Stable Value Protection (SVP) features are a ubiquitous aspect of many Bank-Owned Life Insurance (BOLI) programs. As an ongoing result of the Great Recession, the prolonged low interest rate environment, and the recent reduction in corporate tax rates, multiple SVP providers are continuing efforts to de-risk their positions (including seeking to terminate contracts). These actions, coupled with changing investment objectives of policyholders and new SVP entrants seeking market share, are poised to result in a transformation of the BOLI SVP market in the coming years.
As is the case with any transforming market, participants are
well advised to conduct rigorous due diligence, including a
review of the accounting implications of any new SVP feature.
What are BOLI/COLI Products?
Bank-owned life insurance (“BOLI”) (also known as corporateowned life insurance or “COLI”) is a life insurance product in which a bank insures one or more consenting employees (usually key executives) where the bank pays the premiums and is the beneficiary of the policy. BOLI is purchased primarily as a vehicle to fund employee benefits in a tax efficient manner. Investment income, net of insurance fees, accrues in the product on a tax-deferred basis, and death benefits are typically non-taxable under current tax law. However, if the policy is surrendered prior to maturity, the policyholder is responsible for paying the tax on the previously untaxed gain.
The types of policies used in BOLI can vary between wholelife, universal-life, or variable universal-life. BOLI products are typically classified as either general account (GA), separate account (SA) or “hybrid” where the classification is based on the structure of how premiums are invested and interest is credited. For GA BOLI, the investments are held in the insurance company’s general account, the insurance company makes the investment decisions, the cash surrender value is unsecured and available to the general creditors of the insurance company, and the interest rate credited or dividends paid to the BOLI policy is determined by the insurance company and subject to a guaranteed minimum rate. For SA BOLI, the investments are held in separate accounts established by the insurance company that are insulated from the insurance company’s general creditors, the policyholder can select the investment style from investment portfolios that the insurance company makes available, and the policyholder assumes the investment and price risk. A “hybrid” account combines certain features of general (interest crediting rate declared by the insurance company) and separate accounts (assets held in an insulated account).
SA BOLI frequently employs an SVP feature to smooth fluctuations in the market value of the underlying investments (price risk). With an SVP feature, a financial company (the “SVP Provider”) agrees to establish a defined crediting rate process and maintain a record of a “book value” that is distinct from the market value of the underlying investments.
Accounting Considerations Before Replacing an SVP Feature
SVP Providers are becoming more aggressive in replacing older contracts with newer contracts to shore up risk, capital and profitability. Aside from the economic considerations, current policyholders should also consider the accounting implications and consult with their accounting advisor before replacing an SVP feature.
While the accounting literature generally requires the policyholder to record the investment in BOLI at its net realizable value, adjustments may be necessary depending upon the policy design. In a basic policy, the cash value, net of any surrender fees, represents the net realizable value (also referred to as the “cash surrender value” or “CSV”).1 However, certain policy features may complicate the determination of the appropriate carrying value such as:
- What conditions must be satisfied to qualify for the payments?
- Over what period of time will the surrender value be paid?
- If the surrender value will be paid in periods that extend beyond one year, is the amount receivable under the contract subject to discounting?
- Is the post-surrender interest rate different than the presurrender rate?
- Is the post-surrender interest rate a market-based rate?
- What spread, relative to matching duration Treasury rates, do the payments generate?
- Is the rate likely to be reasonable under various economic and interest rate environments?
If it is probable that certain provisions will cause the policyholder to receive a different amount than the CSV and/or the payment period is beyond one year, then the CSV may be required to be discounted or adjusted in another manner.
Due to these complexities, particularly with products that include an SPV feature, consultation with your accounting advisor is recommended before replacing an SVP feature.
Senior Manager, DHG Insurance
Partner, DHG Insurance