these costs. The expected total cost of these benefit plans may extend beyond the employees' working lifetimes. The present value of the liability of the current and projected future costs for each employee must be accrued over his working life. The net after-tax discounted number represents the present value liability for the bank. A properly designed BOLI plan can recover all of these costs.

The amount of BOLI the bank can buy directly corresponds to the total employee benefit cost. The "financing" is achieved by purchasing an amount of BOLI that produces sufficient present value gains to equal (but which may not exceed) the present value liability.

Investment Features of BOLI

These are the investment features of BOLI:

• Higher return on capital
• Tax-free yield if policies are held to death
• Tax-deferred yield if policies are surrendered
• Capital guarantee
• Liquidity - reasonable ability to terminate agreement
• Minimal credit risk - BOLI carriers are AAA to AA (S&P) (General Account)
• Separate Account - eliminates credit risk of the insurance company

How BOLI Works

1. The bank insures the top 35% of employees payroll with BOLI.
2. The bank owns the policies and receives the death benefits tax-free.

Plan Economics

BOLI is a more profitable investment than other bank investments. The reason is BOLI earnings are sheltered from income tax. This is how BOLI works:

1. The bank will normally sell a portion of its treasuries or other investments.
2. These investments will be replaced with BOLI, which creates non-taxable income.

Plan Accounting

BOLI creates an immediate increase in income to the bank (without payment of death benefits):

• This is achievd through annual increases in the cash value.
• Each year, the bank records the increase, plus the net effects of death benefits as they are received.
• The increases in cash value and the death proceeds are recorded free of income tax.
• BOLI is accounted for by the FASB Technical Bulletin 85-4. (It is not subject to FASB Statement 115.)

What is the Right Amount of BOLI for My Bank?

The OCC also provides guidelines on the amount of insurance allowable as compared to the bank's capital. No more than 25% of the bank's capital should be in life insurance.

Types of BOLI Products

Common Characteristics
BOLI policies are available through select carriers who have developed products for the institutional buyer. These contracts have common characteristics, which are:

• Single premium contracts (MEC & Non MEC)
• Normal loads are significantly reduced
• Policies produce an immediate yield to the bank as first year income
• Multi-Pay Contracts are available

BOLI Product Description

Modified Endowment Contract (MEC)
MEC's have the lowest death benefit in relation to cash value, therefore offering the highest yield on the bank’s investment. Like all insurance contracts, the cash value buildup and death benefits in a MEC are income tax-free. However there is a 10% penalty tax on the interest portion of any cash surrenders. Usually single premium BOLI contracts are Modified Endowment Contracts.

Multi-Pay Non-MEC
Traditional BOLI is a single premium contract that was developed specifically for banks. Normally, it is the best performing contract for a bank. However, there are instances when it is not the best contract for some bank situations. In those instances Greenhouse Financial, LLC offers multi-pay, non-Modified Endowment Contracts. Typically the bank will pay seven equal annual premiums. This payment plan helps with the Bank's liquidity in several ways. The amount invested in BOLI is lower in the first years of the contract. The cash value can be borrowed from the contracts tax free. In other words, even though premiums are level for seven years, they can be lowered and stretched out for additional years. Another beneficial aspect is equity growth. Equity growth can be planned into the contract and allow the bank to have significantly higher death benefits. When implementing executive deferred compensation it is sometimes best to have a combination of single premium and multi-pay BOLI to receive the beneficial aspects of both plans.

Annual Portfolio Yield Product
The carrier invests the premium in its general investment portfolio. This is sometimes called a General Account or Portfolio Product. Investment control rests solely with the life insurance carrier. Many factors influence the annual creditiing rate returned by the carrier, including investment results and mortality experience.

Separate Account or Private Placement Product
The carrier places the premium in an account separate from the carrier’s general assests. The yield is dependent on the investment performance of the policy assets. The policy owner may select from many different funds with different investment objectives.

Comparison General Account vs. Separate Account Asset Management

Mechanics of Separate Account Transaction

Financial Proforma