BOLI, bonds and banks: Accounting for early surrender

By Donald B. Susswein, Virginia Li and Joseph Wiener

Recent increases in market interest rates are leading some banks to consider surrendering their bank-owned life insurance to reinvest the proceeds (net of a tax charge) in a new BOLI policy with a higher yield. One of the Big Four accounting firms has suggested that such a “surrender and redeploy” transaction could call into question the deferred tax treatment of the new policy as well as any existing policies not yet surrendered. How realistic is this concern?

We reviewed that issue from our individual professional perspectives as tax and financial product experts with experience working with similar issues. Our views are not necessarily those of our firm.

Taking the broadest possible perspective, our analysis compared the financial and regulatory accounting treatment of BOLI and corporate-owned life insurance to the treatment of conventional debt securities, including securities classified as “held to maturity” or “available for sale.”

Our research and analysis conclude that accounting and regulatory authorities may view the economics of BOLI as similar to that of a conventional debt security classified as “held to maturity.” HTM securities are not periodically revalued based on temporary fluctuations in their market values because those temporary fluctuations may be less important for securities that will be held to maturity.

BOLI policies are similarly valued at their stated cash surrender value, without regard to fluctuations in market interest rates, and are generally not required to record any deferred tax liability for the possibility of a future tax cost that would be imposed if they decided to surrender the policy before the death of the insured. That tax treatment is available only if the BOLI policy is “expected” to be held until the death of the insured, a concept that is somewhat similar to the concept of a “held to maturity” bond. However, the exact meaning of the “expectations” test is unclear and is less developed than the HTM standards for conventional debt instruments.

Most important, for HTM securities, the accounting and regulatory standards impose a “taint” on a bank’s entire portfolio of HTM bonds if the bank sells certain portions of its HTM securities or reclassifies certain portions of them as “available for sale.” In that case, none of the bank’s formerly HTM securities (even those that might ostensibly meet the HTM standard, standing alone) can continue to be classified that way, with potentially adverse accounting results. The “taint” may be lifted after several years if the bona fides of the bank’s classification policies are reestablished.

Our full analysis and research does not reach any conclusions as to what current financial accounting or regulatory accounting standards require. The paper does conclude that accounting or regulatory authorities seeking a reasonable way to apply, clarify or reform the current “expectations” standard may well conclude that a similar “tainting” rule should be applied, either as a new rule or as an interpretation of the current “expectations” standard to BOLI and COLI policies involved in a “surrender and redeploy” transaction. That could produce a similar effect to what one of the Big Four firms has already suggested may be currently required.

Donald B. Susswein is a tax lawyer and principal with RSM US. Contact him at [email protected].

Virginia Li is a Certified Public Accountant and partner with RSM US. Contact her at [email protected].

Joseph Wiener is a tax lawyer and senior manager with RSM US. Contact him at [email protected].