by Sam Eifling on Monday, May. 3, 2010 12:00 am
If a bank tells you its most valuable asset is its people, you might take it quite literally.
Though it's considered a "mature" financial instrument (the opposite of "new-fangled"), bank-owned life insurance, or BOLI for short, is an increasingly valuable instrument for banks to pay for executive benefits and perhaps shore up the bottom line in case of the unforeseen.
"It is widespread," said Larry J. Brandt, the chairman and CEO of First Federal Bank of Harrison. "It provides investment income, if you wish to call it that, to offset the cost of providing benefits, and benefits for financial institutions is a substantial amount."
Not every bank carries BOLI. New York Life's executive benefits affiliate, NYLEX, counts $115.9 billion in BOLI holdings among 4,025 banks nationwide as of September 2007, but even in the Southeast, the region where the greatest proportion of banks carry the insurance, only 35 percent of banks have it.
Among Arkansas banks, BOLI holdings vary widely. The cash surrender value of Bank of the Ozarks' insurance holdings was $47.4 million as of the end of 2009; Centennial Bank had $51.9 million; Simmons First National of Pine Bluff had $20.2 million of the stuff. Meanwhile, Arvest Bank of Fayetteville, which holds more assets than those three banks combined, had just $5.8 million. Jonesboro-based Liberty Bank of Arkansas, the fifth-largest bank chartered in the state, had $3.3 million. Metropolitan National Bank of Little Rock had none at all.
If the banks actually did withdraw those amounts, they'd be taxed heavily - probably near 50 percent, all told - but it's likely, said Mike Myers, a Houston attorney who has tried corporate-owned life insurance cases, that the death benefits on those policies are worth five to 10 times the cash surrender value. For a massive institution such as Bank of America to carry $17.7 billion in BOLI suggests its employees are insured for somewhere in the 10-figure range.
"It's on probably every third person at the bank," Myers said. "There must be coverage on more than just the key executives, because the numbers are just too big." (The insurance holdings line on Federal Deposit Insurance Corp. forms could include policies taken out on some larger borrowers, but those are considered a negligible portion of the total, Myers said.)
Depending on the terms of those policies, banks are likely to reap a tax-free windfall even after the executives retire or leave the company. Some may not endure even that long.
Several Arkansas banks that carry BOLI have seen mid-career executives die unexpectedly in the past two years. Tom Steves, an executive vice president at Centennial Bank, died in a motorcycle accident last May, and Ron Strother, the CEO of Centennial's parent company, Home Bancshares Inc., died Jan. 31 in Little Rock from a self-inflicted gunshot wound. Mark Pennebaker, the senior vice president for lending at the Bank of the Ozarks in North Little Rock, died on vacation in Mexico last fall. On April 24, Brad Mooney, a senior vice president of Centennial, died of an apparent heart attack at age 40.
Banks filings don't disclose individuals' coverage, but occasionally an earnings report will show immediate evidence of a death benefits payout. A 2008 quarterly filing by First Federal Bancshares of Arkansas Inc. of Harrison indicated that it earned a $1.1 million profit during a quarter when it received a $1.2 million death benefit claim. Quick math says BOLI made an otherwise money-losing quarter profitable for the institution.
Brandt declined to give the name of the deceased, but did say he was a former vice president who had left to work at another bank. And when he died, First Federal's old BOLI policy paid out.
Asked whether his relationship with his employer changes when it becomes a beneficiary of a life insurance policy - a position not unlike a family member - Brandt chuckled.
"Naturally, I signed a consent agreement, like any officer would," he said. "A substantial amount of benefit expense has been paid for me by the company. It's a very equitable way for the bank to recover some of their expenses. Naturally, you don't have 20 executives die all at once. It may be one every 20 years. But your benefit expense goes on every year." Benefit expenses tend to run about a third of the bank's total compensation costs for executives, he said.
Much of banks' affinity for BOLI are those interest payments that get plowed into executive compensation, said Chuck Dudley of Hot Springs, a vice president of Argent Financial Group who has been selling BOLI since 1996. "The money accrues tax-free," Dudley said. "If the rate's 4 percent - and they're not quite that good right now - that might be a 6.5 percent return. That's not bad."
