BankOwned Life Insurance

1
Bank-Owned Life Insurance

• Note to management These slides are intended for
  use when presenting BOLI issues to your board.
  Text in bold and in brackets indicate
  placeholders for bank-specific information

2
Role of Board

• The board is responsible for establishing
  policies related to the banks investments and
  compensation.
• The banking agencies expect bank boards to be
  responsible for ensuring that the purchase and
  holding of BOLI are consistent with safe and
  sound banking practices.
• The elements of a successful BOLI program
  include
• Adoption of policies and procedures
• A thorough pre-purchase due diligence process
• Ongoing post-purchase monitoring
• Managing risks associated with BOLI

3
Background on BOLI

• BOLI is life insurance owned by the bank that
  insures against the lives of bank personnel, such
  as employees and directors.
• BOLI is a long term asset, the proceeds of which
  can be used
• To offset the costs of providing employee
  benefits
• To help the bank manage certain risks of loss
• To provide additional compensation
• Cash flows from BOLI policies are income-tax free
  if held to full term, and thus can provide
  attractive tax-equivalent yields.

4
Banks Use of BOLI

• Add slides here to describe the banks intended
  or existing use of BOLI, such as key person
  insurance, defraying benefit expenses, and
  additional compensation.

5
Regulation of BOLI

• The banks regulator has issued guidance titled
  the Interagency Statement on the Purchase and
  Risk Management of Life Insurance covering the
  acquisition of BOLI.
• The Statement focuses on management and board
  oversight over all aspects of purchasing and
  holding BOLI.
• Any of the following could subject the bank to
  regulatory criticism
• The amount of BOLI held exceeds concentration
  limits
• The purchase decision is not based on a thorough
  analysis of the risks and rewards of holding BOLI
• The banks ongoing post-purchase management of
  BOLI is inadequate
• BOLI is also subject to state insurance law,
  accounting rules, and tax laws.

6
Policies and Procedures

• The board has been provided with the Bank-Owned
  Life Insurance Policy Statement for approval.
• The statement covers
• Management and board responsibilities
• Risk management process
• Establishment of BOLI limits
• Pre-purchase analysis
• Ongoing risk management process
• Vendor and carrier selection
• Identification and management of BOLI risks

7
Amount of BOLI to be Held

• A bank may not hold life insurance in excess of
  its risks of loss or costs to be recovered.
• The amount of BOLI held may not exceed 25 of the
  banks capital or, the bank has obtained
  regulatory approval to hold BOLI in the amount of
  __ of its capital.
• The banks policy is to limit the aggregate cash
  surrender value of policies from one insurance
  carrier to dollar value or of capital and the
  aggregate cash surrender value of policies from
  all carriers to dollar value or of capital.
• The bank intends to purchase or currently holds
  BOLI with an aggregate cash surrender value of
  ________, which is ___ percent of the banks
  capital.

8
Pre-Purchase Analysis

• The banks pre-purchase analysis consists of the
  following elements use for purchase decisions
• Identifying the banks need for BOLI
• Determining the amount of insurance needed
• Assessing vendor qualifications
• Analyzing the available products
• Selecting a carrier
• Assessing the reasonableness of additional
  compensation provided
• Analyzing the risks and the banks ability to
  monitor and manage them
• Evaluating alternatives to meeting the banks
  objectives
• Documenting the process

9
Pre-Purchase Analysis

• Identifying the Need for BOLI
• State the banks costs to be offset or the risks
  to be insured against. For example
• Key persons
• The following are identified as key persons,
  whose services are essential to the continued
  success of the bank
• Name and position of person
• Name and position of person
• Include slides showing worksheets estimating the
  insurable value of these persons to the bank
• Benefit plan costs
• The bank provides nonqualified plans and
  qualified plans, including 401(k) obligations,
  medical benefits, profit-sharing, and life
  insurance benefits.
• Include worksheets projecting the banks benefit
  expenses

10
Pre-Purchase Analysis

• Additional Compensation
• Prepare a slide to discuss the type and amount
  of additional compensation provided by the bank
  that will be, or is, offset through BOLI.
  Include managements analysis confirming that
  such compensation is not excessive

11
Pre-Purchase Analysis

• Determining the Amount of Insurance Needed
• Prepare a slide describing managements
  calculation of the amount of BOLI to be purchased
  to meet its identified needs and objectives.

