Separate Account BOLI Products Available for Community Banks

Hoosier Banker, Aug 2007 by Andritsch, Todd A

For the past 25 years, banks of all sizes have purchased bank-owned life insurance (BOLI) to offset the rising cost of their employee benefit programs. With after-tax returns - often higher than other available investment alternatives - BOLI has maintained its reputation as a sound financial strategy with low risk.

Although hybrid products have been available, two predominant types of insurance products lead the market - general and separate account BOLI. Historically, separate account products have been the structure of choice of large banks, while community banks have traditionally purchased general account products.

Recently, however, separate account products have emerged for the community bank market with many of the same attractive features that larger bank products enjoy, making them an attractive alternative for comparison and consideration.

GENERAL ACCOUNT BOLI

From a credit perspective, general account BOLI is often thought of as a loan to the insurance company. The bank's credit risk is to the insurance company, not to any specified invested assets.

To mitigate credit risk, banks that purchase general account products typically diversify their purchase among several highly rated insurance companies. The insurance companies invest the bank's premium dollars into their general investment account, and credit the bank's insurance policies with interest. Although the interest credited to the insurance policies is based on the performance of the underlying investments in the insurance company's general investment account, there is typically no transparency of top or bottom line return provided to the bank.

General account BOLI provides banks with book value accounting and no mark to market volatility as the value of the underlying assets change traditionally very attractive to the small community bank.

SEPARATE ACCOUNT BOLI

In a separate account BOLI structure, the bank has an extra layer of credit protection. The insurance company sets up legally distinct separate accounts outside of its general investment account. The bank's premiums are invested in these separate accounts outside the reach of the insurance company's general creditors. Therefore, from a credit risk perspective, the bank has exposure to the assets inside the separate account, not the insurance company.

Within the separate account there are multiple investment fund options available to the bank. Depending upon the option chosen, risk-based capital treatment can range from 20 percent to 100 percent. Oftentimes the funds are actively managed by highly reputable outside investment managers with an excellent track record. Separate account structures typically have more transparency when it comes to top line return and expenses.

In most cases, the bank will receive a quarterly report from the insurance carrier showing the composition of the investments inside the separate account at the individual security level. The yield of the assets, mortality expenses and investment management expenses also are disclosed.

The separate account structure also allows the bank to allocate the cash values to investment funds within the insurance product. If the bank has a change in its investment philosophy or is dissatisfied with the performance of the investment fund, it can reallocate to other funds available within the separate account. However it must be noted that, among other regulatory restrictions, in order for the separate account product to maintain its tax treatment as life insurance, the insurance company must legally own all of the assets.

As increases and decreases in cash value are directly passed on to the bank, a stable value agreement between the bank and an independent third parry contracted by the insurance carrier smoothes the periodic volatility of the investment fund. The agreement is designed to pass through the total return of the fund over its lifetime, less the expenses of the agreement. Essentially the agreement provider guarantees to pay the difference between actual market value and book value of the fund upon surrender of the policy, allowing for stable, book value accounting within limits.

For banks looking for stable returns, strong guarantees and minimal risks, general account BOLI products remain a sound asset purchase. For those seeking the rewards of a lower expense structure, flexible investment strategy and reduced exposure to credit risk, separate account products may be worth consideration. Many banks have chosen to diversify their BOLI portfolios to include both general account and separate account products.

Todd A. Andritsch

Clark Consulting-Banking Practice

About the Author

Todd A. Andritsch is senior consultant, north central region, Clark Consulting-Banking Practice. He joined the company in 2002, prior to which he was vice president and division head of Harris Trust & Savings Bank, Chicago. Previously Andritsch was first vice president of commercial banking at LaSalle Bank, Chicago. He has 18 years of banking experience. Andritsch earned a bachelor's degree from Drake University and a master's degree from DePaul University. The author can be reached at 317-336-7722, todd.andritsch@clarkconsulting.com.