Updated: Dec 9, 2019
There are over 3,400 banks that own bank-owned life insurance (BOLI) policies with policy cash surrender values of over $177 billion. Many of the BOLI portfolios include what are referred to as “Legacy BOLI” policies. These are life insurance contracts owned by the bank where the insureds are no longer actively employed at the bank. These Legacy BOLI policies were issued 10 to 20+ years ago with the vast majority of the policies being issued as general account life insurance contracts. The investment risk for this type of policy is shifted to the life insurance company who delivers an interest (or crediting) rate. This interest rate is 100% controlled by the insurance company with the guaranteed minimum interest rate being the only thing protecting the bank. In addition to the risk associated with the declared interest rate, policy charges can be increased up to state approved maximum costs. These charges include policy administrative charges and cost of insurance (mortality) charges. This results in a difficult dynamic for the bank - interest rates are going down while policy charges are going up.
The Legacy BOLI Tax Trap
Banks are faced with two realities for Legacy BOLI: (1) the contracts have large embedded taxable gains plus an additional 10% MEC tax penalty, and (2) the insureds are no longer employed at the bank making a tax-free 1035 exchange to a new life insurance policy impossible. What can the bank do? Most banks think they are stuck and just need to accept the poor returns and be patient while waiting decades for the policies to mature upon the death of the insureds.
A New Risk for Banks - The "Disinterested 3rd Party" Risk
Many life insurance carriers who are backing the Legacy BOLI contracts are no longer in the bank or corporate markets and no longer offer BOLI contracts. Moreover, life insurance carriers are acutely aware of the lack of options banks have regarding their BOLI on terminated insureds. This creates a unique tension and reality for banks owning Legacy BOLI. This risk we refer to as the "Disinterested 3rd Party" risk. These risks are typically seen in one or more of the following ways:
Product crediting rates (interest rates) are not competitive – rates are at or close to guarantees. These rates are controlled by the insurance company and may not be in line with the carrier's own portfolio rate of return.
Increases or plans to increase the cost of insurance charges (some are at or approaching contractual maximum costs).
Increases or plans to increase the underlying interest rate carrier haircut and other non-guaranteed policy charges.
The insureds are aging which compounds the financial impact of increases in policy costs.
The above reality has created a perfect storm for banks in that they think they are “stuck” with accepting the Legacy BOLI net returns effectively giving them no options to improve the performance of these assets or escape these yields without substantial cost and penalties.
Are portions of your bank-owned life insurance (BOLI) assets delivering low, uncompetitive net returns?
Don't let the embedded taxable gain or the fact that these assets are on terminated employees prevent you from maximizing yields for your shareholders. We can help you evaluate your Legacy BOLI policies and provide solutions to help you improve yields and create liquidity without immediate tax cost and without penalties.
Principal, TRC Financial