12
Pre-Purchase Analysis

• Determining the Amount of Insurance Needed
• Use if benefit obligations are to be tied to
  BOLI yields
• The calculations shown in the previous slide are
  projections only. The interest yields on BOLI
  policies will be periodically re-set by the
  carrier describe the interest-crediting
  policies, or in the case of separate policies,
  state that the yields of the underlying assets
  will fluctuate with the market. Therefore, it
  is impossible to determine with certainty the
  amount that will be available to the bank to meet
  its obligations.
• Discuss the banks policy recommended to be
  adopted regarding the link between BOLI and the
  banks benefit obligations, ensuring that the
  policies closely reflect what the bank
  realistically expects from its BOLI program.
  Fully apprise the board of how changes in
  projections may affect the banks position, and
  what steps the bank may have to take in response
  to such changes.

13
Pre-Purchase Analysis

• Assess Vendor Qualifications
• Management has selected ___________ as its
  broker/advisor/consultant on acquiring BOLI.
  Management has determined that vendor has the
  adequate reputation, experience, and financial
  soundness to honor its long-term commitment to
  the bank on BOLI.
• In making this decision, management
• examined the following vendor materials
• conducted the following due diligence on vendor

14
Pre-Purchase Analysis

• Analysis of Available Products
• Prepare a slide discussing the products that
  management is considering, the relevant
  characteristics, and how the products could meet
  the banks objectives. Demonstrate how the
  selected products are most appropriate for the
  bank.
• Exchanges the ability of the bank to exchange
  carriers in the event of the deterioration of the
  existing carriers financial condition is limited
  by state insurable interest laws. Generally, a
  bank may only insure against the lives of
  existing, rather than former, staff. While the
  departure of an insured person from the bank will
  not affect the validity of the relevant policy,
  it does prevent the bank from exchanging
  carriers. Also describe policy restrictions and
  fees on exchanges
• Note consider presenting this portion together
  with your vendor

15
Pre-Purchase Analysis

• Selecting the Carrier(s)
• In addition to the previous slide evaluating the
  available products, prepare a separate slide
  showing managements review of the available
  carriers. Include in the review
• results of credit analyses of the carriers
• their capacity to perform needed services over
  the long term
• their commitment to the BOLI products
• Note consider having your vendor assist in
  presenting this portion

16
Pre-Purchase Analysis

• Assess the Reasonableness of Additional
  Compensation
• Use this slide if the bank intends to acquire
  BOLI to supplement employee or director
  compensation
• The banks regulator has issued rules
  prohibiting banks from providing excessive
  compensation. Compensation is considered
  excessive when amounts paid are unreasonable or
  disproportionate to the services performed,
  considering all cash and non-cash benefits.
  Other factors include
• The persons compensation history
• Comparison with other individuals with comparable
  expertise at the bank
• The banks financial condition
• Comparable compensation practices at peer banks
• The costs and benefits to the bank of providing
  post-employment benefits
• The existence of any malfeasance by the
  individual
• Other factors the banks regulator determines
  to be relevant
• Compensation that could lead to material
  financial loss to the bank is prohibited as an
  unsafe and unsound practice.

17
Pre-Purchase Analysis

• Split-Dollar Arrangements - Defined
• Under a split-dollar arrangement, the bank and
  the individual share rights to the policys cash
  surrender value and death benefits. Split-dollar
  arrangements are used to provide benefits to
  personnel as additional compensation.
• Describe how the bank uses split-dollar
  arrangements.
• The insurance arrangement is consistent with the
  banks compensation objectives and does not
  produce excessive compensation.

