The Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of Thrift Supervision have issued an interagency statement on bankowned life insurance (BOLI), OCC Bulletin 2004-56 dated December 7, 2004, to remind financial institutions that the purchase and risk management of BOLI must be consistent with safe and sound banking practices. This bulletin rescinds OCC Bulletin 2000- 23, Bank Purchases of Life Insurance-Guidelines for National Banks, dated July 20, 2000.

The new interagency statement contains much of the same information from the previous bulletin, while clarifying and expanding some sections and adding information on other topics. The paragraphs that follow will provide an overview of the statement and provide further interpretation on the issues.

The regulatory agencies have said that "while BOLI can be a useful product to recover costs associated with providing employee benefits, [they] are concerned that some institutions have invested a significant amount of capital in BOLI without an adequate understanding of the full array of risks it poses. The statement emphasizes that, in addition to credit and interest rate risks, BOLI exposes institutions to liquidity, transaction, reputation, and compliance risks, which are often more difficult to measure and control." Benmark's consultants are available to do a BOLI review of an institution’s existing BOLI holdings to ensure compliance with the new statements.

The statement describes supervisory expectations for a thorough pre-purchase analysis and a sound risk control framework to address BOLI exposures on an ongoing basis. The statement also recommends that financial institutions develop and implement comprehensive BOLI policies that articulate an institution’s tolerance for risk. Additionally, the statement discusses accounting issues, the limited conditions under which institutions may hold equities in a separate account BOLI product, and the risk-based capital treatment for BOLI.

A new component of the bulletin discusses Accounting Considerations and states that institutions should follow FASB Technical Bulletin 85-4, Accounting for Purchases of Life Insurance to account for the asset. Additionally, the statement discusses policies with surrender charges, specifically regarding insurance companies that issue a rider or other contractual provision providing for a waiver of surrender charges only if all of the policies are surrendered at the same time. Because it is not known at any balance sheet date whether one or more of the policies will be surrendered before the deaths of the insureds, the possibility that the institution will surrender all of these policies simultaneously and avoid the surrender charges is a gain contingency. The bulletin specifically mentions that this "contingency" revenue may never be realized and therefore, that the institutions will now be required to record BOLI with the cash value amount the policy could be surrendered for as of the date of the balance sheet under FASB Statement No. 5, Accounting for Contingencies. Additionally, policy earnings, such as dividends that are not earned as of the statement date can also be considered "contingency" revenue. The statement emphasizes the fact that bank management and board members have responsibility for ensuring that the purchase and holding of BOLI is consistent with safe and sound banking practices. It also alerts institutions that BOLI holdings inconsistent with safe and sound banking practices are subject to supervisory action.

Under Policies and Procedures the statement did not change its guideline of concentration of credit, but stated that if a bank intends to purchase BOLI in an amount in excess of capital thresholds, the management should conduct an analysis to support that such acquisitions do not give rise to an imprudent capital concentration. Management should obtain approval from its board of directors or a designated board committee prior to the acquisition. Additionally, the agencies may require special reports explaining that the BOLI amount is prudent and is not unsafe or unsound. The tone of the bulletin suggests that it is generally not prudent for an institution to hold BOLI with an aggregate CSV that exceeds 25 percent of the institution’s capital.

The bulletin revisited the importance of the pre-purchase analysis to ensure that the institution understands the risks, rewards, and unique characteristics of BOLI. The nature and extent of this analysis should be commensurate with the size and complexity of the potential BOLI purchases and existing holdings. The bulletin stated that complete records of a prepurchase indicate a well managed institution. It also states that "reliance solely upon pre-packaged, vendor-supplied compliance information does not demonstrate prudence with respect to the purchase of insurance." An institution unable to demonstrate a thorough understanding of BOLI products it has purchased and the associated risks may be subject to supervisory action. The statement details Vendor Qualifications and discusses that the vendor’s commitment to investing in the operational infrastructure necessary to support BOLI is a key consideration in vendor selection, and that the vendor’s services "may be critical to successful implementation and operation of a BOLI plan." Therefore, vendors who only sell the insurance product and then rely on the administration of a third-party might not be able to demonstrate their long term commitment and qualifications to the buying institution.

The Risk Management of BOLI section mentions that "risk assessment and risk management are vital components of an effective BOLI program." Complete risk assessment should be conducted during the prepurchase analysis and with the ongoing monitoring of the BOLI. As with the previous bulletin, liquidity, credit, interest rate, compliance, transaction and price risks are detailed as well as additional risks of reputation, tax, and insurable interest implications. Reputation risk is the risk to earnings and capital arising from negative publicity regarding an institution’s business practices. While this risk arises from virtually all bank products and services, reputation risk is particularly prevalent in BOLI because of the potential perception issues associated with an institution’s owning or benefiting from life insurance on employees.

Following are a few of the new risk considerations:

• Calculation of the percentage of insured persons still employed by the institution. Larger institutions often find that their policies insure more former employees than current employees. This information can help the institution assess reputation risk.
• Evaluation of the material changes to BOLI risk management policies.
• Assessment of the effects of policy exchanges. Exchanges typically are costly and it is a sound practice to review the costs and benefits of such actions.
• Peer analysis of BOLI holdings. To address reputation risk, an institution should compare its BOLI holdings relative to capital to the holdings of its peers.