BOLI and Benefits: Two Peas in a Pod

Since the early 1980s, business-owned life insurance or BOLI has been the go-to strategy for banks and credit unions to offset the cost of executive and employee benefits. At the end of June 2021, more than 900 credit unions reported owning $7.9 billion—more than 9% of CU net worth—in cash surrender value, which is the amount left over after fees when you cancel a life insurance policy or annuity. What makes BOLI work so well?

BOLI is an institutional life insurance policy insuring CU officers. Unlike the typical life insurance policy we buy as individuals, BOLI is engineered to provide the least amount of death benefit gain and the maximum amount of growth in cash surrender value. The growth in CSV is recorded monthly as “other non-interest income.” Most CUs offer the insured officer the ability designate their own beneficiary for some of the death benefit gain.

The crediting rate, the interest rate earned on the contract value (principal plus accrued income) expressed as an effective annual yield, adjusts at least annually. The crediting rate history shows BOLI moves in the general direction of broader interest rates, albeit more slowly and with a lag. Unlike directly-held fixed-income investments, however, general account BOLI has no mark-to-market risk—something to consider as interest rates begin to rise.

If the current fixed-rate BOLI is not appealing enough, you should consider whether “indexed BOLI” is right for you. With indexed BOLI, the crediting rate is not merely declared by the insurer—it measures the change to an external index like the S&P 500, but with a minimum and a maximum crediting rate. It is critical to note that the CSV is never exposed to the S&P500; CSV is still always backed by the insurer.

BOLI Rules and Regulations

Regulators have encouraged—and sometimes required—credit unions to follow the interagency guidance on purchasing and monitoring BOLI applicable to banks. This includes a thorough pre-purchase analysis as well as an annual risk assessment. It includes vendor due diligence, which is why it’s important to partner with a provider that can provide technical and compliance support.

The interagency guidance also requires a CU to quantify its ability to buy BOLI by annually measuring the cost of employee or executive benefits. And this is where some confusion comes into play. Often BOLI is co-presented with a benefit and is mistakenly viewed as being a benefit. Offering an executive benefit and buying BOLI are two distinct decisions that can certainly work together—since BOLI can help to offset the cost of the benefit—but are nonetheless distinct. Even if your CU does not purchase BOLI, it may still be prudent to offer supplemental benefits to key people.

Retirement Income Analysis

One of the first steps to evaluating whether offering employee and executive benefits is appropriate is to do a retirement income analysis. An RIA takes a snapshot of current benefits (such as 401k, profit-sharing, pension, social security and executive benefits), projects them to retirement age and calculates the percentage of final income that could be replaced by current benefits. The projected replacement ratio can then be compared to a targeted replacement ratio, thereby offering a rational and defensible starting point for quantifying a benefit amount.

Once your CU has targeted a benefit amount, it should then compare the three common approaches to delivering a benefit (remember, BOLI is not in this list because it is not a benefit, but rather a way to fund a benefit):

1. Supplemental executive retirement plan or SERP. This is a promise by the CU to pay a benefit at a future date. Accounting rules require that the CU incur current annual expenses that build a liability on the balance sheet for the expected benefit. No specific asset is required; the CU will generally make payments from cash on hand. The executive recognizes the benefit as ordinary income when vested. The CU will be subject to an excise tax if total W-2 compensation to the executive exceeds $1 million.
2. Restricted executive bonus agreement or REBA. This uses a life insurance policy owned by the executive. (This is not BOLI, which is owned by the credit union!) Premiums are designed to accrue enough cash value on a tax-deferred basis that the executive can structure income-tax-free distributions to supplement income. The premiums are reported as current ordinary income by the executive, and there is generally no accrual for any post-retirement obligation. Compared to a SERP, a REBA can offer savings to the CU of 20%-30% while providing the executive with greater benefit security.
3. Split-dollar loan arrangement or SDL. Like the REBA, SDL uses a life insurance policy owned by the executive—again, this is not BOLI. Instead of treating the premiums as current expense to the CU and income to the executive, they are expected to be repaid in full by the policy cash value or death benefits and are therefore treated for income-tax and balance sheet purposes as a loan.

Each benefit type offers its own advantages. For example, REBA and SDL may not be viable if there are underwriting concerns for the executive. The SERP provides the CU with greater control as the tradeoff to absorbing the largest expense of the three. After careful consideration and modeling, the CU should choose the one or ones—yes, you can do different things for different executives—that best matches its objectives.

BOLI is a compelling tool that a CU can use to improve earnings and help it offer better benefits to its executives and employees. Whether you already own BOLI or it has been a while since you have considered it, market forces present strong reasons for a fresh look.

Supplemental benefit plans, whether or not they are backed by BOLI, are the tools that can directly help you attract, retain and reward the key people driving member value. Even if you have had a SERP for years, it should be reviewed, and other structures considered that might be more powerful for both the CU and the executive.

IZALE Financial Group’s founder and CEO, Scott Richardson, helped develop the interagency guidance for BOLI, and the IZALE team has designed and implemented over 1,100 benefit plans. Richardson has a law degree from William Mitchell College of Law, St. Paul, Minnesota. He earned designations as a Chartered Life Underwriter and Chartered Financial Consultant, and holds Series 6 (Investment Company and Variable Contracts Representative), 7 (General Securities Representative), 63 (Uniform Securities Agent State Law), 65 (Uniform Registered Investment Adviser Law) and 24 (General Securities Principal) licenses. To receive a complimentary retirement income analysis, to get a second opinion on your in-force BOLI or to see how additional BOLI can help your CU, or to learn more about the differing ways to structure executive benefits, visit IZALE Financial Group, a CUES Supplier member.