18
Pre-Purchase Analysis

• Split-Dollar Arrangements Written Agreements
• Describe the key terms of the written agreements
  entered into with bank personnel that establish
  the rights and obligations of affected parties.
  Review advice provided by tax, insurance, and
  legal advisors.

19
Pre-Purchase Analysis

• Evaluate Alternatives to Meeting the Banks
  Objectives
• Describe managements exploration of
  alternatives to BOLI to meet its objectives

20
Pre-Purchase Analysis

• Document the Process
• Describe managements maintenance of adequate
  documentation supporting the banks pre-purchase
  analysis and of its BOLI program generally

21
Pre-Purchase Analysis

• Identifying and Managing BOLI Risks
• The banks regulator has identified a series of
  risks associated with the acquisition of BOLI
  that the bank must fully comprehend, monitor, and
  manage. The banks management plan includes a
  thorough evaluation of all these risks, and
  development of policies and procedures to
  identify, measure, monitor, and control them.
  The risks identified by the agencies are
• liquidity risk
• transaction/operational risks
• reputation risk
• credit risk
• interest rate risk
• compliance/legal risk
• price risk.

22
Pre-Purchase Analysis

• Liquidity Risk the risk to earnings and capital
  arising from the banks inability to meet its
  obligations without incurring unacceptable losses
• BOLI is a long-term, illiquid asset. The bank
  generally will not receive any proceeds from the
  insurance until payment of death benefits.
• To obtain access to BOLI assets prior to
  maturity, the bank must either surrender the
  policies or borrow against them. Surrendering
  policies will subject the bank to charges
  quantify, and possibly tax penalties and
  liabilities for previously untaxed increases in
  the cash surrender value of the policies.
  Borrowing against a policy is disadvantageous in
  most cases due to limitations on the ability to
  deduct interest and other possible adverse tax
  consequences.
• Discuss steps that management has taken to
  manage liquidity risk

23
Pre-Purchase Analysis

• Transaction/Operational Risks the risk that
  arises from the failure to understand and manage
  the complexities of making the investment
• The performance of BOLI products depends on a
  variety of factors, most notably, the policies
  interest-crediting rate, mortality cost, transfer
  and surrender charges and limitations, and other
  charges.
• For separate account policies, the bank must also
  make investment decisions, and evaluate the costs
  and benefits of purchasing stable value
  protection contracts.
• Ambiguous policy terms expose policies to
  challenge by the IRS or other authorities as
  something other than tax-preferred insurance
  policies.
• Changes in accounting rules, agency regulations,
  and legislation can make future BOLI cash flows
  subject to income tax.
• Discuss the significant terms of available or
  purchased policies and how the bank will manage
  them

24
Pre-Purchase Analysis

• Reputation Risk risk to earnings and capital
  arising from negative publicity regarding the
  banks business practices.
• The banking agencies have identified potential
  adverse reactions from the public, from employees
  and employees estates when the bank is seen to
  benefit from the death of a current or former
  employee, or if there are disputes between the
  bank and the estate of the insured deceased over
  the rights to split-dollar policies.
• Risks may be heightened to the extent that
  policies are placed on the lives of employees not
  generally seen as part of senior management.
• Review the steps management has taken to manage
  reputation risks, such as by clearly documenting
  informed consent by the insured individuals
  obtained before purchasing insurance.

25
Pre-Purchase Analysis

• Credit Risk the potential impact on earnings and
  capital arising from an obligors failure to meet
  the terms of a contract with the bank or
  otherwise perform as agreed.
• Life insurance policies are long term assets.
  The credit quality of the carrier and the
  duration of the contract are key factors. A
  general account policy is an unsecured obligation
  of the carrier. The risks associated with
  separate account policies are based primarily on
  the assets held in the separate account rather
  than the carrier.
• Describe the steps management has taken to
  identify and manage credit risks, such as
  performing credit analyses on carriers to ensure
  they can meet their obligations to pay death
  benefits and, if applicable, to pay the cash
  surrender value upon the surrender of a policy.
• Describe the banks policies and procedures of
  ongoing monitoring of carriers condition, limits
  on BOLI holdings, and concentration exposures.

