Banks have been using separate account BOLI as informal offset to employee benefits costs since the late 1990s. During the early 2000s, the separate account structure became the product of choice for many mid- and large-sized banks. The structure requires an allocation of premiums to one or more investment sub-accounts offered by the insurance carrier. Separate account BOLI offers some distinct advantages over other forms of BOLI including:
- Product expense clarity
- Access to professional third-party money management
- Investment flexibility
- Enhanced credit protection
In order to manage short-term, mark-to-market earnings volatility, most separate account BOLI policies include a stable value feature designed to smooth this earnings volatility of the underlying investment sub-account over a rolling period approximating the underlying duration of the sub-account(s). It is important to understand this stable value feature is an accounting derivative and not a financial put to the stable value provider or carrier. Separate account policyholders should expect to ultimately receive the performance of the underlying investment sub-account, less product expenses plus any mortality gains.
The financial crisis, related regulation and the decade long low interest rate environment has had a material impact on the performance of all BOLI policies, but most notably on separate account BOLI. Following the credit crisis and adoption of Basel III, a set of international banking regulations developed by the Bank for International Settlements to promote stability in the international financial system, many separate account BOLI policies were de-risked through changes in the sub-accounts available for stable value coverage. This de-risking coupled with a now decade long low interest rate environment has led to lower yields for all BOLI policies. Unlike general and hybrid account policies, separate account policies are not supported by minimum guaranteed crediting rates, resulting in many policies yielding well below 2%.
The implications to any life insurance policy of long term poor performance can be severe. Year-over- year increases in mortality charges due to aging insureds could lead to a point at which overall policy expenses are greater than the policy crediting rate, resulting in negative yields and the potential for policy lapses.
What should banks do with low/underperforming performing separate account policies?
Separate account policyholders should analyze future policy performance using reasonable mortality assumptions and multiple interest rate assumptions, including assumptions where interest rates will remain “lower for longer.”
Policyholders should also evaluate if current death benefits are at the minimum level per the definition of life insurance. Long term low cash value growth can cause situations where death benefits are excessive relative to cash values, thereby creating a yield drag. Policyholders unhappy with the current and projected performance of their separate account BOLI performance should consider alternatives including:
- Investment sub-account reallocation: The structure allows for investment sub-account reallocation, but most banks rarely take advantage of this feature. Banks should consider reallocation into sub-accounts that offer the potential for higher returns. These sub-accounts may increase overall credit risk and product risk-weighting, but potentially higher returns may improve the long-term viability of the policy. As many current stable value wraps will not allow allocations into sub-accounts with greater risk, the policyholder may consider terminating their existing stable value wrap and reallocation to a new stable value wrap that offers increased investment flexibility.
- Surrender/redeploy: Some banks have considered surrendering their separate account BOLI policies and redeploying the proceeds into a general account structure. The surrender of a BOLI policy creates a taxable event to the policyholder. Upon reallocation of the surrender proceeds, some carriers will offer product enhancements that can limit/eliminate the current period P&L impact of surrender.
- 1035 Exchange: Some banks have executed a 1035 exchange of separate account policies into a general account structure. Due to tax and insurable interest implications, this transaction is limited to active employees only. The exchange of a separate account policy can also create costs as the exchange is typically done at the underlying market value of the policy and a stable value termination fee is typically applied.
Making any decisions relative to separate account BOLI is complex, with potential long-term implications to product performance. A careful review of the policy, private placement memorandum and stable value provisions should be conducted prior to taking any action.
If you would like to discuss the review of your separate account BOLI policy, or have any questions regarding Newport Group’s BOLI Administrative offerings, please call Scott Bethune or Justin Robertson at 336-333-2050.
Securities are offered through Newport Group Securities, Inc., a dually registered investment advisor and broker dealer, member FINRA and affiliate of Newport Group, Inc. Securities in California are offered under the Newport Group Securities Insurance Services. Other insurance products may be offered by Newport Group, Inc. Newport Group and its affiliates do not provide tax, legal or accounting advice.
This material has been prepared for informational purposes only, and is not intended to address the circumstances of any particular individual or entity, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before making any decisions. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future.