Presentation on theme: "Sample insurance constraints"— Presentation transcript:
0 Business Owned Life Insurance (“BOLI”) John Simone Client Advisor, Structured Solutions GroupBusiness Owned Life Insurance (“BOLI”)FOR INSTITUTIONAL USE ONLY. Not for public distribution.
1 Insurance companies operate in a universe of strict capital and regulatory constraints Sample insurance constraintsCapital requirements and efficiency within risk-based capital frameworkBook incomeBalance sheet diversificationState insurance regulation / rating agencies restrictionsSubstantial rise in employee benefitsRising cost of health benefits
2 Benefit liabilities are rapidly growing Average percentage increase in health insurance premiums (1988–2007)Source: Kaiser/HRET Survey of Employer-Sponsored Health Benefits, ; KPMG Survey of Employer-Sponsored Health Benefits, 1993, 1996; The Health Insurance Association of America (HIAA), 1988, 1989, 1990; Bureau of Labor Statistics, Consumer Price Index, U.S. City Average of Annual Inflation (April to April), ; Bureau of Labor Statistics, Seasonally Adjusted Data from the Current Employment Statistics Survey, (April to April)Note: Data on premium increases reflect the cost of health insurance premiums for a family of four. The average premium increase is weighted by covered workers.1 Estimate is statistically different from estimate for the previous year shown (p<.05), No statistical tests are conducted for years prior to 1999.
3 What is COLI/BOLI?Corporate Owned Life Insurance (“COLI”) and Business Owned Life Insurance (“BOLI”) represent the same insurance structure – a group variable life insurance contract purchased on the lives of employees whereby the company purchasing the policy is the owner and beneficiary of the policyCOLI differs from BOLI in that it is commonly used by corporations to “hedge” or offset a specific benefit liability such as a non-qualified deferred compensation plan. Any gains or losses in the policy value (asset) is offset against gains and losses in plan’s obligation to participants (liability). Because of this direct matching between assets and liabilities, COLI does not provide any incremental earnings benefit to the purchaser of the policyIn contrast to COLI, BOLI is used by financial institutions as an investment vehicle to informally hedge broad based benefit liabilities such as employee health benefits. Typically there is not a direct asset and liability offset, creating a marginal increase in earnings to the owner of the policy. Typically, BOLI uses a Stable Value Protection (“SVP”) wrapper to smooth gains and losses associated with the contract’s accounting treatment to minimize period to period earnings volatility
4 What is a BOLI transaction? Three steps of structuring the transactionSize the Transaction: determine number of employees to insure and capital commitment to BOLI assetStructure the Contract: choose insurance carrier, select investment option(s) and evaluate SVPReceive Periodic Death Benefits: purchaser receives it’s premium plus investment gains minus expenses in the form of tax free death benefitsBOLI provider structures, transacts and sources insurance policyBOLI BuyerA life insurance company purchases a policy to hedge against rising healthcare costs and future liabilitiesSeparate Account BOLIHeld as a separate account on balance sheet of the insurance carrierAllows BOLI purchaser to choose from a variety of investment optionsBuys policy from third partyStable Value WrapProvided by a third partyJ.P Morgan Asset ManagementManages underlying investment optionsUndertakes to provide stable redemption valuesSource: J.P. Morgan Asset Management
5 Evolution of the BOLI marketplace Recent regulatory action has made it easier for insurance companies and other firms to participate in BOLI1991:BOLI Marketplace created by OCC1994:Limited number of insurers participate in BOLI1999:Insurers begin to invest in Separate Account SVP contracts2006:COLI Best Practices Act (“COLI BPA”) is made law as part of the Pension Protection ActIRS Revenue Procedure states insurers receive the full tax benefits of BOLI if they meet the safe harbor provisions of the COLI BPA
6 BOLI has favorable GAAP and Statutory Accounting treatment GAAP Accounting treatmentBalance Sheet: “Other Asset”Income Statement: “Other Income,” “above the line treatment due for income is recurring in nature.” Please note that BOLI is accounted for under FASB 85-4 which states that the asset is booked at ‘net realizable value’. Therefore, all realized and unrealized gains and losses of the contract are booked through the income statement which is similar to how a trading security is treated under FASB 115. Because of this treatment, many financial institutions have found it advantageous to ‘wrap’ their BOLI assets with Stable Value Protection to achieve a book value accounting treatment whereby gains and losses are amortized over a period of time to minimize period to period volatilityStatutory Accounting treatmentBalance Sheet: BOLI is characterized as “Aggregate Write-In Other Than Invested Asset” on the Statutory Accounting Statements.Income Statement: BOLI gains are part of Net Investment Income via Aggregate Write-Ins for Investment Income
7 Regulatory capital treatment Statement of Statutory Accounting Principles (SSAP) 21-BOLI is an Admitted AssetNAIC Life Risk-Based Capital Report—zero percent default RBC confirmed by NAICRisk-Based Capital Charge for P&C: 5%
8 Rating Agency, IRS and NAIC Guidelines AM Best BCAR Models for 2007 and 2008: BOLI carries the same risk charge of Class 1 BondsS&P Risk-Based Capital Model: The asset default charges are the same as those applied to bond securities: For Separate Account SVP, S&P will evaluate the SVP counter party and agreementIRS Revenue Procedure released in September of 2007 provides clear guidelines on the tax treatment specifically for insurersNAIC Liquidity/Cash Flow Testing: no negative impact when applying the liquidity/cash flow test to BOLI. Insurers that utilize SVP, use the current crediting rate to model liquidity/cash flow of the BOLI contract which is the current book value
9 Case study/marginal benefit analysis: Why is this an attractive investment? $ millions1 Forward looking returns (10 to 15 years) based on J.P. Morgan Asset Management Capital Market Assumptions as of 11/30/082 RBC rates will be 0% on BOLI if XYZ is owner and beneficiary RBC rate is 0% because BOLI is reported on "Aggregate write-in for other than invested assets” line of statutory statement (current instructions)3 Assumes XYZ invests its statutory surplus in Investment Grade Bonds4 $ designates dollar amount5 % designates percentage amount6 BOLI Contract Expenses: Investment Management: 17 BPS: SVP 20 BPS: Insurance Expenses 43 BPS. Above chart is shown for illustrative purposes only.
10 Why invest in BOLI now?Recent regulatory changes give clear guidance to insurance companiesTax efficiencyBalance sheet and income statement advantagesCapital efficient diversificationTransparency