Option permits efficient investment in insurance carrier's diverse portfolio.
by Scott Richardson, Founder & CEO of IZALE for CUES's Credit Union Management Magazine
If the key employee dies, the credit union receives the death benefit from the policy. While nearly all credit unions share some of the life insurance gain in excess of cash surrender value with the key employee’s designated beneficiaries, BOLI provides no direct cash or retirement benefit to the key employees themselves.
One of the most frequent reasons more credit unions don’t adopt BOLI is the misunderstanding that many boards often harbor about it. As noted above, BOLI is not an executive benefit, but an alternative for the traditional investment portfolio. What makes BOLI attractive is the ability to efficiently invest in an insurance carrier’s balance sheet. What does this mean, exactly?
A credit union could extend the duration of its investments to match a carrier’s; however, the expected rise in interest rates would cause market value adjustments that would negatively impact the credit union’s net worth. Buying BOLI puts a credit union in position to benefit from the carrier’s high ratings and strong capital position, offers superior credit risk and acts as a backstop against market adjustments.
Not all BOLI products are the same, and there is an art and a science to purchasing this form of investment. One of the first design considerations is how the policy crediting rate is to be determined. The vast majority of inforce BOLI is fixed universal life, commonly referred to as UL. With UL, the carrier sets the crediting rate at the beginning of each policy year based on what the carrier expects to earn on its assets. Interest is credited each month and mortality costs are deducted. UL has a guaranteed minimum crediting rate that ranges from 1 percent to 2.5 percent. Universal life products are fairly stable and predictable, which is desirable from a budgeting standpoint.
Some carriers now offer “indexed universal” life, commonly referred to as IUL. With IUL, the carrier buys an option that “collars” the S&P 500, with a minimum crediting rate (a “floor”) of 0 percent and a cap of 6 percent to 9 percent. Only the crediting rate is exposed to the fluctuations of the S&P 500—not the cash values on the credit union’s balance sheet. Each month, interest is credited based on the change in the 12-month look-back for the S&P 500, subject to the floor and cap. Some carriers waive mortality costs if the crediting rate is 0 percent, creating a true 0 percent floor, while others will continue to deduct such costs, resulting in a slightly negative yield for that month. Indexed universal life insurance is less predictable and harder to include in a budget; however, a 10-year comparison of IUL to UL shows that IUL outperformed the more common UL approach. As a result, IUL may be appropriate as part of a larger BOLI portfolio.
Another design consideration is how to implement BOLI. If a credit union has fewer than 29 employees, the only option is “regular issue.” With RI, the insurance is underwritten with a medical exam, lab samples and possible review of medical records. As a result, RI can take up to 60 days to implement, and there are inherent health privacy concerns surrounding the medical information.
Credit unions with 29 or more employees may qualify for “Guaranteed Issue” insurance. With GI, the credit union objectively identifies a group of at least 10 officers (10 highest paid, VPs and above, etc.) that is accepted by the carrier. Each person in the group is then asked to consent to the purchase of BOLI. There are no invasive questions or tests, and medical records are not retrieved. A GI placement can be implemented in a week to 10 days. The simplicity and speed of implementing GI, however, comes with a trade-off: The yield with GI is generally about 15-20 basis points lower than with RI, although the credit union can begin enjoying BOLI earnings with GI sooner.
Business-owned life insurance can be a powerful asset for a credit union to own. A thorough pre-purchase analysis, modeled after the regulatory guidance for banks and conducted with the help of an experienced vendor, can help you understand the nuances and design a program that matches your objectives.
Scott Richardson is founder, president and CEO of IZALE Financial Group, Elgin, Ill., which serves financial institution clients nationwide from offices in six states, providing executive benefits, BOLI solutions, and fee income strategies.