What Is a Bank-Owned Life Insurance Policy?

Updated: May 22, 2024

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Bank-owned life insurance (BOLI) is a special type of life insurance where a bank is both the policy owner and beneficiary. Banks purchase these policies on the lives of certain key employees, essentially investing in their employees' lives. The bank pays the premiums and, in return, receives the policy's death benefit when the insured employee passes away. This arrangement offers banks a tax-efficient investment strategy, as the policy's cash value grows tax-free and the death benefits are typically exempt from income tax. BOLI policies thus serve as a financial tool for banks, balancing investment growth with risk management.

Types of Bank-Owned Life Insurance Policies

Bank-owned life Insurance (BOLI) policies come in different forms, each with its own features and benefits. Understanding these types can help banks select the BOLI policy that best aligns with their strategic objectives. Here are the three main types of BOLI policies:

  • General Account: This is the most common and oldest type of BOLI policy. The insurance company's general account holds the policy's assets and liabilities. The insurer's general account assets often back the policy performance.
  • Separate Account: In this type of BOLI policy, a separate account from the insurer's general assets holds the policy's assets. This distinction provides greater protection for the bank against the insurer's insolvency, but it may also involve more investment risk. Insolvency occurs when the insurance company is unable to meet its financial obligations.
  • Hybrid Account: This type of BOLI policy combines features of both general and separate account BOLI. It offers a level of protection against the insurer's insolvency, similar to a separate account BOLI, while also providing a minimum guaranteed return like a general account BOLI.

Banks may choose their BOLI policy type depending on the level of risk they want to take on and the protection they need from insurer insolvency.

Why Do Banks Purchase Bank-Owned Life Insurance

Banks often opt for bank-owned life insurance (BOLI) policies for various strategic reasons. These policies offer financial advantages that can contribute to a bank's overall financial health. Here are some common reasons why banks invest in BOLI policies:

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    Tax-Efficient Investment

    The cash value growth within a BOLI policy is tax-deferred, and the death benefits are generally income tax-free. This provides banks with a tax-efficient investment strategy.

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    Offsetting Employee Benefit Costs

    Banks often provide a range of benefits to their employees, such as health insurance, retirement plans and other perks. These benefits can represent a significant expense for the bank. BOLI policies can help manage these costs. When the bank receives death benefits from a BOLI policy, they get funds that they can use to offset the costs associated with providing different employee benefits.

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    Stable Return on Investment

    BOLI policies typically offer a steady return on investment, which can be higher than returns from other types of investments.

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    Risk Management

    BOLI policies can serve as a risk management tool, providing a death benefit to the bank upon the passing of a key employee.

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    Financial Performance Improvement

    The tax advantages and stable returns from BOLI policies can contribute to the overall improvement of a bank's financial performance.

What Is the Tax Treatment of Bank-Owned Life Insurance?

The tax treatment of BOLI policies is one of the key reasons they are attractive to banks. Here's how it works:

  • Cash Value Growth: The increase in the cash value of a BOLI policy is tax-deferred. This deferral means the bank does not have to pay taxes on the policy's earnings as they accumulate over time.
  • Death Benefits: The death benefits received from a BOLI policy are generally income tax-free. This provides a significant tax advantage to the bank, as it can receive a substantial amount of money without the burden of income tax.
  • Premium Payments: The premiums the bank pays for a BOLI policy are not tax-deductible. However, the tax benefits gained from the tax-deferred growth and tax-free death benefits often outweigh the lack of a tax deduction for premium payments.
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Tax laws can change, and the specifics can vary based on the bank's situation and the structure of the BOLI policy. Banks may want to consult a tax advisor or legal professional when considering BOLI policies.

Risks Associated With Bank-Owned Life Insurance Policies

Although bank-owned life insurance policies can be beneficial, banks must also navigate potential risks associated with these investments. Understanding these challenges is essential for effective risk management. Here are some potential challenges:

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    Departure of Key Employees

    A key employee leaving the bank can impact the BOLI policy. While the policy may stay in place even if the employee leaves, the bank may lose out on the potential death benefit. This could result in a financial loss, especially if the bank has already paid significant premiums on the policy. Employee retention is an important consideration when banks invest in BOLI policies.

