Even though life insurance can be a confusing topic, it’s one of the most important purchases you can make for the future of your family.
One reason life insurance can be so confusing is because of the various types of policies offered by different insurance providers.
Bank owned life insurance, also referred to as BOLI, is not the typical family-oriented policy you may be used to associating with the life insurance industry.
In fact, these types of policies are extremely tricky to understand and involve several small intricacies, often leading to a lot of confusion and questions on the part of the insured.
We are going to scratch the surface of the bank owned life insurance world without diving into any complexities.
There are a handful of additional factors which go into these plans, all of which revolve around the insurance and taxes impacting the policy.
What is a Bank Owned Life Insurance Policy?
With a bank owned policy, both large-scale and community banks can purchase a life insurance plan on a key senior executive or group of essential employees at a certain company.
Whichever bank purchases the plan is considered the owner, purchaser, and beneficiary of the policy.
As would be expected, the life insurance policy provides protection for the bank if one of the key employees were to pass away unexpectedly.
Because they are also named the designated beneficiary of the policy, the bank will be awarded tax-free death benefits and any cash value build-up associated with the insurance policy.
In accordance with new legislation, the insured must gain informed consent from the employee or employees in question before a bank owned life insurance policy can be taken out.
How Does Bank Owned Life Insurance Work?
Since the 1980s, these policies have been used in a tax-efficient way to offset the costs of employee benefit programs.
Essentially, these policies are used as a way to fund employee benefits at a specific company, helping the institution pay for employee benefit packages at a much cheaper rate than not using one at all.
Some insurance carriers may even allow banks to allocate bank owned life insurance policies toward other initiatives, but on a case-by-case basis.
These plans have several advantages for the banks who own them. The banks will even get a much better return on their investments compared to a more traditional investment, such as a bond or mortgage-backed securities.
On top of the performance of the investment, the money is growing inside of the policy tax-free, meaning the deposit gains are actually larger than they appear. Keep in mind this is a benefit you can’t get with other vehicles.
This is why BOLI policies are often referred to as “tax shelters” for banks.
Who Pays the Insurance Premiums?
The bank, as an institution, will pay the insurance premiums of the policy, which have an attractive cash redemption value attached to them.
Premiums can be paid in the form of a single premium lump sum, or annual premium payments can be set up. However, banks typically choose to move forward with a single premium deposit.
Nonetheless, a specialized funding vehicle is created for these payments, also referred to as the bank’s insurance trust.
With these plans, additional benefits can be offered to the key employees at an organization, while also reaping some of the benefits.
This is one of the main differences between bank owned life insurance plans and key man policies, which are strictly a life insurance policy and upper management.
There are a lot of advantages to investing in these types of policies for corporations, but there are a few downsides to consider as well.
For example, some banks try to diversify their investment portfolios by taking a vested interest in bank owned life insurance policies.
One of the most notable downsides to these policies is their inherent liquidity. You can sell these policies at any time, but you’ll face a penalty and additional taxes on the plan.
By investing in this type of policy, banks are also subject to any potential, associated investment losses, whether big or small. Therefore, banks should review their current risk profile and corporate objectives before investing.
Overall, the main issue with these policies is that the bank also takes on all of the risks associated with holding the insurance policy. There is a chance all of the premiums deposited into the account could be lost.
It’s also important to mention that these plans do not focus on providing insurance coverage to essential employees.
In fact, bank owned life insurance plans typically do not provide any insurance protection to the employee, but rather provide protection to the company as a whole, which is just an added benefit.
As a result of purchasing a bank owned life insurance plan, parties may be forced to comply with certain employment laws or other unique tax considerations.
Types of BOLI Plans
Three different types of bank owned life insurance are offered, and the size of a bank helps determine which type of plan would best suit their needs.
These plans are all similar when it comes to their nuts and bolts, but they all have a few distinct advantages and disadvantages:
This plan is one of the most common and straightforward types of bank owned life insurance. With this kind of account, once the bank makes an investment in a general account, the deposit then belongs to the insurance provider.
At this point, the insurance company can invest the deposit in whatever ways they see fit.
Unlike separate or hybrid accounts, general accounts are contingent upon any creditors’ rates associated with the insurance company in question.
General accounts are also less complicated in nature than separate or hybrid accounts, particularly since less parties are involved.
This type of account is very similar to a general account, but the insurance carrier separates the holdings into a general account and well-known fund managers maintain the investments.
With this kind of account, there is more associated risk for the investments, but there is also the potential for more reward at the same time.
As you can imagine by the name, the hybrid account is a mixture of the general and separate account types.
The hybrid account takes some of the best qualities of the general and separate accounts in order to create a new form.
This account gives you the transparency of a separate account, but boasts the stability of a general account. In other words, the hybrid account is really the best of both worlds.
It’s easy to see how people can be confused about bank owned life insurance and all of the different aspects of these plans.
Traditionally, these life insurance plans are bought for companies to protect themselves against any financial loss from the death of an important member of their organization.
However, bank owned life insurance policies are being viewed more and more often as financial keys to investment money while also sheltering against additional taxes.
The actual purpose of these types of policies is to provide a funding source for investments to offset the cost of providing benefit packages to employees within a specific organization.
Therefore, it’s crucial that banks work with reputable and highly rated life insurance companies so they know they’re making a quality investment call at the end of the day.