Bank Purchases of Life Insurance
Guidelines for National Banks
Bulletin 96-51
September 20, 1996

TO: Chief Executive Officers of all National Banks, Department
 and Division Heads, and all Examining Personnel
 
PURPOSE

This bulletin replaces Banking Circular 249 (Rev.), Bank
Purchases of Life Insurance, dated May 9, 1991. This bulletin
provides general guidelines for national banks to help ensure
that bank purchases of life insurance are consistent with safe
and sound banking practices.

BACKGROUND

Corporate-owned life insurance (COLI) includes all life insurance
that a corporation, such as a bank, purchases and owns or has a
beneficial interest in. Life insurance is a financial instrument
which serves many necessary and useful business purposes. 
However, as with most financial instruments, COLI can be
complicated and is not without risk. Furthermore, COLI
transactions are unique and represent activities which differ
greatly from the main business activity of most corporations. 
Some national banks have purchased COLI without fully
understanding the transactions and the associated risks.

This bulletin is designed to help national banks make informed
decisions consistent with safe and sound banking practices. 
Bankers should complete a thorough analysis before purchasing
COLI. This bulletin sets forth supervisory policy, including
minimum standards for pre-purchase analyses, applicable to the
purchase of COLI by national banks. The bulletin also includes
discussions of the most common uses of COLI and the associated
risks.

LEGAL AUTHORITY

The authority for national banks to purchase and hold an interest
in life insurance is found in 12 USC  24(Seventh). The law
provides that national banks may exercise "all such incidental
powers as shall be necessary to carry on the business of
banking." The OCC has further delineated the scope of that
authority through regulations, interpretive rulings, and letters
addressing the use of life insurance for purposes incidental to
banking. Those purposes include: key-person insurance, life
insurance on borrowers, life insurance purchased in connection
with employee compensation and benefit plans, and life insurance
taken as security for loans.[1] These specific bank uses of life
insurance are illustrations rather than legal restrictions. 
Other permissible uses of bank owned life insurance may exist. A
purchase of life insurance is incidental to banking, and
therefore, legally permissible, if it is convenient or useful in
connection with the conduct of the bank's business. This
authority is subject to supervisory considerations, however, and
such life insurance holdings must be consistent with safe and
sound banking practices.

SUPERVISORY POLICY 

The purchase of permanent life insurance (permanent insurance)[2]
policies subjects the policyholder to several risks. The cash
surrender value[3] (CSV) of most life insurance products is
subject to credit risk. Usually, the CSV is a long-term,
unsecured, nonamortizing obligation of the insurance company. 
The CSV is also subject to several other risks, such as
transaction risk, interest rate risk, liquidity risk, compliance
risk, and price risk. 

National banks holding life insurance in a manner inconsistent
with safe and sound banking practices may be subject to
supervisory action. This bulletin outlines supervisory
considerations to be used in making this assessment. Supervisory
action may include, but is not limited to, partial surrender or
divesture of affected policies.
 
Pre-purchase Analysis:

The safe and sound use of bank owned life insurance depends on
effective senior management and board oversight. Regardless of
the bank's financial capacity and risk profile, the board must
understand the role bank owned life insurance plays in the
overall business strategies of the bank. 
The board's role in analyzing and overseeing bank owned life
insurance should be commensurate with the size, complexity, and
risk inherent in the transaction. Although the board may
delegate decision-making authority related to bank purchases of
life insurance to management, the board remains responsible for
ensuring that purchases of life insurance are consistent with
safe and sound banking practices.

The objective of the pre-purchase analysis is to help ensure that
the bank understands the risks, rewards, and unique
characteristics of COLI. As such, each purchase or assumption of
a beneficial interest in COLI should be preceded by a thorough
pre-purchase analysis. At a minimum, the pre-purchase analysis
should consider the following standards.

