Managing the BOLI Risk

Bank-owned life insurance (BOLI) is a popular investment asset that can be used as an added benefit for key executives. For example, a portion of the death benefit may be allocated to the executive. The returns can be used to offset employee expenses such as health care or 401(k) plans. The percentage of U.S. banks holding BOLI continues to grow year after year. The percentage increased from 53.4 percent in 2012 to 56.4 percent in 2013, says David Shoemaker, a principal at BOLI provider Equias Alliance. He talked to Bank Director magazine recently about market trends and what boards should know about risk management of BOLI plans.

Why are banks buying BOLI today?
BOLI continues to offer a higher after-tax yield than most other investments of similar risk and duration. The extra income boosts capital and can aid growth or provide higher shareholder dividends. In a standard general account or hybrid separate account BOLI product, there are no mark-to-market adjustments on the bank’s books. BOLI interest rates are variable and will generally follow changes in market rates (but on a lagging basis), making them more advantageous than fixed-income products in a rising interest rate environment.

What are the risks that a bank should pay attention to?
As part of its annual risk assessment review, the bank should review the current and long-term performance of BOLI as well as the financial condition of the carriers. BOLI regulations going back to 2004 state that banks should perform their own analysis and not just rely on ratings. The Dodd-Frank Act highlighted the importance of this as well.

What impact will Basel III have on BOLI?
Basel III will not have any impact on general account BOLI policies, which are backed by the credit of the insurance company and carry a minimum interest guarantee and a risk weighting of 100 percent. However, hybrid separate account policies, which are also backed by the insurance company, offer additional benefits such as multiple investment accounts that are legally protected from creditors of the carrier. Typically, these policies are assigned risk-weights as low as 20 percent or as high as 100 percent. Under Basel III, our understanding is the bank has the option to evaluate each security in the portfolio individually, which would be a time consuming and expensive task, or may save time and money and simply risk weight the BOLI asset at 100 percent.

What are the responsibilities of the board when it comes to risk management of the bank’s BOLI program?
It is the responsibility of management and the board to make sure there is proper oversight of the BOLI program. The bank should have a BOLI policy that details the bank’s purchase limits for one carrier and for all carriers in aggregate. The policy should outline the processes for performing the pre-purchase due diligence as well as the ongoing risk assessment reviews. The board should have a reasonable understanding of how BOLI works and the risk factors associated with it, including credit and liquidity risk. If the bank owns a variable separate account product, additional due diligence should be performed since it is a more complex product.

Regulators are worried about the risk posed to banks by third-party vendors. How does this impact banks with BOLI?
One of the key messages in the regulatory guidance is that banks should adopt risk management processes commensurate with the level of risk and complexity of the third-party relationship. With regard to BOLI and non-qualified benefit plan design and administration, I believe banks will move increasingly to providers that offer a high level of technical support, including CPAs, attorneys and analysts, and that have significant internal support systems to aid in designing and servicing non-qualified benefit plans as well as BOLI. Companies will want to deal with providers that have internal controls independently tested and certified with a report known as Service Organization Control (SOC) 1 Type 2, through the American Institute of Certified Public Accountants’ SSAE 16 standards.

David Shoemaker is a registered representative of, and securities are offered through, ProEquities Inc., a Registered Broker/Dealer, and member of FINRA and SIPC. Equias Alliance is independent of ProEquities Inc.