Pub. 7 2018 Issue 8

l e a d i n g a d v o c a t e f o r t h e b a n k i n g i n d u s t r y i n k a n s a s 16 KBA LEADERS LEDGER: MANAGING BOLI By: Kathy Taylor, KBA EVP General Counsel B ank Owned Life Insurance (BOLI) is a life insurance policy purchased by a bank or bank holding company to insure the life of certain employees - most commonly to recover losses associated with the death of key employees or to recover the cost of providing pre and post retirement employee benefits. BOLI is reported as an asset of the bank and its earnings as noninterest income. BOLI is a useful tool and can be a good investment for the bank. Because the cash flows from a BOLI policy are generally income tax-free, if the institution holds the policy for its full term, BOLI can provide attractive tax-equivalent yields to help offset the rapidly rising cost of providing employee benefits. Bank regulators recognize the usefulness of this investment but remind banks that the purchase and risk management of BOLI must be consistent with safe and sound banking practices. The federal banking regulators (Office of the Comptroller of Currency (OCC), Board of the Federal Reserve System (the Fed) and Federal Deposit Insurance Corporation (FDIC)) issued an Interagency Statement on the Purchase and Risk Management of Life Insurance in December 2004. The Statement describes bank regulators’ expectations for a thorough pre-purchase analysis and a risk control framework to address BOLI exposures on an ongoing basis. Each institution is to establish internal policies and procedures governing its BOLI holdings, including guidelines that limit the amount of all BOLI policies from one insurance company, as well as the aggregate of BOLI policies from all insurance companies. Generally, the statement provides that it is not prudent for an institution to hold BOLI if the aggregate cash surrender value exceeds 25% of the institution’s capital, as measured in accordance with the relevant (OCC, the Fed or FDIC) agency’s concentration guidelines. The statement further provides that any institution that plans to acquire BOLI in an amount that results in the aggregate cash surrender value being in excess of 25% of capital, or any lower internal limit, to obtain prior approval from its board of directors or the appropriate board committee. This general rule applies to the initial purchase, but also applies to natural increases in the investment. The statement provides that an institution holding BOLI in an amount that approaches or exceeds the 25% of capital threshold should expect examiners to more closely scrutinize the policies and controls associated with BOLI assets and will require corrective action where deficient. For state-chartered banks, the statement is incorporated in whole, by reference, in state statute under K.S.A. 9-1101(20). In addition to the limitation to the cash surrender value of BOLI in the aggregate, the state statute also provides that the cash surrender value of any BOLI underwritten by any one life insurance company shall not exceed 15% of the bank’s capital which is defined as “capital stock, surplus, undivided profits, 100% of the allowance for loan and lease losses, capital notes and debentures and reserve for contingencies”. Policies purchased prior to July 1 1993, are exempted from these limitations and are considered “grandfathered”. Abiding by these limitations is fairly straight forward when purchasing such an investment, however, bank regulators also require institutions to conduct periodic post-purchase risk assessments. A comprehensive assessment of BOLI risks on an ongoing basis is an important element of the risk management process especially for an institution whose aggregate BOLI holdings represent a capital concentration. Management should review the performance of the institution’s insurance assets with its board of directors at least annually. If the institution’s BOLI investment is approaching these limitations, management needs to acknowledge this, complete an analysis to support a finding that the increase is within the institution’s risk tolerance and does not constitute an imprudent capital concentration, make the board of directors aware and in doing so, demonstrate to regulators, the ongoing management of this investment. Some content in this article is provided by Derek Isaacs, Managing Partner and Mike Norris, Senior Consultant, Banc Consulting Partners.