Draft Bank Owned Life Insurance David Payne/Arnie Winick BFS Group presented: MAY 13, 2016
How Does BOLI Work? A single premium purchase of a life insurance policy on the lives of highly compensated employees* (top 35% highest paid). Bank is the owner and beneficiary of the life insurance policies. The policy s initial cash value is 100% of the initial premium. Principal does not fluctuate (not a mark-to-market asset). Inside build-up of the policy s cash value is non taxable income to the bank. Death benefit proceeds are received tax-free. Institutionally priced products that result in higher yields. Total policy value is available upon request, with no surrender charge. Growth in cash value is recorded as Other Non-Interest Income on the Bank s financial statements. Regulatory guidance permits BOLI to be purchased to offset employee benefit costs. PAGE 2
How Much BOLI Can a Bank Buy? In accordance with OCC 2004-56 and SR 04-19, the bank should not exceed 25% of their Tier 1 Capital plus ALL. (FDIC is Tier 1 Capital only) When considering a BOLI transaction the regulators require a Bank to insure that the transaction complies with its legal lending limit and concentration of credit limit. 3
BOLI Product Types GENERAL ACCOUNT SEPARATE ACCOUNT HYBRID ACCOUNT Underlying policy values are owned and invested by the life insurance company and are part of the carrier s general assets. Product pricing and description follow the general rules governing life insurance. Historically, the vast majority of BOLI held by community banks is general account Underlying policy assets are held for the benefit of the policy owner in a bankruptcy remote trust. Managed by professional managers retained by the insurance company (Creates a regulated security and is required to comply with securities laws). Not book value guaranteed. Underlying policy assets are held for the benefit of the policy owner in a bankruptcy remote trust. Managed by professional managers hired and guided by the insurance company. (Not a regulated security). The carrier has more flexibility with investment options. PAGE 4
Options for Investing $10,000,000 Considerations Loan Bond Muni BOLI Current Average Yield 3.95% 1.60% 1.73% 3.50% Income Earned $395,000 $160,000 $173,000 $350,000 Income Taxes Due (at 37.96%) ($149,942) ($60,736) N\A N\A Loan Loss Provision XP (at 1.25% Pre-Tax) * ($38,775) N\A N\A N\A Lost TEFRA Interest Expense Deduction N\A N\A (36,442) N\A Net Income Earned $206,283 $99,264 $136,558 $350,000 Held to Maturity "Bonus" No No No Yes (averages another 30% to 40% of the accumulated CSV) Duration Typically short Typically five years or less Typically five to ten years Long, but with quarterly rate resets Credit Risk Varies Typically low Moderate but very concentrated Very low Call\Redemption Risk Yes (early payoff or loss of customer) Yes Yes No Collateral Real estate, inventory, equipment, etc. Promise to pay from a single government or corporate entity Promise to pay from a single municipality Cash Value Mark-to-Market Risk No Yes Yes No Personnel Costs Yes Yes Yes No Basel III Capital Effect Yes No No No 5
% Rate Historical Rates (Average Rates) 11.00 10.00 9.00 8.00 7.00 6.00 5.00 4.00 3.00 2.00 1.00 0.00 Year BOLI Historical Rates* BOLI Tax-Equivalent Moodys 30yr AAA Corporate Bond Index ** 5 Year Treasury 10 Year Treasury Tax Rate: 40% BOLI historical rates are an average of first year net crediting rates from a sample of general account products. Treasury rates are based on the average of the past year s rates. These returns do not reflect the payment of any death benefits. Past returns are not indicative of future results. **The minimum maturity for the bonds in this index is 20 years, with an average of 30 years. The bonds have maturities as close as possible to 30 years; they are dropped from the list if their remaining life falls below 20 years, if they are susceptible to redemption, or if their ratings change. Source: Based on the following highly rated carriers- Great-West Life, Guardian Life, MassMutual, Midland National, Ohio National, New York Life, Northwestern Mutual, & Savings Bank Life Insurance PAGE 6
