Where do you save your money? For many people, the answer is “in a bank.” So it surprises people to learn that one of the places banks store and grow their cash is outside of the banking system altogether.
Banks store and grow a significant portion of their capital using permanent life insurance, generally a special kind of whole life insurance. It’s referred to as “BOLI”—bank-owned life insurance, and banks own a LOT of it!
In this article, we’ll explain why banks buy life insurance, how much they have, and why it’s relevant to YOU. (As it turns out, most people want the same benefits the banks are receiving!)
Life Insurance is the Banker’s Secret Bunker
Best-selling author Barry James Dyke said in an interview, “The banking industry – one of the most powerful and influential industries in the United States – has a deep affection for cash value life insurance and treats it like a golden asset.”
Banks have had the ability to purchase life insurance since early 1980’s, according to BankDirector.com. From nothing to many billions, it has grown steadily, often with double-digit annual gains in volume of cash surrender value (CSV). By 2008, the research of Barry James Dyke revealed a surprising fact: “According to the FDIC, banks are the largest purchasers of cash value life insurance in the United States.”
Around the start of the Financial Crisis, banks accelerated new purchases of this old-fashioned product. Life insurance brought stability, protection, and growth during unpredictable times. During the Great Recession, BOLI outperformed both stocks and the safe assets that banks sell to their customers—without risks of fractional banking or market volatility. This year, BOLI assets reached $180.5 billion—and counting.
Never heard of BOLI? You’ve got company. Motley Fool’s “Math Guy,” Matthew Frankel, calls it “a little-known way that banks make money,” explaining that BOLI is life insurance purchased by banks on their executives and key employees. It is primarily used to offset the costs of employee benefits, such as healthcare, 401(k) programs, and vacation days. It also plays a role in helping banks meet their capital requirements.
How common is it for banks to buy life insurance? The majority of banks in the U.S., including about three-fourths of banks with assets of $500 million or more, hold life insurance as a general asset of the bank. (This means it is separate and distinct from policies established for the benefit of the insured or key individual).
Why Banks Buy Life Insurance
Banks buy life insurance because it offers benefits not available through their own products and institutions. Bank products have low rates and are taxable, while life insurance offers guaranteed growth, tax advantages and an opportunity to shore up balance sheets with an asset so reliable it can be used as collateral.
As Frankel explains, “BOLI policies produce far superior returns than traditional bank investments… and, the growth in the cash value of the policies, as well as any death benefits paid out, are completely tax-free.” (Note: Policies cancelled before the insured passes can create tax liabilities.)
Banking on a Return
The most common reason cited by bankers for purchasing BOLI are that it “provides competitive returns with superior credit quality,” reports BankDirector.com. According to BoliColi.com, BOLI returns typically exceed after-tax returns of more traditional bank investments such as municipal bonds, mortgage-backed securities and 5-and 10-year Treasuries by 150 to 300 basis or 1.5 – 3% annually.
The favorable tax treatment of life insurance has a sizable impact on returns. In October of 2016, BankDirector.com confirmed, “Current BOLI net yields are in the range of 3.00 percent to 3.75 percent which generates tax equivalent net yields of 4.85 percent to 6.05 percent for a bank in the 38 percent tax bracket.”
Life Insurance also offers a measure of safety and strength. Tier 1 capital represents a bank’s equity and reserves. It is the core capital that is the measure of a bank’s financial strength and how well-protected it is against the risks it takes. It represents the highest quality capital that, from a regulator’s point of view, is essential to the health of a bank. According to Frankel, “BOLI assets are beloved by banks for their robust capital profiles… Since the policies are considered somewhat liquid – due to their cash-surrender value – they can be counted as Tier 1 capital under new capital requirement rules.
According to the 2016 Equity Alliance/ Michael White BOLI Holdings Report, the FDIC asset-concentration guidelines are 25 percent of Tier 1 capital. This means that Cash Surrender Values (CSV) can provide up to 25% of a bank’s top-shelf capital.
Banks find BOLI an attractive Tier 1 asset partly because life insurance companies invest for long-term stability and do not employ leverage. This makes bank-owned policy cash value a high quality, low-risk asset. As financial author Barry James Dyke explains, “…if a life insurance company has $1 million on deposit, that company may loan no more than $920,000, and usually only a fraction of that. As such, life insurers are 100 percent reserve-based lenders, which makes them stable institutions in down economies.”
