Sovereign Bancorp, which has its New England corporate headquarters at 75 State St. in Boston, began investing in bank-owned life insurance in 1998.

The recent attention given to bank-owned life insurance in the national press has some banking industry insiders worried that the wrong pall is being cast.

With article headlines like “Profiting When Employees Die,” some bankers are worried that consumers will think they are waiting ghoulishly in the wings for rank-and-file employees to pass on, enriching the coffers of already bloated vaults.

Nothing could be further from the truth, according to industry executives. Rather, bank-owned life insurance is simply a way for banks to cover what may be an extreme loss to the institution while earning tax-free assets to fund employee benefits.

Additionally, according to a spokesman for the state Division of Insurance, any policy taken out on an employee in the Bay State must be disclosed to that employee, a stipulation that, at least in Massachusetts, refutes accusations of furtive tactics.

“It’s not that complicated but people can make it complicated,” said Kevin L. Kaeding, president of Marlboro-based Kaeding, Ernst & Co., a provider of bank-owned life insurance.

“Essentially, it is nothing more than buying a life insurance policy that’s designed to have one payment, not a series of payments,” he said.

A bank could invest $1 million in BOLI and at the end of 12 months have earned $55,000 to turn over to other benefits, he said as an example. While regulators allow this gain to be posted as an asset, it cannot be used to enrich the bank. It must be used to offset an employee benefit such as a medical, dental or 401(k) plan. According to Kaeding, the majority of bank clients he handles are community-sized and need the extra income to provide the best employee benefits.

“They’re [banks] not taking all of their employees and insuring them and hoping that they end up with a mortality gain,” he said.

Typically, a community bank would look at insuring only its officers. “There is a great reluctance to go too deeply into the employee pool. In my experience community bank presidents say, ‘We don’t want to be profiting from the death of a worker,'” said Kaeding. So-called “janitor’s insurance” is what the industry has termed BOLI that stretches down into the rank and file. According to several industry executives, most banks in the region aren’t interested in that.

Kevin McKechnie, associate director of the American Bankers Insurance Association, a subsidiary of the American Banker Association, said BOLI is very attractive to banks of all sizes. “The first reason it’s attractive is you have a major problem replacing key banking personnel,” he said.

While the pros include offsetting the cost of a valued and sometimes irreplaceable employee being lost and gaining assets to pay for benefits, BOLI is not without its drawbacks. “Certainly one of the cons right now is this perception that it’s being used improperly or nefariously. I think those are disappointing comments [in the press] and I don’t think it’s true at this junction since I haven’t seen an allegation of wrongdoing or illegal impropriety,” said McKechnie.

“I was really disappointed to see that because that means the authors of that article really ought to call my wife a death profiteer. She didn’t benefit emotionally when her father passed away; she did benefit financially [from life insurance],” he said, adding it’s disappointing the public discussion has taken on such tones.

‘Just Plain Stupid’

Losing an employee with some 15 years of experience or more can lead to substantial costs for any organization, said McKechnie. “It’s not simply the employee and the salary, it’s all of the training investment, all of the institutional expertise and stature,” he said. “For example, what if GE [General Electric] lost Jack Welch [before his retirement]? How would you replace that person? Is there an amount of money that could replace that person?”

But replacing a valued manager isn’t the reason Sovereign Bancorp began investing in BOLI in 1998, according to Dick Ehst, director of corporate communications for the Philadelphia-based bank, which now has an extensive presence in Massachusetts and New England.

“As you know, probably one of the most unmanageable costs that any company has is the cost of its medical insurance. As of late, that has been escalating at rather alarming rates. We felt this was one way of mitigating that kind of expense, admittedly over time,” he said.

If insuring against the loss of a key employee were the sole intention of BOLI, then Sovereign would have simply purchased key-man insurance, said Ehst. Sovereign has purchased $600 million in BOLI for 600 of its key managers.

“We did it a little differently. We solicited the leadership group so we’ve got roughly 600 leaders who have consented to allow the bank to purchase insurance on their lives. That’s roughly half of the leadership team,” said Ehst.

While the roughly $106 million earned over the three-year period since Sovereign began purchasing BOLI is being used to offset the medical expenses of employees, with 7,000 full-time employees it’s hardly enough to fully cover the total expenses, he said.

BOLI is a very simple concept, said Ehst. “[It] might not be simple to understand and certainly might not be simple when others have chosen to approach this program differently, such as not giving the employees the right to consent – that’s just plain stupid. But I think our approach is sound; it makes good business sense and will benefit everyone involved,” he said.

According to Kaeding, there are several benefits to consider in using BOLI. “If you take bank-owned life insurance from the plus side, you have an asset that is highly rated; typically it will be AA or AAA rated as evaluated by Moody’s Investors Service [or] Standard & Poor’s and Fitch [Ratings]. So you have excellent asset quality,” he said.

Top-flight, non-taxable earnings are another benefit to the program as well as earnings that adjust on an annual basis. “So the bank never has to worry about being under water with that investment,” he said. Lastly there is, of course, the death benefit itself should that occur.

The negatives of BOLI are the fact that it’s a long-term investment and that the regulators don’t consider the asset liquid.

According to the ABIA’s McKechnie, there are a few legislative bills that may affect BOLI nationwide but shouldn’t have much effect in the commonwealth. Both pending bills have to do with disclosing such insurance policies to the employees they cover as well as the amount of insurance, he said.

Most of the association members he’s spoken with are already disclosing the policies to employees anyway, he said. “Therefore, I’m not sure that to the extent it’s going to be compelled by the federal government we would have anything negative to say about that,” he said. However, if the bill requires that banks notify employees and former employees retroactively, his association may be concerned about the cost burden placed on smaller banks to accomplish that.

Kaeding said BOLI is a good bank asset. “But you must understand it and its limitations and do a careful due-diligence process on the purchase. If you go through all of those steps, I think most banks will find it’s a worthwhile addition to the balance sheet,” he said.

Bank-Owned Life Insurance Both an Asset and Liability

by Banker & Tradesman time to read: 5 min
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