Broker Check


March 22, 2023

The collapse of Silicon Valley Bank, Silvergate Bank, and Signature bank, as well as challenges at First Republic Bank and Credit Suisse, has shaken confidence in the global financial system plus raised questions about whether life insurers could find themselves in a similar situation. At first blush, the data is not comforting, so a proper comparison at a closer examination of the business models might be helpful.

  • Both banks and life insurers invest in bonds.
  • Both face interest rate risk in terms of the market value of their bond portfolio.
  • However, several substantial differences between banks and life insurance companies result in materially lower liquidity risks for life insurers:
    • Most notably, the nature of their liabilities is substantially different – banks must meet withdrawal demands immediately, which can result in a "run on the bank."
    • In contrast, most life insurance policies do not demand deposits – policyholders may generally demand the cash value. Still, it may be subject to a surrender charge, market value adjustment, cancellation of an embedded guarantee, and/or loss of life insurance or health insurance benefits.
    • All these reasons act as a strong deterrent to surrendering life insurance policies.
    • In addition, insurers establish and maintain policy reserves (in addition to their capital positions) to support their contractual liabilities.
    • In contrast, banks do not generally hold reserves to cover their deposits (as banks assume not all depositors will request their funds simultaneously).
    • Life insurers file financial statements based on statutory accounting, which differs from GAAP accounting - chiefly, virtually all bonds are recorded at book value or amortized cost and not at market values under the tacit assumption that these assets will be held to maturity.
    • Accordingly, life insurers' unrealized gains and losses are experienced, but the perceived interest rate risk to asset values and capitalization is not "on display" each quarterly reporting period.
    • This does not mean that life insurers are immune from possible liquidity risks.
    • Fixed annuities, for example, pose a higher liquidity risk than life insurance policies, given their interest rate sensitivity, relatively short duration, lack of significant life and health benefits, and concentration of distribution.
    • Life insurers could face liquidity needs if claims for life and/or health benefits become elevated, such as with higher mortality experience in 2020-2022.

    All things considered, in my humble opinion:

    • Life insurance is the world’s safest industry.
    • Life insurers may provide greater net returns than Bank CDs.
    • Life insurance can provide “guaranteed” returns when using Fixed contracts.
    • There is no IRS reporting on earnings until you withdraw money from your account.
    • Depending on the terms of your policy, most cash values can be accessed anytime without penalties, unlike retirement accounts.
    • When properly structured, Life insurance can help you potentially reduce taxes in retirement.
    • The Government places tight restrictions on advertising these benefits even though they are 100% legal. This may be because they cannot make a dime off it.
    • Effectively, if limits are placed on how good a program is, such as limits on ROTH, 401k, etc., you should want to take advantage of the same within those limits.
    • Some of the smartest financial minds on the planet are bankers. They use BOLI (aka Business owned life insurance) as it bolsters their balance sheets and reduces risk exposure for arguably the most profitable business in the world, i.e., banking since they use fractional reserve methods.
    • Similarly, many families have used “family banks” for generations to perpetuate and grow wealth on a tax-favored basis. The platform that underpins this strategy uses a system of life insurance policies for multiple generations.

    As a result of the foregoing, in the past week, we have seen a significant increase in the:

    1. A flight of capital from smaller banks to larger banks.
    2. Flight of capital from Banks, in general, to Insurance companies.


    Advantages of BOLI

    Some of the top insurance carriers currently offer products with tax-equivalent yields in the 3 to 4 percent range, which many banks believe is very attractive compared to alternative investments. The tax-advantaged interest generated by a fixed-income BOLI policy is typically substantially higher than what a bank can earn on other investments with a similar risk profile, especially in the current rate environment.

    In addition, BOLI activity has been driven by strong credit quality and leverage ($1 invested in BOLI typically returns $3 to $4 of tax-free death benefits). BOLI is used to offset and recover employee benefit costs, such as health care and 401(k) or other employee benefit expenses in compliance with regulatory guidelines.

    Many banks purchase BOLI to informally fund specific deferred compensation plans and/or to provide supplemental life insurance, which can be tailored to the individual participant. Non Qualified plans can be highly customized and are generally designed not as retirement plans but as plans to provide them with cash during their working years. For example, a plan could assume a bank’s top loan officers receive a contribution of 5 to 15 percent of their salary annually. The deferred compensation earns interest, and the balance pays while employed and perhaps within five to ten years following retirement. This popular strategy uses BOLI financing to attract, reward, and retain younger, high-performing mid-level officers.

    For a properly structured plan, the bank purchases individual life insurance policies on a group of eligible employees; per IRC §101(j), each insured must provide written consent to be insured and be a highly compensated employee. This is commonly measured as the top 35 percent of bank employees by compensation. For example, if a bank had 60 employees, it could acquire life insurance policies on up to 21 of the highest-paid employees.

    When purchasing BOLI policies on ten or more eligible participants, the insurance companies often allow “guaranteed issue” underwriting, meaning the employees are not required to undergo a medical exam or have their medical and prescription records reviewed.

    Regulatory guidelines

    Regulatory guidance suggests a guideline aggregate BOLI capacity of no more than 25 percent of capital. Historically, most banks have excess capacity to purchase BOLI as they have remained below 25 percent of the total capital guideline, establishing internal guidelines at or below the regulatory level. Banks should continue to evaluate their BOLI capacity as a percentage of capital as their capital levels change over time.

    For example, a bank that has achieved positive capital growth over the past three years and currently has an additional BOLI capacity of $17 million, corresponding to 19 percent of BOLI to total capital concentration but has assumed in previous years a target BOLI concentration of 21 percent. If the bank attains the 21 percent target, this would assume an additional $8 million of new BOLI, which at a 3.72 percent tax-equivalent yield would improve the bottom line by $235,000. Again, the small increase in percentage from 19 to 21 percent results in $8 million of investment opportunity.

    According to FDIC data as of Sept. 30, 2020, the cash surrender value of BOLI policies held by U.S. banks grew to $182.2 billion, up from $176.5 billion reported one year earlier. Sixty-six percent of all U.S. banks have recorded BOLI on the Call Report, 72 percent of all U.S. banks with assets over $100 million, and 77 percent over $250 million have BOLI on their Call Reports.

    Effectively, given the tax and security advantages of Life insurers as a group versus Banks as a group, it seems that consumers (particularly those in the high tax brackets) can Optimize outcomes by utilizing more Insurance backed options in their financial strategies. 

    Vijay Khetarpal, CLU, ChFC, CFP, AIF | Phone: (703)287-7140 |

    Securities and investment advisory services are offered through Royal Alliance Associates, Inc., member FINRA/SIPC. Royal Alliance Associates, Inc. is separately owned. Other entities and/or marketing names, products, or services referenced here are independent of Royal Alliance Associates, Inc. 8607 Westwood Center Drive, 3rd Floor, Tysons Corner, VA  22182 • (703) 893-2550.

    This information does not substitute for specific individualized tax, legal, or investment planning advice.

    Guarantees are subject to the claims-paying ability of the insurance company.  Like most insurance and annuity contracts, policies and contracts contain exclusions, limitations, reductions of benefits, surrender charges, and terms for keeping them in force.