By David Hauptman
Historically low interest rates and unusually large amounts of cash on bank balance sheets has resulted in significant reductions in bank net income, return on assets (ROA) and return on equity (ROE) over the past year.
The effort to recover some of these reductions has led to a renewed interest in bank-owned life insurance (BOLI) and credit union-owned life insurance (CUOLI).
BOLI and CUOLI offer multiple benefits:
- A 3% return. Bank Owned Life Insurance net returns currently average 2.8% to 3.2%, compared with cash equivalents returning less than 0.5%. This results in the opportunity for banks to realize incremental increases in net income of about 2.5%.
- Diversification. BOLI helps diversify balance sheet investments in bank-eligible investments that currently outperform most other investments. Unlike bonds, BOLI returns increase when rates rise.
- Key person life insurance. Banks receive a tax-free death benefit when a key-person dies, whether an active employee or not.
- An executive benefit plan. Insured executives receive a pre-retirement death benefit typically equal to a multiple of annual salary. This death benefit does not require additional cost to the bank.
When it comes to investing their money, banks have numerous options, but loans remain a primary earning asset. However, both commercial and consumer loans are underperforming during the COVID-19 pandemic.
The pandemic led to record low interest rates but also an increasing number of loan defaults. In addition, the Current Expected Credit Losses (CECL) accounting standard requires banks to set aside additional loss provisions for each loan, increasing reserves and reducing investable assets. Conversely, CECL has no adverse impact on BOLI or CUOLI.
Four considerations to building an effective BOLI program
There’s a lot to think about when building a BOLI program, and each bank or credit union will want to personalize their program to fit the individual needs of their organization.
Here’s four things to consider:
- Which key employees will you insure? Regulations allow banks and credit unions to insure up to 35% of their highest-paid employees; insurance companies will waive medical underwriting requirements as long as banks insure a sufficient number of executives to spread the death benefit risk. Ultimately, the bank will need to consider the amount of BOLI investment, the employees it wishes to insure for key-person coverage and the executives it wishes to include in the executive benefit program.
- Which benefits will be funded? BOLI helps banks and credit unions fund their employee benefit programs, including healthcare and retirement benefit costs.
- Build a compelling executive benefits plan. Many programs allow banks to offer executive benefits that will help attract and retain top talent. These programs include death benefit plans and executive retirement plans.
- Perform regular BOLI diagnostics. It is important to conduct regular independent diagnostic reviews of BOLI programs. A thorough review will include a complete audit of executive benefit plans, as well as a review of current executives insured, limits and policy costs. In addition, banks should perform a complete market analysis to determine if it’s an optimal time to increase BOLI, or if a different carrier or product can reduce existing program costs.
For more information on building or assessing your financial institution’s BOLI or CUOLI program, contact your HUB advisor today.