FAQ: Employer-Owned Life Insurance
What is BOLI/COLI?
"BOLI" is an acronym commonly used to describe bank-owned life insurance. "COLI" is an acronym used to describe corporate-owned life
insurance (COLI). The term "BOLI/COLI" is used more generally to describe employer-owned life insurance. The product itself is basically
a permanent life insurance policy where the employer insures the life of its key executive(s). The employer pays the premium, owns
the policy, and is the beneficiary of the policy.
BOLI/COLI is often sold along side of a nonqualified plan
; however, BOLI/COLI is
a general asset of the employer that is separate and distinct from any benefit obligation established for the insured or key individual.
The executive has no interest in the insurance policy unless the employer explicitedly agrees to split the policy's death proceeds
in a separate split dollar arrangement
How is BOLI/COLI Used?
As a general rule, death benefits and policy earnings on life insurance contracts are not taxable. Employers use the tax advantages of BOLI/COLI to offset and recover the cost of new and/or existing employee health and welfare benefits, post-retirement benefits, and/or supplemental income to key individuals.
BOLI/COLI earnings are used to offset or mitigate the benefit expense reported on the income statement. The tax-free death proceeds are used to recover the cost associated with providing benefits to employees and key employees, or satisfy an outstanding benefit liability in the event of premature death of a covered individual.
What is a Modified Endowment Contract (MEC)?
For traditional life insurance, the cumulative amount paid on the policy cannot exceed the annual premium that would pay up the policy in the first seven years. A policy that fails the so-called seven-pay test is classified as a modified endowment contract or “MEC”.
MECs are not necessarily a bad thing, in fact, MECs generally outperform non-MEC policies; however, it is important to understand the loss of some favorable tax treatment usually accorded to life insurance.
Like traditional life insurance, MEC policies offer the accumulation of tax-deferred earnings and tax-free death proceeds. On the other hand, MEC distributions such as policy loans, partial and full surrenders, and account withdrawals are treated as taxable income to the extent of gains on the policy, and sometimes gains on other polices when multiple MECs policies are involved. The taxable amount is also subject to an additional 10 percent penalty (See MEC Tax)
It is also important to note that once a policy is classified as a MEC, it will always be treated as a MEC. A policyholder cannot reduce premiums or cash value to re-classify a MEC policy as a non-MEC. Employers opting for this type of policy should always anticipate holding this asset for the life of the insured.
What is the Modified Endowment Contract tax (MEC) tax?
Pre-death distributions under a MEC policy are included in gross income and subject to federal income tax. In addition to regular income tax, there is a 10% excise tax on the amount includible in gross income, similar to the early withdrawal penalty for individuals under age 59 1/2. The 10% penalty associated with MEC policies or single-premium BOLI policies are referred to as “MEC tax”.
What is a Split Dollar Benefit?
A split-dollar life insurance arrangement splits the policy’s premium and policy benefits between two parties, usually an employer and employee. Generally, the bank pays the premium costs while the policy is in effect, pursuant to a prearranged contractual agreement. At the death of the insured or the termination of the agreement, the parties split the policy benefits or proceeds in accordance with the agreement.
How is BOLI Reflected on the Financial Statements?
In accordance with FASB Technical Bulletin 85-4, BOLI should be reported on the balance sheet at its cash surrender value as of the balance sheet date, net of surrender charges and/or early termination penalties.
What is a 1035 Exchange?
Section 1035 of the Internal Revenue Code is a tax-free replacement of one insurance contract for another covering the same person(s). In other words, if an insurance policy is not performing as expected, the employer may switch to a different product or insurance carrier without incurring taxation.
How is BOLI Reported for Bank Regulatory Purposes?
For Call Report purposes, the amount that could be realized under the BOLI policy should be reported on Schedule RC, Item 11, "Other assets" and Schedule SC-F, Item 5, "All other assets". Policy earnings should be reported on Schedule RI, Item 5.1, "Other noninterest income". Policy expenses should be reported on Schedule RI, Item 7d, "Other noninterest expense".