Why do bank holding companies purchase bank-owned life insurance?
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Why do bank holding companies purchase bank‑owned life insurance? Rebel A. Cole1 · Travis Davidson2 · Hongxia Wang3 Accepted: 21 September 2020 © Springer Science+Business Media, LLC, part of Springer Nature 2020
Abstract Bank-owned life insurance (BOLI) is life insurance purchased by bank holding companies (BHCs) for key employees, whose proceeds can be shared by the company and employees’ heirs. We investigate reported benefits of purchasing BOLI to shed light on the dramatic increase in BOLI assets using a sample of 2040 firm-year observations from 2004 to 2013. We document that a BHC owning BOLI enjoys an average annual earnings increase of $12.5 million and an estimated annual tax shield of $3.4 million. This tax shield is nearly twice the size of average total CEO compensation. We provide empirical evidence that BOLI complements other forms of executive compensation. We empirically test potential agency costs associated with using BOLI as compensation but find no evidence of such costs. Further investigation shows that BHCs use BOLI to attract talented executives and benefit shareholders. We conclude that the significant benefits documented in this study provide convincing rationale for the increasing use of BOLI in recent years. Keywords Corporate governance · Executive compensation · Bank-owned life insurance · Bank holding company · Bank holding company performance JEL Classification G21 · G22 · G34
1 Introduction Bank-owned life insurance (BOLI) is life insurance purchased by a financial institution to cover the loss incurred due to the death of a key employee by providing a financial cushion until a successor takes office. Because the financial institution typically owns the policy, it not only receives the death benefits, but also incurs investment risk and accrues investment income as the cash surrender value of the policy increases over time. In the past decade, the use of BOLI has increased significantly. Aggregate BOLI assets in our sample have * Travis Davidson [email protected] 1
College of Business, Florida Atlantic University, Boca Raton, FL 33431, USA
2
College of Business Annex 205, Ohio University, Athens, OH 45701, USA
3
Coastal Carolina University, Wall 101C, Conway, SC 29528, USA
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almost quintupled from $25.8 billion in 2003 to $124.2 billion by year-end 2013.1 Given the significant increase in the use of BOLI, the Office of the Comptroller of the Currency (OCC) and three other government regulatory agencies jointly issued a statement in 2004 that provided guidelines for purchasing BOLI. They identified multiple sources of potential risk associated with BOLI and recommended risk management strategies for BOLI usage (OCC 2004).2 Davidson (2017) finds a positive relation between BOLI and liquidity risk, credit risk, and interest-rate risk, providing empirical evidence supporting the concerns of regulators. Given the concerns, it is not clear why BOLI use continues to grow so dramatically and what benefits BHCs attain from their purchas
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