Insights

Banks are expected to conduct a review of their bank-owned life insurance (BOLI) portfolio annually under the guidance of the Interagency Statement of 2004. This supervisory oversight responsibility assures regulators that a bank’s risk management processes for BOLI are consistent with safe and sound banking practices. Due to the nature of the insurance information, most vendors assist their clients through the process, but this review is often only a snapshot in time of the BOLI portfolio. What should be included in the review for the bank to be assured that expectations are being met and risks are identified?

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The BOLI Asset

BOLI is a long duration asset, often expected to be held for 30 – 40 years. In one sense, BOLI can be considered as a “zero coupon perpetual bond.” Despite not being an actual bond, it has many attributes of a bond. These attributes include:

• A stated maturity value (death benefit), with a promise to pay guaranteed by an insurance company (the “issuer”) – yet, with an unknown maturity date
• An accrued value, referred to as cash value, determined by the issuer’s assessment of mortality expectations, expenses and interest earnings
• A fair market value, the cash surrender value, available upon redemption prior to maturity

While the annual review process generally assesses the current state of the “bond”, this process should further consider two questions:

1. What is the present and projected return on the money invested for the “bond” (the premium)?
2. What are the potential risks to the return on and return of the money invested?

Each of these questions can be examined in the annual review process. After all, the BOLI “bond” was acquired for the earnings to be a long-term financing strategy for employee benefit and compensation plans and for the maturity value to meet certain benefit obligations such as survivor income and split-dollar benefits. Guiding the board and bank management through this assessment necessitates an additional step in the review process: insurance company projections to reveal the future outlook of the maturity value of the “bond."

Annual Review

The annual review process should be more than just meeting the regulators’ expectations. Expanding the review to assess the projected results from BOLI can provide a bank with a broader assessment of its BOLI asset’s ability to meet the original death benefit expectations. Acting on the following recommendations with the guidance of NFP executive benefits consultants and account executives provides a more thorough BOLI risk management process:

• Periodically include insurance projections into the process.
• Consider the characteristics and performance of the underlying investment portfolios supporting your BOLI.
• Understand what actions are available to mitigate risks in your BOLI’s ability to meet original expectations.

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