Why are companies doing these types of plans and why in the world are banks buying life insurance with some of their tier one assets? Let’s delve into the details.
Banks investing in life insurance is a fascinating model. Most notably, our largest client is a bank for which we established their BOLI, or Bank-Owned Life Insurance products. My background provided me with the knowledge required to navigate those meetings effectively, even though I still leveraged the assistance of others and had established a connection with the owner.
When it comes to BOLI, it operates as a single premium modified endowment contract (MEC). Banks make a large, one-time deposit into a single premium universal life policy. This functions quite distinctively from traditional universal life (UL) or indexed universal life (IUL) policies you might be familiar with. They purchase BOLI primarily as a tier one asset, making a one-time lump sum investment where the cash value is positive from day one and appreciates over time. Additionally, the death benefit offers long-term benefits.
For instance, if you own a bank and have employees, including myself and 30 others, you might take out policies on them. You're already providing benefits like health coverage and 401(k) matches. The death benefit from these policies can help recover those costs. Furthermore, some smaller, family-style banks choose to implement BOLI with a split-dollar arrangement. This approach ensures that employees or their beneficiaries receive a portion of the death benefit, for example, one to one and a half times their salary, so it doesn’t feel like the bank is merely profiting from their death.
However, with BOLI, the cash value does not provide a disbursement benefit to executives. Instead, banks use cash reserves, or borrow funds directly from the Federal Reserve at minimal interest rates, and invest them in BOLI products. The yield from these products typically exceeds the borrowing costs, allowing banks to sit, grow their investments, and the death benefit ultimately accounts for inflation over the long term.