BOLI and Health Care
Key employees demand exceptional benefits—including excellent health care coverage. Yet for the last decade, employer health insurance costs have been rising at a rate that far exceeds increases in both the rate of general inflation as well as workers’ earnings1. How can you manage these inevitable increases in health care costs while still providing competitive benefits for your executives?
OFFSETTING HEALTH CARE AND OTHER BENEFIT EXPENSES
In addition to considering the latest cost-sharing trends, prudent bankers are also managing rising health care insurance expenses by reallocating bank assets into bank-owned life insurance (BOLI). A reallocation of a small portion of your bank’s assets into BOLI can likely offset 52 percent to 76 percent of the cost of providing employee health insurance over the next five years (see chart below).
Note: Health insurance funding assumptions are 75 employees with $2,500 average annual funding and an 8% annual increase. Assumes 34% percent corporate tax rate, $3 million asset allocated to BOLI @ 3.76% yield in year 2, 3.53% in year 4, and 3.38% in year 5.
The above example is a hypothetical illustration to be used strictly as an educational tool. It is not intended as offering specific investment advice or recommendations.
MORE THAN 50 PERCENT OF U.S. COMMERCIAL AND SAVINGS BANKS NOW USE BOLI TO RECOVER EMPLOYEE BENEFIT COSTS, ACCODING TO THE FDIC2.
Via the Interagency Statement on the Purchase and Risk Management of Bank Owned Life Insurance (often referred to as OCC 2004-56), the various regulatory agencies have confirmed that financial institutions can use BOLI to finance not only employee medical benefits, but also group life and other employee benefit plan expenses including long-term care and supplemental (nonqualified) benefits (e.g., supplemental disability coverage, executive deferred compensation and SERP benefits.)
BOLI IS AN EXCELENT TOOL FOR OFFSETTING RISING BENEFIT COSTS BECAUSE:
- BOLI durations are generally consistent with the long-term nature of benefit plan liabilities.
- BOLI is designed to provide a higher after-tax yield than most bank-eligible investments.
AS STATED IN THE OCC 2004-56
Life insurance holdings can serve a number of appropriate business purposes. Because the cash flows from a BOLI policy are generally income tax-free if the institution holds the policy for its full term, BOLI can provide attractive tax-equivalent yields to help offset the rapidly rising cost of providing employee benefits.”
A recent study by the Kaiser Family Foundation, a nonprofit research group that tracks employer-sponsored health insurance on a yearly basis, shows that the average annual premium for family coverage through an employer reached $15,073 in 2011, an increase of 9 percent over the previous year.
ABOUT THE AUTHORS:
David Shoemaker is a registered representative of and securities are offered through ProEquities, Inc., a Registered Broker/Dealer, and member FINRA and SIPC. Equias Alliance, LLC is independent of ProEquities, Inc.
Booker Moore is a registered representative of and securities are offered through Financial Telesis Incorporated. Financial Telesis Incorporated is a Registered Broker/Dealer, and member FINRA and SIPC. L.R. Webber Associates, Inc. is independent of Financial Telesis Incorporated.
*This article is for informational purposes only; it is not intended as an offer or solicitation for the purchase or sale of any financial instrument and is not intended to present an opinion on legal, tax, accounting or investment matters.
1 A recent study by the Kaiser Family Foundation, a nonprofit research group that tracks employer-sponsored health insurance on a yearly basis, shows that the average annual premium for family coverage through an employer reached $15,073 in 2011, an increase of 9 percent over the previous year.
2 Per FDIC Call Report Data as of 6/30/2012
HOW BOLI WORKS: LIFE INSURANCE THAT PROVIDES INCOME WITH TAX ADVANTAGES
The bank purchases individual life insurance policies on a group of employees. The eligible group is usually an officer group (e.g., assistant vice president and above), but may be based on salary or other parameters. The bank pays the premium(s), owns the cash value of the policies, and is the beneficiary of the insurance. The coverage does not interfere with any other insurance provided by the bank (e.g., group term life insurance). The annual cash value growth and future death benefits are nontaxable if policies are held until death, which provides an attractive tax advantage3.
ACCOUNTING FOR BOLI: NO INITIAL CHANGE TO CAPITAL, BUT INCOME CONTRIBUTES TO NET WORTH
The bank typically sells Treasuries or other securities—or uses funds generated through other cash flow—to purchase BOLI. Since both the source of these funds and BOLI represent bank assets, there is no initial net change to total assets or capital. The bank earns BOLI income from two sources:
- Growth in cash surrender value
Cash surrender value determines the asset value for accounting purposes for the bank’s BOLI policy. This value increases by the amount of interest credited by the carrier and decreases by the internal cost of insurance charges.
- Net death benefitThe other source of income from BOLI is the net insurance proceeds paid to the bank when a covered employee or former employee dies. The incremental net insurance proceeds above the cash value asset is booked as additional gains.
Because of the inherent tax advantages, BOLI can earn a higher after tax rate of return than many bank-eligible alternative investments. By working with quality carriers (those with S&P ratings of A+ and higher) that provide flexible plan features and attractive rates of return, BOLI can drive an increase in earnings per share. The annual increase in cash value and the net insurance above cash value at death are both recorded as gains on a bank’s income statement. By combining BOLI with effective cost-containment/sharing measures, banks can wield a powerful weapon for combating the ever-rising cost of employee health care coverage as well as other employee benefits. Utilizing the combined expertise of David Shoemaker CPA/PFS, CFP® and Booker Moore, Pennsylvania bankers may put themselves in greater control of future benefit costs. Equias Alliance is the Select Vendor for Bank Owned Life Insurance services of the Pennsylvania Bankers Association Services Corporation (PBASC), a wholly owned subsidiary of the Pennsylvania Bankers Association. L.R. Webber Associates, Inc. is the Select Vendor of PBASC for Employee Benefit and Retirement Plan Services and works with PBASC to provide Pennsylvania banks “The Healthcare Consortium,” a healthcare funding program designed to give bankers the ability to closely control their benefit cost while providing flexibility. To learn more about utilizing BOLI to offset rising benefit costs in your bank, contact David Shoemaker, CPA/PFS, CFP® of Equias Alliance at 901-754-4924 or Booker Moore of L.R. Webber Associates, Inc. at (814) 695-8066, Ext 233.
3Death proceeds on corporate-owned life insurance, including policies owned by a grantor trust established by the employer, will be received tax-free to the extent they comply with Internal Revenue Code Section 101(j) as well as other applicable state and federal laws.