What type of Bank is best suited to do BOLI?

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1 Bank Owned Life Insurance (BOLI) Bank Owned Life Insurance (BOLI) is defined as a cmpany wned insurance plicy n ne r mre f its key emplyees that will infrmally fund the financing f emplyee benefits prgrams. Dne prperly, BOLI m a y ffset the current and future csts f pre- and pst-retirement medical cverage, grup life, retirement and many ther benefits ffered t bank emplyees. Because f hw BOLI is accunted fr, it is an ideal asset that can be matched against future liabilities while pssibly prviding a higher current net after-tax yield n the bank s existing assets than what the bank may be able t invest in tday s envirnment. Why d financial institutins buy BOLI? Financial institutins face a wide range f ever-increasing benefit csts. These benefit plans range frm qualified plans such as pensins t grup health benefit plans and supplemental benefits designed t attract and retain key persnnel. BOLI prvides a tax-efficient tl t help ffset these benefit csts. Is BOLI widely used? Yes, in fact mre than 70% f the largest financial institutins (tp 50) in the natin wn BOLI as f 06/30/2015. And as a whle, 55% f all banks have mre than 3.5% f their Tier 1 assets in BOLI. (Surce:FDIC) Hw des BOLI wrk? The bank purchases life insurance n a select grup f management including fficers r ther key persnnel. The bank is the wner f the plicies, pays all premiums and is the beneficiary f the insurance prceeds. As part f the transactin, the bank may prvide a preretirement survivr incme benefit as a way t entice the emplyee t allw the bank t insure the executive. What type f Bank is best suited t d BOLI? While all banks may have a need fr BOLI, it is usually the bank that has ne f the fllwing r a cmbinatin f the fllwing: Cnsistently rising benefit csts Retentin prblems f key executives because f a lack f benefits Large Depsits and a Lw Lan percentage in relatin t thse depsits Unfunded pst retirement bligatins (i.e. benefits) A deferred cmpensatin prgram fr key emplyees Des the financial institutin need t cmmunicate with its emplyees abut BOLl? While mst states require disclsure, there is a new law, called the COLI Best Practices Bill that will require disclsure f the insurance, hw much it is, the fact that the cmpany will maintain the plicy after the emplyee has left the bank, and what the plicy is being used fr. It is has been the practice f Schiff Benefit Grup emplyees t fully disclse all insurance at the time f applicatin. Hw d ptential plan participants react t BOLI funding f emplyee benefit prgrams? While nt every emplyee wh is asked t participate in the insurance pl participates, because f the structure f the insurance, primarily as an infrmal funding tl fr a benefit plan that is either already in existence r a new ne that the insured is ging t receive as part f being insured, mst emplyees pt t allw the bank t insure them. 1

2 Are emplyees required t participate? Participatin in the insurance plan is ptinal. But if bank decides t tie a benefit t the insurance, they have that right if ffering a new discriminatry benefit. What are the underwriting requirements fr BOLI? the bank will be able t fllw the strict rules f the regulating rganizatin while prviding a meaningful benefit t thse invlved. What kinds f BOLI prducts are available? There are tw basic categries f BOLI prducts: Depending n the carrier and the amunt f the premium, in mst cases there is n evidence f insurability. The plicy wuld be issued n a guaranteed t issue basis after answering three r fur health questins. In smaller cmmunity banks full underwriting will be required and depending n the results f the underwriting, the bank will have the ptin nt t place any insurance n a rated emplyee. In this case, the premium wuld be spread acrss the remaining insurable participants. What happens when a participant retires? The bank retains the plicy n the retiree's life since the ecnmics f BOLI are mst effective when BOLI is held fr the lng-term. By tracking the Scial Security numbers f plan participants Schiff Benefits Grup will be able t assist the bank with the administratin f retiree plicies. When an insured dies, this tracking system prvides infrmatin necessary t gather apprpriate dcuments frm the bank in rder t file a death claim with the insurance cmpany. As an alternative, the bank may ffer a nminal deductible death benefit in the frm f nrmal incme t the insured s beneficiary. When the insured dies, the beneficiary wuld then receive a tax deductible incme and the bank wuld receive the tax free prceeds. Des the bank benefit frm the death f its emplyees? Mst BOLI plans are designed t be a zer sum prgram. BOLI is designed t ffset csts f benefits fr bth thse insured and the rank and file emplyees. By designing the plans prperly at the utset General Accunt: The plicies are backed by the general accunt f the insurance cmpany and the financial strength f the carrier is a primary cncern fr the bank when selected the carrier. Since the cash value is at risk with the specific carrier, the assets are cnsidered t be 100% risk base weighted. The advantages f these prducts are that they nrmally prvide minimum interest rate guarantees in the range frm 1.00% t 2.5%. The current interest rates are usually guaranteed fr the first year, credited mnthly and reset n a quarterly r annual basis after the first anniversary. These prducts might have a new mney rate r a prtfli rate, but ver time, the prducts perfrm n a relatively equal basis. New Mney Rate: Interest is credited t the plicy based upn what the carrier is able t get in the market at the time f issuance r anniversary Prtfli Rate: Interest is credited t the plicy based upn the verall prtfli f the insurance carrier which may be better r wrse than what the bank is able t d in the market. Mst plicies that are designed this way have a 5 t 7 year turnver rate n the underlying assets. Blended Rate: This is a hybrid f a New Mney 2