I. Determination of the Need for Insurance

The bank should determine the need for insurance by identifying
the specific risk of loss or obligation to be insured against. 
The existence of a risk of loss or an obligation does not
necessarily mean that a national bank can purchase or hold an
interest in life insurance. For example, a national bank may not
purchase life insurance on a borrower as a mechanism for
effecting a recovery on obligations that have been charged-off,
or are expected to be charged-off for reasons other than the
borrower's death.[4] Also, a national bank should surrender or
otherwise dispose of permanent life insurance acquired through
debts previously contracted (DPC) within a short time frame,
generally 90 days, of obtaining control of the policy.[5]

Additionally, the purchase of insurance to indemnify a national
bank against a specific risk does not relieve a national bank
from other responsibilities related to managing that risk. For
example, a national bank may purchase life insurance to indemnify
itself from the loss of a "key-person." However, "key-person"
life insurance should not be used in place of, nor does it
diminish the need for, adequate management or "key-person"
succession planning.[6]

II. Quantification of the Amount of Insurance Needed

The bank should estimate the size of the obligation or the risk
of loss and ensure that the amount of insurance purchased is not
excessive in relation to the estimate. For such estimates,
national banks may include the cost of insurance and the time
value of money in determining the amount of insurance needed. 
The estimate of the amount of insurance needed should be based on
reasonable financial and actuarial assumptions. In situations
where a national bank purchases life insurance on a group of
employees or a homogenous group of borrowers, it can estimate the
size of the obligation or the risk of loss for the group on an
aggregate basis and compare that to the aggregate amount of
insurance purchased. 

Purchasing or holding excessive permanent insurance may be an
unsafe and unsound practice if it subjects the bank to
unwarranted risks. Bank-owned life insurance subjects the bank
to several risks which may be significant. The risks are
explained in the "Risks Associated With COLI" section of this
bulletin. 

III. Vendor Selection

The vast majority of COLI purchases are made through vendors,
either brokers/consultants or agents. Most corporations have
used brokers/consultants. However, some corporations have
purchased COLI through agents who work for specific insurance
companies. It is also possible to purchase COLI directly from
insurance carriers without using a vendor.

The role of the vendor, if any, depends on the type of vendor
selected. For example, the vendor may be an agent of a specific
insurance company who serves as the bank's primary contact with
the insurance company, explains the company's various products,
and helps the bank in making product selection. Or, the vendor
may be an independent broker who has established working
relationships with many insurance companies. In addition to
being the bank's primary contact with the insurance company, the
broker will work with the bank in selecting a carrier and in
designing, negotiating, and administering/servicing the COLI. 

The bank does not have to use a vendor. In deciding whether or
not to use a vendor or what type of vendor to use, the bank
should consider its knowledge of COLI, the amount of resources it
can and is willing to spend servicing/administering the COLI, and
the benefits a vendor may provide. Depending on the role of the
vendor, the vendor's services can be extensive and critical to
successful implementation and operation of a COLI plan. If the
bank uses a vendor, it should make appropriate inquiries to
satisfy itself regarding the vendor's ability to honor its
commitments, which may be long-term. In assessing the vendor's
ability to honor its commitments, the bank should typically
review the vendor's services, general reputation, experience, and
financial capacity. The nature and thoroughness of the review
should be determined by the size and complexity of the potential
COLI purchase.

IV. Carrier Selection

COLI plans are typically of long duration and may represent
significant risks for the bank. Therefore, carrier selection is
one of the most critical steps in a COLI purchase. The bank
should review the product design, pricing, and administrative
services of the carrier(s) and compare them with the bank's
needs. In addition, the bank should also review the carrier's
ratings, general reputation, experience in the market place, and
past performance. A broker/consultant, if used, may assist the
bank in this regard. 

Furthermore, before purchasing life insurance, the bank should
perform a credit analysis on the selected carrier(s) in a manner
consistent with safe and sound banking practices for commercial
lending. A more complete discussion of the credit analysis is
included in the "Credit Risk" section of this bulletin.