The philosophy behind BOLI is to goose non-qualified compensation plans - which, unlike a qualified plan such as a 401(k), doesn't limit the amount the institution can offer an executive. But because it's tied to the mortality of the insured, it's literally a lifetime investment. It's long term, complicated and involves a hefty upfront investment - maybe a million dollars - that may discourage a bank from buying.
"A lot of times you have boards of directors who don't understand insurance or don't like it," Dudley said. "They may have a 90 percent loan-to-deposit ratio, and if it's not a particularly liquid investment, it doesn't necessarily make sense to do it. Some haven't understood it and don't want to get involved in it."
You must figure that if only a third of banks in the Southeast carry BOLI, there must be a catch. Bank consultant Randy Dennis makes a distinction between split-dollar policies that provide for supplemental executive benefits and what are called "key-person" policies that exist primarily to provide a bulwark in case of unexpected deaths.
The latter, he appreciates. The former, not so much. After all, a bank is in the business of lending, so why take a small return, even a tax-free return, on a lump sum that could be lent out at higher rates?
"What we find over time is, the policies don't yield anything like what they say they will," said Dennis, president of DD&F Consulting Group, a Little Rock firm that consults for and provides risk management work for banks. "I'm not against life insurance. I think it's important. It provides a benefit to the bank, to provide some time to replace people and fill the holes left as a result of an untimely passing. It can be used wisely, but it's sold probably more than used wisely."
Millions in Payouts
A tour through the FDIC reports of some of the larger banks doing business in Arkansas suggests that banks have been warming to BOLI during the past five or six years. Regions Bank of Birmingham, Ala., for one, had at the end of 2009 a cash surrender value of $2.42 billion, double what it had at the end of 2006 and up from zero a year prior to that. Bank of the Ozarks had no CSV as recently as the third quarter of 2004.
Liberty Bank, with its $3.3 million at the end of last year, didn't have any CSV until 2005, the same year Simmons First National Bank of Pine Bluff also appears to have begun investing in BOLI. First National Bank of Fort Smith, with $2.3 million in CSV at the end of '09, had none at the end of 2007.
The income works out to millions for the banks. Bank of the Ozarks reported a BOLI income of $3.2 million in 2009 ($1.9 million in CSV increase plus $1.3 million in death benefits) and $4.1 million in 2008 ($2 million in CSV increase plus $2.1 million in death benefits). Centennial Bank, lumping together all its non-interest income, saw an increase in that category from $25.8 million in 2007 to $30.7 million in 2009.
Dudley surmises that changes in the structure of BOLI spurred its recent growth, from general account to separate account investing. The general account gives the insurance company full control of the premium. Any investments the insurer makes with that premium, then, are out of the bank's hands - and therefore amount to a risk the bank can't adjust.
"In the middle part of the 2000s," Dudley said, "big banks had started looking at separate account, and it trickled down to community banks." Separate account allows banks to adjust the allocations of those holdings. A bank might, then, choose to divide the premium among government securities, mortgage-backed securities and the insurance company's general fund. "The bank, by regulation, can look through to the investment in those funds and adjust their risk weighting," Dudley said. "That can be of real value to them."
'Dead Peasant' Insurance
The yields are attractive enough to some companies to take out life insurance on employees, often without the workers' knowledge. A 1996 memo churned up in a suit against Winn-Dixie for making itself the beneficiary for 36,000 employees' life insurance policies gave this practice a ghoulish nickname: "Dead Peasant" insurance, a phrase coined by one of the grocer's attorneys. Wal-Mart Stores Inc. of Bentonville, among other companies, came under fire for similar actions.
The Pension Protection Act of 2006 outlined best practices for BOLI and its corporate-owned cousin, COLI, designating income from death proceeds as tax-free income so long as the insured is notified and signs off on the policy, and is among the most highly compensated employees of an institution.
Failing these conditions, any payouts from the policies won't be tax free, a provision that Myers said was meant to discourage a company from taking out policies without consent. "Every court that I've been in front of has usually held that Wal-Mart doesn't have an insurable interest in the lives of rank-and-file employees, absent something like written consent," the attorney said. "Just taking out a policy on a rank-and-file employee without their written consent would be illegal in most states."
But for many bank executives, at least, that arrangement works out much more favorably.
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