26
Pre-Purchase Analysis

• Interest Rate Risk the potential impact on
  earnings and capital arising from an obligors
  failure to meet the terms of a contract with the
  bank or otherwise perform as agreed.
• Review the interest yields of the underlying
  assets in the carriers investment portfolio, and
  how the yields affect interest crediting to the
  policyholder.
• Review the interest-crediting features of BOLI
  to be acquired, and managements view of how the
  yield and the method of crediting would meet the
  banks objectives.
• If separate accounts are used, review
  managements plan to monitor and respond to
  interest rate fluctuations of the underlying
  assets.

27
Pre-Purchase Analysis

• Compliance/Legal Risks the risk to earnings and
  capital arising from violations of, or
  nonconformance with, laws, rulings, regulations,
  prescribed practices, or ethical standards.
• Failure to comply with applicable laws,
  regulations, and prescribed practices could
  compromise the success of the banks BOLI program
  and result in penalties or loss of tax benefits.
  The risks include failure to comply with
• Taxation rules, which form the basis for their
  favorable tax treatment
• State insurable interest rules, which form the
  basis of treatment of BOLI as insurance policies
• Accounting rules
• Other laws and regulations
• Review the banks management plan to monitor
  legal changes and respond to them

28
Pre-Purchase Analysis

• Price Risk the risk to earnings and capital
  arising from changes in the value of portfolios
  of financial instruments (applicable to separate
  accounts).
• The value of separate account products is the
  amount that could be realized upon surrender.
  Since the insurance carrier will provide neither
  a minimum cash surrender value nor guarantee an
  interest-crediting rate, the bank assumes price
  risks in its investments in separate accounts.
  Since the bank does not control the separate
  account assets as it would if it held the assets
  directly, it is more difficult for the bank to
  control price risk.
• If the bank is purchasing stable value
  protection contracts, review managements review
  and analysis of those contracts
• If the bank is not purchasing stable value
  protection, review managements plan for
  monitoring and reporting that will enable it to
  recognize and respond to price fluctuations in
  the fair value of the account assets.

29
Ongoing Risk Management

• Bank management and the board are responsible for
  exercising continuous risk management by
  monitoring BOLI risks on an ongoing basis.
• The performance of insurance assets should be
  reviewed by management and the board at least
  annually. More frequent reviews may be warranted
  in connection with significant changes to the
  BOLI program such as in connection with
  additional purchases, a decline in the financial
  condition of the insurance carriers, anticipated
  policy surrenders, and changes in tax laws or
  interpretations that could have an impact on the
  performance of BOLI.

30
Ongoing Risk Management

• These are elements of an annual review of the
  banks BOLI holdings
• a review of the agency-designated risks and how
  the banks management policies are responding to
  them
• a review of employees covered (additions,
  modifications)
• a review of employees covered by an MA
  counterpart that also owns BOLI (e.g., are the
  employee positions insured by the other company
  consistent with the banks policies on who is
  insured?)
• an assessment of death benefit amounts to ensure
  they are in line with employee salaries
• a calculation of the ratio between insured
  persons who are employed by the bank and those
  who are formerly employed
• an assessment of material changes to the banks
  BOLI risk management policies
• an assessment of the effects of exchanging
  policies (understanding such effects should be
  part of the pre-purchase due diligence)
• an analysis of mortality performance and the
  impact on income
• an evaluation of material findings from internal
  and external audits and independent risk
  management reviews
• a review of policy surrenders (e.g., the reasons
  for them, costs and benefits of surrenders, and
  any penalties and tax implications)
• a comparison of BOLI holdings of peer banks to
  ensure that the banks holdings are not excessive