V. Review the Characteristics of the Available Insurance
 Products

There are a few basic types of life insurance products in the
marketplace. However, these products can be combined and
modified in many different ways. The resulting final product can
be quite complex. The bank should review the characteristics of
the various insurance products available. It should select the
product or products with characteristics that match the
institution's objectives and needs. To do this, the bank should
thoroughly analyze and understand the products being considered. 

When purchasing insurance on "key-persons" and individual
borrowers, the bank should consider whether the bank's need for
the insurance will be eliminated before the insured individual
dies. In such cases, term or declining term insurance may be the
most appropriate form of life insurance.[7]


VI. Analyze the Benefits of COLI

The bank should analyze the benefits of COLI purchases being
considered. The analysis should include an assessment of how the
purchase will accomplish the objective specified in (I),
Determination of the Need for Insurance. It should also include
an analysis of the anticipated performance of the insurance. A
more complete discussion of this analysis is included in the
"Transaction Risk" section of this bulletin.

VII. Determine the Reasonableness of Compensation Provided to the
 Insured Employee if the Insurance Results in Additional
 Compensation

Split-dollar insurance arrangements[8] typically provide
additional compensation and/or other benefits to the employee. 
Before a national bank enters into a split-dollar arrangement, it
should identify and quantify the compensation objective, and
ensure that the arrangement is consistent with the stated
objective. Also, the bank should combine the compensation
provided by the split-dollar arrangement with all other
compensation to ensure that total compensation is not excessive. 
Excessive compensation is prohibited as an unsafe and unsound
practice. Guidelines for determining excessive compensation can
be found in Appendix A to 12 CFR Part 30 Interagency Guidelines
Establishing Standards for Safety and Soundness.

VIII. Analyze the Associated Risks and the Bank's Ability to
 Monitor and Respond to those Risks

Ownership of or beneficial interests in COLI may subject a
national bank to several risks. These risks include:
transaction, credit, interest rate, liquidity, compliance, and
price. A bank's pre-purchase analysis should include a thorough
evaluation of these risks. An explanation of each risk is
included in the "Risks Associated With COLI" section of this
bulletin.

Furthermore, the pre-purchase analysis should allow a national
bank to determine whether the transaction is consistent with safe
and sound banking practices. In making this determination, a
national bank should consider, among other things:

. The complexity of the transaction.
. The size of the transaction relative to the bank's capital.
. The diversification of the credit risk.
. The financial capacity of the bank.
. The financial capacity of the insurance carrier(s).
. The bank's ability to identify, measure, monitor, and control
 the associated risks.

In assessing the size of the transaction, a national bank should
consider the CSV relative to its capital levels at the time of
purchase. The bank should also consider projected increases in
the CSV and projected changes in capital levels for the duration
of the contract.

Consistent with prudent risk management practices, a national
bank should establish internal quantitative guidelines. These
guidelines generally limit the aggregate CSV of policies from any
one insurance company and the aggregate CSV of policies from all
insurance companies. Among other things, a bank should consider
the legal lending limits (12 CFR Part 32) and concentration of
credit guidelines (OCC Bulletin 95-7, dated February 9, 1995)
when establishing the respective limits.

IX. Evaluate Alternatives

Some COLI purchases involve indemnifying the bank against a
specific risk. For example, COLI is sometimes purchased to
indemnify the bank against the potential for loss arising from
the untimely death of a "key-person." As an alternative to
purchasing COLI, a bank may choose to self-insure against this
risk. Other COLI purchases are used to recover costs or provide
for employee benefits. In these cases, instead of purchasing
COLI, a bank may choose to invest the money that would have been
used to purchase the insurance in other assets. Regardless of
the purpose of COLI, a complete pre-purchase analysis will
include an analysis of the alternatives.