Regulators Guidance to Banks At the conclusion of 2014, there were over 500 institutions nationwide reporting Cash Surrender Value (CSV) greater than 25% of the sum of Tier 1 Capital and ALL. This measure is used by the Federal Reserve to gauge concentrations. Over 40 of those institutions reported CSV greater than 50% of Tier 1 & ALL. This is a great example of how comfortable the regulators are with bank s investing in BOLI. Regulatory guidance states a bank should not purchase greater then 25% of Capital in BOLI, all banks originally follow this guidance. However, during the recession when many bank s capital deteriorated because of credit quality their BOLI CSV continued to grow tax-free, resulting in the allowed percentage to increase above the guidance. Currently there are seven banks with over 100% of Capital in BOLI because of prior losses, yet the regulators, knowing the high quality of BOLI and the ability to grow tax free, rarely request the institutions to redeem in order to be under the 25% guidance. Regulators know that BOLI is immediately liquid and therefore remain comfortable with the asset even above the guidance. PAGE 7
BOLI Market Place Today Unprecedented low rates and an ultra-competitive lending environment have led bankers to seek quality assets with reasonable yields. Particularly assets that don t add undue Interest Rate Risk or other comprehensive income mark-tomarket to their balance sheet: In comparison to alternative earning assets, BOLI is the only asset a bank can purchase to accomplish these goals No loans of this credit quality can compete with BOLI yields Thus why the majority of the top US Banks are fully invested in BOLI capacity When purchasing General Account BOLI: The bank is a direct creditor to the insurance company assets It is likely that the highest rated companies such as MassMutual, Northwestern Mutual, New York Life, etc. would compare favorable to the best credits in the bank s portfolio Misperception of the duration of BOLI: Mirrors the insurance companies fixed income portfolio Typically a 5yr-6yr duration While initially performs as a fixed rate instrument, the yield to the bank slowly adjusts as interest rates move PAGE 8
BOLI Outlook Economic analysis does not show a pending turn to higher interest rates in the near future, opportunity for products that continue to outpace other alternatives Continued increase in acceptance of BOLI as a high quality credit risk that can offset rapidly increasing healthcare and associated employee benefit costs and provide stable increases to non-interest income Increased use of BOLI to fund recruiting and retention packages as well as provide pure asset yield General Account Products with more frequent resets will be the product of choice in a rising interest rate environment Separate Account Products will continue to be out of favor because of mark to market risk and lack of wrap providers Hybrid Separate Account Products are an alternative for banks looking for bankruptcy protection PAGE 9
2014 New BOLI Premium Allocation Breakdown 2014 BOLI Premium Sales Approximately $3.2 Billion 2014 BOLI Sales Product Segmentation Separate Account/PPVUL, 1% General Account, 77% Hybrid, 22% * Based on 2014 Market Data PAGE 10
2015 New BOLI Premium Allocation Breakdown 2015 BOLI Premium Sales Approximately $4.04 Billion 2015 BOLI Sales Product Segmentation Separate Account/PPVUL, 13% General Account, 75% Hybrid, 12% * Source: SNL/FDIC call report as of 12/31/15 and 2015 Market Data
NJ Bank BOLI Holdings ALL THREE TYPES 8% 9 SEPARATE ACCOUNT BOLI 18% 20 HYBRID ACCOUNT BOLI 43% 49 GENERAL ACCOUNT BOLI 69% 79 NO BOLI HOLDINGS 25% 29 TOTAL BANKS 114 0 20 40 60 80 100 120 12
2015 New Jersey BOLI Placement 2015 New Jersey New BOLI Purchases/$175 Million BFS All Others All Others 30% BFS 70% 13131313
BOLI Myths The bank is profiting from the death of its employees Illiquidity is overstated, surrender is typically accomplished within 2-3 weeks Large surrender fees associated with BOLI BOLI can t keep pace with loan yields BOLI is subject to mark to-market accounting Duration Issues PAGE 14
Summary Conservative investment Yields competitive/superior tax deferred returns Direct improvement to a bank s bottom line Simple to implement, no cost to bank Helps banks offset rising employee benefit costs The investment choice of over 54% of the banks in the US PAGE 15