3 Rate plicy and a Prtfli plicy. In the early years, the crediting rate is based upn the rate that the carrier is currently getting and then steps int the prtfli rate ver time. Separate Accunt: The returns f these plicies reflect assets in a segregated accunt that are nt subject t the general creditrs f the insurance cmpany. Plan returns are subject t market fluctuatins. With a separate accunt prduct, the plicy wner bears the risk f default f assets in the separate accunt. Which insurance cmpanies underwrite the prducts? Mst f the majr insurance carriers have BOLI prducts. Like its industry peers, Schiff Benefits Grup has access t these majr insurance carriers. As part f the BOLI purchase we will help the bank analyze the differences between the credit qualities f the carriers versus the perfrmance f their prducts. Ultimately, it is the banks chice as t what type f blended perfrmance that the bank wuld like t implement. (Surce: A + + A.M. Best, Aaa Mdy's Investr Services, AAA Fitch, AAA Standard & Pr s) Is BOLI liquid? Mst BOLI prducts d nt have surrender charges built int their prduct. As such, the plicies can be surrendered at any time fr its cash surrender value. Hwever, if the bank surrenders any plicy, r all f them, ding s may cause adverse tax cnsequences t the bank. Therefre, in rder t receive the full ecnmic benefits f BOLI, it shuld be cnsidered a lng-term asset. What are the tax cnsequences f surrendering BOLI? Since mst BOLI plans are established as Mdified Endwment Cntracts under IRC Sectin 7702, any withdrawal r surrender f funds in excess f the riginal premium will have an additinal 10% penalty tax. This is true if there is a partial surrender f ne f the plicies r a cmplete surrender f all the plicies. In the case f a single plicy surrender, the IRS assumes that all f the gains frm the cmplete BOLI prgram are earned in the first plicy surrender and therefre are taxable ut f the prceeds. In that regard, partial surrenders shuld be strngly avided. BOLI is a lng-term asset. Hw can I manage credit risk? The bank shuld d a thrugh review f the credit wrthiness f any ptential carrier as part f its due diligence. In additin t the carriers, regulatrs have als stated that yu shuld chse yur vendr, the firm that will search fr the insurance prducts, first and then chse that carriers. A firm that has strng financial supprt and supprt services can help prvide updated credit infrmatin ver the life f yur BOLI cverage. What happens if the tax treatment f BOLI changes? BOLI's current tax benefits have been unsuccessfully challenged ver the years. There are strng bank regulatry guidelines fr prper use f BOLI. If the tax treatment is changed, existing plans may be grandfathered. Hwever, if existing plicies are nt grandfathered, they may be surrendered fr their cash surrender values. BOLI Accunting Treatment Hw is the incme earned and recrded? The Bank earns incme in a BOLI arrangement frm tw surces. The first is frm the grwth f the cash value f the plicy under FAS Technical Bulletin While the full cash value wrks fr the cmpany, the cmpany recrds as an asset the cash surrender value (the full cash value less any applicable surrender charges in the event the cntract is surrendered in the year being recrded). The cash value increases each year as the insurance carrier credits interest. 3

