ABA Banking Journal - January 2008 - (Page 38B) INSURANCE REPORT: DIGITAL MAGAZINE EXTRA BOLI PART I ity related to purchases of BOLI to senior management, the board remains ultimately responsible for ensuring that the purchase and holding of BOLI is consistent with safe and sound banking practices. This article covers the pre-purchase analysis which should take place before entering into a BOLI contract. Part II addresses additional issues. management and the board should consider whether the bank’s need for the insurance might end before the death of the insured. 5. Pre-purchase analysis stage An effective pre-purchase analysis involves the following management and board actions: 1. Identify the need for insurance and determine the economic benefits and appropriate insurance type. This involves the bank analyzing the cost and benefits of planned BOLI analysis, including projected policy values (cash surrender value and death benefits) using multiple illustrations of these projections provided by the carrier, some of which incorporate the bank’s own assumptions. Carrier selection. To achieve the tax benefits of insurance, institutions must hold BOLI policies until the death of the insured. Therefore, carrier selection is one of the most critical decisions in a BOLI purchase and one that can have long-term consequences. The bank alone retains the responsibility for carrier selection. Management should review the carrier’s commitment to the BOLI product, as well as its credit rating, general reputation, experience in the marketplace, and past performance. 6. 2. Quantify the amount of insurance appropriate for the bank’s objectives. The interagency statement provides that a bank should estimate the size of the employee benefit obligation or the risk of loss to be covered, and ensure that the amount of BOLI purchased is not excessive in relation to this estimate and the associated product risk. When using BOLI to recover the cost of providing employee benefits, the estimated present value of the expected future cash flows from BOLI, less the cost of insurance, should not exceed the estimated present value of the expected after-tax employee benefits cost. Determine the reasonableness of compensation provided to the insured employee if the insurance results in additional compensation. Insurance arrangements that are funded by the institution and that permit the insured officer or employee to designate a beneficiary are a common way to provide additional compensation and other benefits to the insured. Analyze the associated risk. And to this we add, analyze the ability to monitor and respond to those risks. The bank’s pre-purchase analysis must include a thorough evaluation of all significant risks (as enumerated below), as well as management’s ability to identify, measure, monitor, and control those risks. 7. 3. Assess vendor qualifications. While it is possible to purchase insurance directly from insurance carriers, the vast majority of insurance purchases are made through vendors. A vendor may design, negotiate and administer the BOLI policy, but the bank should ensure that it understands the product it’s purchasing and that it selects a product that best meets its needs. In particular, an institution that uses a vendor should make appropriate inquiries to satisfy itself about the vendor’s ability to honor its long-term commitments, particularly when the vendor is expected to be associated with the institution’s insurance program over an extended period of time. 8. Evaluation of alternatives. Regardless of the purpose of the BOLI, a comprehensive pre-purchase analysis should include an analysis of available alternatives. Prior to acquiring BOLI, the bank should have thoroughly analyzed the risk and benefits, compared to alternative methods for recovering costs associated with the loss of key persons, including pre- and post-retirement employee benefits. Document the decision. A well-managed institution must maintain adequate documentation supporting its comprehensive pre-purchase analysis, including an analysis of both the types and designs of products purchased and the overall level of BOLI holdings. ❖❖❖ 9. 4. Review the characteristics of the available insurance products. Design features of permanent insurance determine: a. whether the policy is a general obligation of the insurance company, a separate obligation unique to the bank, ; or a combination of the two; b. whether the insurance contract is a modified endowment contract that contains certain tax penalties if surrendered; and c. the use of credit earnings to the policy. When purchasing insurance on a key man, 38b JANUARY 2008/ABA BANKING JOURNAL The purchase of BOLI can be an effective way for the bank to manage exposure arising from its commitment to provide competitive employee benefits. Consistent with safe and sound banking practices, the bank must, however, understand the risks associated with the product. By addressing the risk issues with a pre-purchase analysis, the bank will, at the least, know if the tune is “bearable” while they waltz! BJ www.ababj.com/subscribe.html http://www.ababj.com/subscribe.html
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