The Financial Double Standard
Banks retail financial products such as checking and savings accounts, CD’s, credit cards, mutual funds, and mortgages. But if you walk into a bank and try to put your money where the bank puts much of theirs, they won’t be able to help you. Why? Because they don’t sell the financial product they use themselves to:
- Grow cash reserves at rates several times higher than that of bank savings accounts
- Enjoy tax-deferred growth and (often) tax-free gains
- build tax-advantaged cash position much faster than typical retirement vehicles allow (due to contribution limits)
- Increase liquidity and stability through building cash position
- Fund future needs and prepare for rising costs
- Protect themselves from the unexpected loss of key people.
As Denver Nowicz of Wealth for Life explains,
“Banks, when it comes to investing their own money—don’t follow conventional wisdom and put their cash into mutual funds, stocks, hedge funds, term life insurance or risky real estate deals. Instead, they place a large portion of their vital reserves, known as Tier One Capital, into high cash value life insurance or permanent insurance….
“Banks invest billions into high cash value life insurance. Surprisingly, for many banks, life insurance is their largest asset class.
BOLI, CUOLI, COLI and YOU!
Banks buy life insurance, and they aren’t the only entity that uses life insurance to store and grow cash. Increasingly, credit unions are also buying life insurance, known as CUOLI. Many corporations also own life insurance, referred to as COLI (corporate-owned life insurance). Countless small businesses utilize life insurance to protect themselves against the loss of a key employee and to have liquidity for improvements or emergencies.
Bank-owned policies are not the same type of policy you might purchase as an individual, although BOLI policies share similarities with other types of permanent life insurance, especially whole life designed for maximum cash value. Like whole life, bank-owned policies have both a cash value and a death benefit component. Unlike most whole life policies, bank-owned policies are single premium MECs, or Modified Endowment Contracts, which means that withdrawals or policy loans from MECs can trigger tax consequences and even penalties.
Bank-owned policies are treated as long-term investments that are rarely leveraged or surrendered. Perhaps most similar type of policy publicly available is a Single Premium Whole Life policy, which is also a MEC and has some distinct advantages and disadvantages.
Another key difference between whole life insurance and bank-owned policies is the potential use of the policy. While BOLI is highly regulated, private life insurance policies can be used to fund anything—a business start up, home improvements, rental home down payment or college tuition.
What We Can Learn from Bank-Owned Life Insurance
A family is not a business, and certainly not a bank. But we always encourage people to think of their finances (or their family’s finances) as their “personal economy.” What lessons can we learn from banks that we can apply to our own finances?
Banks and other savings institutions who remain healthy put tried-and-true financial advice to work:
- Think long-term, resisting short-term gains and speculation.
- Anticipate and prepare for costs, including unlikely losses.
- Save money in long-term assets with gains that outpace inflation.
- Build equity and ownership in “real” assets such as life insurance and real estate.
- Avoid speculation for short-term gains with high risk.
- Reduce, defer or avoid taxation, remembering that what matters isn’t how much you earn, but how much you get to keep.
- And don’t forget Rule #1: Never lose money.
Financial Advice Worth Following
The trick to building wealth is to do what the financial institutions DO, not what they tell investors to do. While financial entertainers and mega-authors question and critique the value of high cash value permanent life insurance, our bedrock financial institutions contradict their advice through investing hundreds of billions of dollars in this same industry. This is a fact worth noting.
The 2008 Financial Crisis revealed the tragedy of short-term thinking for short-term profits. Now with the rise of bank-owned life insurance, the jury is in: Life insurance can strengthen a bank’s balance sheet, bringing stability, protection, long-term gains and favorable taxation.
Furthermore, life insurance brings the same benefits to small businesses and even families. It makes your personal economy more profitable in good times, more stable in the face of financial storms, and more flexible to face everyday challenges and opportunities. If you have been prejudiced against life insurance by those who misinform, we urge you to seek the facts. High cash value life insurance is “the banker’s secret” that can help you and your family prepare for a prosperous future.
For more on life insurance, we recommend Kim Butler’s Live Your Life Insurance. You can also contact us directly to discuss policies, obtain a quote in the form of an illustration, or get a policy started!
—By Kim Butler and Kate Phillips