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    Long-term Commitment

    BOLI policies are long-term investments, and banks may face penalties for early withdrawal, limiting their liquidity. For instance, if a bank surrenders the policy before its maturity, it may be subject to taxes on any gains from the policy. There could also be a penalty on these gains, further increasing the cost of early withdrawal.

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    Regulatory Risks

    Banks must comply with regulatory requirements when purchasing and maintaining BOLI policies, and failure to do so can result in penalties. For instance, banks that fail to comply with regulations could jeopardize the tax benefits associated with the insurance.

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    Insurer Solvency

    The bank's return on investment depends on the insurance company's financial health. Financial distress or insolvency of the insurer can adversely affect the policy's returns, emphasizing the need for banks to assess the insurer's financial health before committing to a BOLI policy.

Considerations for Employees Covered by Bank-Owned Life Insurance

Banks purchase BOLI policies for certain key employees. Understanding certain aspects of a BOLI policy can help these employees navigate their employment benefits and personal insurance needs more effectively.

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    No Direct Benefit to Employee or Family

    As the bank is the beneficiary of the BOLI policy, neither you nor your family will receive any death benefits from the policy. A BOLI policy does not replace the need for personal life insurance. It serves a different purpose and benefits the bank, not the employee or their family.

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    Privacy Concerns

    Obtaining a BOLI policy involves gathering insurability information, which might raise privacy concerns among employees. However, it's important to note that consent is a fundamental requirement. For a bank to take out BOLI insurance for individuals, it must have the employees' consent. If an employee does not agree to the policy, the bank cannot proceed with taking out coverage. This consent ensures transparency and respect for the employee's privacy and choice.

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    Selective Coverage

    A BOLI policy will not cover every bank employee. Banks typically purchase these policies only for certain key employees whose loss could significantly impact the bank's operations. While a BOLI policy may cover some employees, many others will not receive coverage.

These considerations are vital for employees to understand their position within the framework of BOLI policies, highlighting the need for personal insurance planning alongside awareness of the bank’s BOLI strategies.

Benefits for Employees Covered by Bank-Owned Life Insurance

BOLI policies offer indirect benefits to the bank employees who are covered. While the bank is the policy owner and beneficiary, the financial stability it gains from these policies can positively impact the work environment and employee benefits.

  • Employee Benefits Funding: One of the significant advantages is the role of BOLI returns in funding employee benefits. The financial gains from these policies can enable banks to offer their employees more robust or stable benefits packages.
  • Financial Stability of Employer: BOLI policies contribute to the bank’s financial stability. This stability can indirectly lead to job security, as a financially secure bank is better positioned to withstand economic fluctuations and maintain its workforce.
  • No Direct Cost to Employee: As an employee, you are not responsible for the premiums of the BOLI policy. The bank handles all costs.

Depending on how their employer utilizes the returns, bank employees may benefit significantly from BOLI policies.

FAQ: Bank-Owned Life Insurance

We listed some commonly asked questions about BOLI to help you better understand how bank-owned life insurance policies work.

What is bank-owned life insurance?
Who are the beneficiaries of bank-owned life insurance policies?
Can an individual get a bank-owned life insurance policy?
Should I participate in bank-owned life insurance?
Is bank-owned life insurance a good investment?
Do banks invest in life insurance?
How can I invest in BOLI?
Who provides bank-owned life insurance policies?

About Melissa Wylie

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Melissa Wylie is the Content and SEO Manager at MoneyGeek, with nearly a decade of editorial experience and six years of work in financial content focused on small businesses. She previously held SEO positions at Bankrate and LendingTree, with bylines on ValuePenguin and MagnifyMoney.

Wylie has a journalism degree from the University of North Texas. Her strong foundation in journalism helps her craft content that simplifies complex financial topics to help everyone feel confident when making decisions with their money.