4 The secnd surce f incme cmes frm the insurance prceeds paid t the Bank when insured emplyees die. The accunting treatment fr a typical BOLI plan can be summarized as fllws: BOLI purchase is reflected as an OTHER ASSET in the call reprt. Earnings (increases t cash surrender value) will be recrded as an after tax credit t an incme accunt (OTHER INCOME). Receipt f the net-at-risk prtin f death prceeds are als reflected as an after tax credit t an incme accunt (OTHER INCOME). Hw is BOLl regulated? The regulatins gverning BOLI depend n the structure f the financial institutin: Natinal Banks: The OCC acts as the primary authrity fr BOLI usage fr natinal banks. It has updated its guidelines fr BOLI usage peridically in recent years. Its mst recent declaratin is OCC Bulletin This dcument utlines the ways in which banks. It has updated its guidelines fr BOLI usage peridically in recent years. Its mst recent declaratin is OCC Bulletin This dcument utlines the ways in which BOLI can be used, as well as the risks that must be addressed prir t plan inceptin and ver the life f the plan. State Banks: Part 362 f the FDIC's regulatins prvides the authrity fr state chartered banks' use f BOLI. These guidelines largely defer t the parameters utlined in OCC Bulletin , althugh exceptins may be permitted. In additin, state banks must make sure that any BOLI transactins fall within specific guidelines that may be issued by their state banking department. Thrifts: Nw that savings and lans are regulated by the FDIC, they largely fllw the parameters f OCC Bulletin In all cases, it has been SBG s experience that a bank shuld engage a Third Party administrative firm, which SBG can recmmend, t prvide the nging due diligence, administratin and BASEL cmpliance necessary t administer a BOLI prgram. Any vendr that ffers administratin fr free, may put yur firm at risk (accrding t the OCC) as they may nt prvide true transparency n the prducts that they have sld. Beynd banking regulatins, are there limits n hw much BOLI a bank can purchase? Regardless f an institutin's charter, any BOLI prgram must cmply with state insurable interest laws. Schiff Benefits Grup can advise yu in determining apprpriate amunts f cverage based n state law and the cmpsitin f a ptential' insured grup The COLI Best Practices Bill limits the percentage f insureds in any cmpany, including banks. These rules have been adpted by all carriers and was made law with the help f insurance rganizatins like Natinal Assciatin f Insurance and Financial Advisrs (NAIFA) and Assciatin f Advanced Life Underwriters (AALU). What ther limitatins exist t the purchase f BOLl? The OCC has been the lead regulatr in this area. There are tw basic tests: ne based n benefits and ne based n capital. The OCC has indicated that the gains frm BOLI cannt exceed the csts they are intended t ffset. Schiff Benefits Grup can help yu in determining cnservative parameters fr the purchase f BOLI. In additin, the OCC says that as a general rule, a bank shuld nt invest mre than 15% f its Tier I capital with any ne 4

5 cmpany and n mre than 25% f its Tier I capital plus 25% f the allwance fr lan and lease lsses in BOLI as a whle. The OCC in the past viewed these as guidelines, as due t BASEL regulatins, has taken a stricter stance due t the financial crisis in the What risks d banking regulatrs say need t be evaluated when buying BOLI? The OCC requires that a bank evaluate six specific risks in its pre-purchase analysis: transactin risk credit risk interest rate risk liquidity risk cmpliance risk, and price risk. While the bank is ultimately respnsible fr its due diligence prcess, we can assist yu in evaluating and dcumenting the analysis f each f these risks at the time f purchase and recmmend that a bank engage ne f third party vendrs fr nging administratin. Are there additinal risks that need t be evaluated? Sme areas that culd ptentially increase the tax risk f BOLI and invite IRS scrutiny include: Investr Cntrl: This issue is primarily related t separate accunt plans. A bank may nt exercise undue cntrl f the prduct's underlying investments. Schiff Benefits Grup can assist in designing a BOLI purchase that cmplies with this guideline, and negtiate dcumentatin frm the insurance cmpany that the investment cntrl is in cmpliance with the Cde in this area. Transfer f Risk: In sme plans with large grups f participants, a technique knwn as experience rating is used t relate mrtality csts t a specific case, rather than a brad grup. Depending n the particular structure, the IRS culd argue that the BOLI plicies are nt life insurance since n risk has actually been transferred t the insurance cmpany. The cnsultants at Schiff Benefits Grup lk frward t helping ur clients design, implement and prvide the administrative supprt fr yur bank s BOLI plan. If yu have any questins abut ur prgrams, and hw they might help yu attract, retain, and reward yur key emplyees while enhancing the bank s bttm line, please feel free t cntact us via phne r belw. Brrwing: A bank cannt directly brrw t fund BOLI r it will lse the interest deductins n the funds that were brrwed t d s. A bank shuld make clear in its dcumentatin that the surce f BOLI funding is nt direct brrwings. Business Objective: A bank must have a valid business purpse fr its purchase f BOLI. Schiff Benefits Grup can assist yu in dcumenting the purpse f yur purchase, which is typically t ffset a variety f benefit expenses. Schiff Benefits Grup, LLC 2 Bala Plaza, Suite 901 Bala Cynwyd, PA (610) inf@schiffbenefits.cm 5