X. Document Decision

The primary objective of this bulletin is to provide guidelines
that will help national banks make informed decisions consistent
with safe and sound banking practices. In doing so, national
banks generally should consider the pre-purchase analysis just
described. A national bank should maintain documentation
adequate to show that the bank made an informed decision. The
bank should continue to monitor that decision based on the
standards set forth in this bulletin. 

RISKS ASSOCIATED WITH COLI

For purposes of the OCC's discussion of risk, examiners assess
banking risk relative to its impact on capital and earnings. 
From a supervisory perspective, risk is the potential that
events, expected or unanticipated, may have an adverse impact on
the bank's capital or earnings. The OCC has defined nine
categories of risk for bank supervision purposes. These risks
are: Credit, Interest Rate, Liquidity, Price, Foreign Exchange,
Transaction, Compliance, Strategic, and Reputation. These
categories are not mutually exclusive; any product or service may
expose the bank to multiple risks. For analysis and discussion
purposes, however, the OCC identifies and assesses the risks
separately.

The applicable risks associated with COLI are: Transaction,
Credit, Interest Rate, Liquidity, Compliance, and Price. The
definitions of these six risks are summarized below. For
complete definitions, see the "Bank Supervision Process" booklet
of the Comptroller's Handbook. An analysis of how each of these
risks impact the decision to purchase and hold COLI is set forth
in the following paragraphs.

Transaction Risk 

Transaction risk is the risk to earnings or capital arising from
problems with service or product delivery. The degree of
transaction risk associated with COLI is a function of a bank not
fully understanding or properly implementing a transaction. In
addition to following the other guidelines included in this
bulletin, national banks should take two additional steps to help
reduce transaction risk. Bank management should have a thorough
understanding of how the insurance product works and the
variables that dictate the product's performance. The variables
most likely to affect product performance are the policy's
interest crediting rate,[9] mortality cost,[10] and other expense
charges. Typically, the most significant variable is the
interest crediting rate, followed by the mortality cost. 
Therefore, before purchasing COLI, a national bank should analyze
projected policy values (CSV and death benefits) from multiple
illustrations provided by the carrier. Banks should consider
using different interest crediting rates and mortality costs
assumptions for each illustration. 

Bank management should also understand and analyze how COLI will
affect the bank's financial condition. Given the anticipated
performance of the insurance, management should analyze the
effect on the bank's earnings, capital, and liquidity. 
Management should also consider the impact on the bank's earnings
and capital should the bank, for any reason, surrender the
insurance before maturity at the death of the insured.

Credit Risk

Credit risk is the risk to earnings or capital arising from an
obligor's failure to meet the terms of any contract with the bank
or otherwise fail to perform as agreed. All life insurance
policyholders are exposed to credit risk. The credit quality of
the insurance company and duration of the contract are key
variables. With term insurance, credit risk arises from the
insurance carrier's contractual obligation to pay death benefits
upon the death of the insured. Credit risk is primarily a
function of the insurance carrier's ability (financial condition)
and willingness to pay death benefits as promised. Credit risk
may be reduced by the support provided by state insurance
guaranty associations or funds. A bank's credit exposure through
the ownership of term life insurance is not reflected on the
bank's balance sheet.

With permanent insurance, credit risk arises from the insurance
carrier's obligation to pay death benefits upon death of the
insured and from its obligation to return the CSV to the
policyholder upon request. The risk is similar to that with term
insurance, but there are a few differences. With most permanent
insurance COLI plans, the expected time frame for collection of
death proceeds is extremely long term. Additionally, the CSV is
an unsecured, long-term, and nonamortizing obligation of the
insurance carrier. The risk inherent in the insurance company's
failure to return the CSV value is reflected on the bank's
balance sheet. 

Before purchasing life insurance, bank management should evaluate
the financial condition of the insurance company and continue to
monitor its condition on an ongoing basis. In addition to
reviewing the insurance carrier's ratings, the bank should
conduct an independent financial analysis consistent with safe
and sound banking practices for commercial lending. As with
lending, the depth and frequency of the analysis should be a
function of the relative size and complexity of the transaction. 

