Building A Better Retirement through BOLI
Article By: T. Stephen Johnson
As community banks continue to cope with the realities of this post-recession environment, many C-level executives no longer see retirement at the age of 65 as a feasible option. Likewise, directors lured by the potential returns are pondering why they should continue to serve the board. Shareholders’ returns on investment are significantly lower since the implementation of Dodd-Frank due to costs of new regulatory requirements, and premiums paid in bank sales currently average around 1.2X book value. Those facts present problems for people hoping that the risk they took in investing their time and money in a new bank would pay off for retirement. What’s worse is that many involved are losing the motivation to perform.
To provide a bit of context, traditionally, organizers of a new community bank would receive warrants for purchasing additional shares in the bank at the original issue price that expired in 10 years. This was allowed by regulators to compensate for the time and risk associated with organizational expenses if the group was not ultimately approved for a bank charter. Due to market conditions, these warrants are now relatively worthless to key players in the startup effort; however, all is not lost for those still hoping for some form of reward for their efforts.
Insert bank-owned life insurance, better known as BOLI. At its most basic level as it relates to retirement, BOLI is a way for banks to fund post-retirement benefits for key employees and directors on a tax-free basis. Its tax-free nature provides yields that range from 100 – 300 basis points more than a bank’s lowest earning investment. That yield difference in the opportunity cost is what provides the funding towards employee retirement benefits.
Banks can allocate up to 25% of Tier 1 capital to life insurance, and those that have access to capital with the capacity to add BOLI are increasingly doing so. In Q1 of 2015, 58.9% of all banks in the U.S. held a combined $151 billion of BOLI assets, up from 49.1% of banks and $127 billion of assets 5 years ago in 2010.
Sometimes we forget that compensation is an investment made by the shareholders to yield increased shareholder value. It’s time for banks to provide compensation plans that drive executive performance and creates a new culture. Key employees should be able to retire and maintain a similar standard of living, which is what BOLI plans are structured to provide.