What Is BOLI and How Does It Work in Accounting and Finance?

Bank-Owned Life Insurance (BOLI) is a valuable financial tool for banks, offering tax advantages and supporting employee benefit funding. It helps institutions manage long-term liabilities effectively while providing stable returns on assets.

Purpose and Structure

BOLI functions as both a financial asset and a way to offset employee benefit expenses. Banks purchase life insurance policies on select employees, typically executives, and become the beneficiaries. This arrangement allows banks to benefit from the tax-deferred growth of the policies’ cash value, strengthening their financial position.

BOLI policies are divided into general account, separate account, and hybrid account types, each offering distinct risk and return profiles. General account policies are backed by the insurance company’s assets, ensuring stability. Separate account policies are tied to specific investment portfolios, providing higher returns but with increased risk. Hybrid accounts blend these features, enabling banks to align investments with their risk tolerance and financial goals.

Insurance Policy Components

Key components of a BOLI policy include the death benefit and cash surrender value. The death benefit represents the amount payable to the bank upon the insured employee’s death, helping recover benefit costs and providing liquidity. Factors such as the insured’s age, health, and underwriting criteria determine the death benefit.

The cash surrender value reflects the policy’s accumulated value, accessible if the bank terminates the policy early. This value grows based on premiums paid and investment performance, offering banks a flexible financial tool for funding employee programs or enhancing reserves. Premiums can be paid as a lump sum or in installments, influencing the policy’s cost and the bank’s financial statements. Single premiums may offer tax benefits, while periodic payments provide cash flow flexibility.

Accounting Treatment

Proper accounting treatment of BOLI is essential for compliance with financial reporting standards. Under U.S. Generally Accepted Accounting Principles (GAAP), BOLI is recorded as an asset on the balance sheet at its cash surrender value, representing the amount receivable if the policy is surrendered. Increases in cash surrender value enhance the bank’s financial stability and can improve metrics like return on assets (ROA) and return on equity (ROE).

Changes in cash surrender value are recorded as income, creating a non-interest revenue stream. According to Financial Accounting Standards Board (FASB) guidelines, these increases are categorized as “other income” on the income statement. The tax-exempt nature of BOLI earnings can also impact the bank’s effective tax rate, requiring careful planning to ensure accurate reporting.

Tax Considerations

BOLI offers significant tax advantages, primarily the tax-deferred growth of the policy’s cash value, allowing banks to accumulate funds without immediate tax liabilities. This supports long-term financial strategies by enabling reinvestment of funds that would otherwise go to taxes.

The Internal Revenue Code (IRC) sections 7702 and 101(j) regulate the tax treatment of life insurance contracts and tax-free death benefits. Adherence to these regulations is critical to maintaining the policies’ tax-exempt status. Banks must notify insured individuals of coverage and meet requirements regarding the insurance’s purpose to avoid tax complications.

Compliance Factors

Compliance is vital in managing BOLI policies. Federal banking regulators, including the Office of the Comptroller of the Currency (OCC), the Federal Reserve, and the Federal Deposit Insurance Corporation (FDIC), provide guidance to ensure responsible use of BOLI. The OCC’s Bulletin 2004-56 outlines the need for a thorough pre-purchase analysis, including evaluating the insurer’s financial stability and the policy’s alignment with the bank’s financial goals.

Ongoing monitoring is essential to maintain compliance. Banks must regularly review BOLI holdings to ensure consistency with risk tolerance and objectives. This includes evaluating the insurer’s creditworthiness, tracking cash value performance, and adhering to limits on BOLI investments relative to capital. Regulators generally expect banks to limit BOLI holdings to no more than 25% of Tier 1 capital to avoid excessive exposure. Non-compliance can result in regulatory scrutiny, fines, or reputational harm, underscoring the importance of sound governance practices.