Interest Rate Risk

Interest rate risk is the risk to earnings or capital arising
from movements in interest rates. General account[11] products
expose the policyholder to interest rate risk. The interest rate
risk of these products is primarily a function of the policy's
interest crediting rate. Interest crediting rates are
established by the insurance carrier. Over the long term,
interest crediting rates are primarily a function of the
carrier's investment portfolio performance. The policy's CSV is
negatively affected (grows at a slower rate) by a declining
interest crediting rate. Since a bank's investment in permanent
insurance is recorded at the policy's CSV, the bank's earnings
decline as the policy's interest crediting rate declines.

Due to the interest rate risk inherent in this product, it is
particularly important that management fully understand the risk
before purchasing the policy. Before purchasing permanent
insurance, bank management should:

. Review the policy's past performance over various business
 cycles.
. Analyze projected policy values (CSV and death benefits).
. Consider having the carrier use a different interest crediting
 rate for each set of policy projections.

Variable or separate account[12] products may also expose the
bank to interest rate risk depending on the types of assets held
in the separate account. For example, if the separate account
assets consist solely of treasury securities, the bank is exposed
to interest rate risk in the same way as holding treasury
securities directly in its investment portfolio. However,
because the bank does not control the separate account assets, it
is more difficult for the bank to control this risk. Therefore,
before purchasing a separate account product, bank management
should thoroughly review and understand the instruments governing
the investment policy and management of the separate account. 
Management should understand the risk inherent within the
separate account and ensure that the risk is appropriate for the
bank. Also, the bank should establish monitoring and reporting
systems that will enable the bank to monitor and respond to price
fluctuations.

Liquidity Risk 

Liquidity risk is the risk to earnings or capital arising from a
bank's inability to meet its obligations when they come due,
without incurring unacceptable losses. Usually, life insurance
policies are not marketable and are illiquid. A secondary market
for life insurance does not exist. Although the CSV of policies
can be accessed quickly, it typically involves substantial loss. 
To access the CSV, the bank must withdraw from or borrow against
the policy. This may subject the bank to surrender charges,
taxes on the gain, and a tax penalty. In addition, the
policyholder generally does not receive any cash flow until the
death benefit is paid. The lack of liquidity in the product is
more significant given that banks normally purchase life
insurance policies through a conversion of a liquid asset (cash
or marketable securities).

Before purchasing permanent insurance, management should
recognize the illiquid nature of the product and ensure the bank
has the long-term financial flexibility to hold this asset in
accordance with its expected use. The inability of a bank to
hold the life insurance until maturity (collection of death
benefits) may compromise the success of the COLI plan.

Compliance Risk

Compliance risk is the risk to earnings or capital arising from
violations of, or non-conformance with, laws, rules, regulations,
prescribed practices, or ethical standards. Failure to comply
with applicable laws, rules, regulations, and prescribed
practices (including this bulletin) could compromise the success
of a COLI program and result in significant losses for the bank
as a result of fines, penalties, or loss of tax benefits. 
Because tax benefits are critical to the success of most COLI
plans, management of a national bank should exercise caution to
ensure that their plans comply with all applicable tax laws. In
addition, bank management should ensure compliance with other
applicable legal and regulatory standards. Other common legal
and regulatory considerations include compliance with state
insurable interest laws, the Employee Retirement Income Security
Act of 1974 (ERISA), sections 23A and 23B of the Federal Reserve
Act, 12 CFR Part 215 (Regulation O), and Appendix A to
12 CFR Part 30 Interagency Guidelines Establishing Standards
for Safety and Soundness. Due to the significance of the
compliance risk, a national bank may want to seek the advice of
qualified counsel.

Price Risk

Price risk is the risk to earnings or capital arising from
changes in the value of portfolios of financial instruments. 
Typically, the policyholder of separate account products assumes
all price risk associated with the investments within the
separate account. Usually, neither the CSV nor the interest
crediting rate on separate account products is guaranteed by the
carrier. The amount of price risk is dependent upon the type of
assets held within the separate account.

Because the bank does not control the separate account assets, it
is more difficult for the bank to control the price risk. 
Therefore, before purchasing a separate account life insurance
product, bank management should thoroughly review and understand
the instruments governing the investment policy and management of
the separate account. Management should understand the risk
inherent in the separate account and ensure that the risk is
appropriate for the bank. Also, bank management should establish
monitoring and reporting systems that will enable them to monitor
and respond to price fluctuations.

ACCOUNTING CONSIDERATIONS

National banks should follow generally accepted accounting
principles (GAAP) for financial reporting and call report
purposes. Financial Accounting Standards Board (FASB) Technical
Bulletin 85-4, "Accounting for Financial Purchases of Life
Insurance" (TB 85-4) discusses how to account for investments in
life insurance. The guidance set forth in TB 85-4 is generally
appropriate for all forms of COLI.

Under TB 85-4, a national bank should record its interest in the
policy's CSV as an "other asset." The increase in the CSV over
time would be recorded as "other noninterest income." In
accordance with call report requirements, the bank should update
its interest in the CSV at least quarterly.

APPLICATION OF THE GUIDELINES

The guidelines in this bulletin are applicable to all purchases
of life insurance entered into after the date of this bulletin. 
Purchases of life insurance policies entered into before the date
of this bulletin will be evaluated in the following manner.

Policies purchased after issuance of Banking Circular (BC) 249,
Bank Purchases of Life Insurance

Policies purchased after February 4, 1991, should comply with
either the guidelines contained in BC 249 or with the guidelines
in this bulletin. 

Policies purchased before the issuance of BC 249, Bank Purchases
of Life Insurance

Policies purchased before February 4, 1991, are provided a "safe
harbor" if the following three conditions are met:

. The policies are convenient or useful in connection with the
 conduct of the bank's business.
. The policies do not threaten the safety and soundness of the
 institution.
. The policies do not represent insider abuse or violate other
 laws, rules, or regulations.

If these conditions are met, no further action by the bank is
needed. However, the OCC may require corrective action at any
time during the bank's ownership or while it has a beneficial
interest in a policy, if any of the three conditions are not met. 
Such determinations will be made on a case by case basis.

ORIGINATING OFFICE

For further information about this bulletin, contact the Office
of the Chief National Bank Examiner (202) 874-5170.



Jimmy F. Barton
Chief National Bank Examiner

END NOTES
[1] The appendix contains a discussion of each of these four uses
of COLI.

[2] Permanent insurance and cash surrender value are described in
the appendix on page 1.

[3] The purchase of life insurance on borrowers whose obligations
have been charged-off, or are expected to be charged-off, is
further discussed in the appendix on pages 6-7.

[4] Life insurance acquired through DPC is further discussed in
the appendix on page 7.

[5] The relationship between "key-person" insurance and
management succession planning is discussed in the appendix on
pages 4-5. 

[6] "Key-person" insurance and life insurance on borrowers are
discussed further in the appendix on pages 4-7.

[7] Split-dollar insurance arrangements are defined and discussed
in the appendix on pages 3-4.

[8] The interest crediting rate refers to the gross yield on the
investment in the insurance policy, i.e., the rate at which the
cash value increases before considering any deductions for
mortality cost, load charges, or other costs that are
periodically charged against the policy's cash value. Insurance
companies frequently disclose a current interest crediting rate
and a guaranteed minimum interest crediting rate. The guaranteed
rate may be less than the current rate. As a result, the
potential exists for future declines in the interest crediting
rate.

[9] Mortality cost represents the cost imposed on the
policyholder by the insurance company to cover the amount of pure
insurance protection for which the insurance company is at risk. 

[10] General account products are defined in the appendix on page
2.

[11] Variable or separate account products are defined in the
appendix on page 2.