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FEDERAL RESERVE BANK OF NEW YORK ai-ioooz/oO M a y 6, 1994 Split-Dollar Life Insurance Arrangements To the Chief Executive Officers o f all State Member Banks and Bank Holding Companies, in the Second Federal Reserve District: L a s t y e a r, th e F e d e ra l D e p o s it In s u r a n c e C o r p o r a tio n (th e " F D I C " ) is s u e d f o r its e x a m in e r s e x te n s iv e g u id e lin e s fo r th e p u r c h a s e o f in s u ra n c e , in c lu d in g s p lit- d o lla r life in s u r a n c e , b y s ta te n o n m e m b e r b a n k s ; a n d th e F D IC s e n t a le tte r to th e c h i e f e x e c u tiv e o f f ic e r s o f a ll s ta te n o n m e m b e r b a n k s re g a r d in g th e ir in s u ra n c e p ra c tic e s . A c o p y o f th e F D I C ’s le tte r is p r in te d h e re in fo r y o u r in f o r m a tio n . S p lit- d o lla r life in s u ra n c e is a ty p e o f life in s u ra n c e in w h ic h th e p u r c h a s e r o f th e p o lic y p a y s th e in s u r a n c e p r e m iu m a n d re c e iv e s o n ly a p o r tio n o f th e d e a th b e n e fit. S p lit- D o lla r L ife In s u r a n c e A r r a n g e m e n ts B e tw e e n a S ta te - C h a r te r e d B a n k a n d Its In s id e r s T h e F D IC g u id e lin e s w e re is s u e d u n d e r s e c tio n 2 4 o f th e F e d e ra l D e p o s it In s u r a n c e A c t, w h ic h w a s e n a c te d a s p a rt o f th e F e d e ra l D e p o s it In s u ra n c e C o r p o r a tio n I m p r o v e m e n t A c t o f 1991 a n d b e c a m e e f f e c tiv e o n D e c e m b e r 19, 1 9 9 2 . S e c tio n 2 4 lim its th e a c tiv itie s a n d e q u ity in v e s tm e n ts o f a ll in s u re d s ta te - c h a r te r e d b a n k s to th o s e a c tiv itie s a n d e q u ity in v e s tm e n ts th a t a re p e r m is s ib le f o r n a tio n a l b a n k s . U n d e r s e c tio n 2 4 , th e F D IC h a s th e s o le r e s p o n s ib ility f o r d e te r m in in g th e p e r m is s ib le a c tiv itie s a n d e q u ity in v e s tm e n ts o f s ta te - c h a r te r e d b a n k s ; th e r e f o r e , th e F D IC g u id e lin e s a p p ly to s ta te m e m b e r b a n k s . In s o m e in s ta n c e s , th e p u r c h a s e o f life in s u r a n c e b y a s ta te - c h a r te r e d b a n k , in c lu d in g s p lit- d o lla r life in s u ra n c e a rr a n g e m e n ts , is o n e o f th e a c tiv itie s a n d e q u ity in v e s tm e n ts g o v e r n e d b y th is s ta tu te . T h e F D IC h a s c o n c lu d e d th a t p a r tic ip a tio n in a s p lit- d o lla r life in s u r a n c e a r r a n g e m e n t is a p e r m is s ib le a c tiv ity f o r a s ta te - c h a r te r e d b a n k o n ly if: (1 ) th e p o lic y m e e ts th e te s ts o u tlin e d in th e O f f ic e o f th e C o m p tr o lle r o f th e C u r r e n c y ’s B a n k in g C ir c u la r 2 4 9 , a c o p y o f w h ic h is a ls o p rin te d o n th e f o llo w in g p a g e s ; a n d (2 ) th e b e n e fits to th e b a n k o ffic e r, d ire c to r, e m p lo y e e , o r p r in c ip a l s h a r e h o ld e r f o r w h o m th e in s u ra n c e is p u rc h a s e d a re r e a s o n a b le . T h e F D IC h a s d e te r m in e d th a t s e c tio n 2 4 a p p lie s to a ll life in s u r a n c e p u r c h a s e s m a d e b y s ta te - c h a r te r e d b a n k s , in c lu d in g th o s e m a d e b e fo re D e c e m b e r 2 0 , 1 9 9 2 . T h u s , i f a s ta te - c h a r te r e d b a n k w is h e s to p u r c h a s e a n in s u ra n c e p o lic y th a t d o e s n o t m e e t th e F D I C ’s tw o s ta n d a r d s s e t fo rth a b o v e , it m u s t o b ta in th e p r io r c o n s e n t o f th e F D IC . T h e F D IC h a s f u r th e r s ta te d th a t a s ta te - c h a r te r e d b a n k p r e s e n tly h o ld in g a n in s u ra n c e p o lic y th a t d o e s n o t m e e t th e s e s ta n d a r d s - w h e th e r o r n o t s u c h a p o lic y w a s p u r c h a s e d b e f o r e D e c e m b e r 2 0 , 1 9 9 2 — m u s t o b ta in th e F D I C ’s p e r m is s io n to re ta in th e M W oA . 2 in s u r a n c e p o lic y . A n y s ta te m e m b e r b a n k h o ld in g a n in s u ra n c e p o lic y th a t d o e s n o t c o n f o r m to th e a f o r e m e n tio n e d F D IC s ta n d a r d s m u s t, u n d e r th e F D I C ’s g u id e lin e s , o b ta in th e F D I C ’s p e r m is s io n to re ta in th e in s u r a n c e p o lic y . In a re c e n t re v is io n to its g u id e lin e s , th e F D IC h a s s u g g e s te d th a t b a n k s e s ta b lis h th e ir o w n in te rn a l c o n c e n tr a tio n lim its f o r in v e s tm e n ts in s p lit- d o lla r life in s u r a n c e p o lic ie s . T h e s e in te rn a l lim its s h o u ld n o t e x c e e d th e m a x im u m a llo w a b le a m o u n ts , i f a n y , th a t e x is t u n d e r a p p lic a b le s ta te la w s o r r e g u la tio n s . In a d d itio n , i f th e a g g r e g a te a m o u n t o f a b a n k ’s in v e s tm e n ts in a ll o f its in s u r a n c e p o lic ie s e x c e e d s 2 5 p e r c e n t o f T ie r 1 c a p ita l, it m a y b e v ie w e d a s a c o n c e n tr a tio n o f c re d it. In a d d itio n to th e le g a l lim ita tio n s p la c e d o n a s ta te - c h a r te r e d b a n k ’s p a r tic ip a tio n in s p lit- d o lla r life in s u r a n c e a r r a n g e m e n ts a s o u tlin e d in th e F D I C ’s g u id e lin e s , s u c h in s u r a n c e a r r a n g e m e n ts a t s ta te m e m b e r b a n k s m a y a ls o , in o u r v ie w , c o n s titu te a n u n s a fe a n d u n s o u n d p r a c tic e in v o lv in g th e d iv e r s io n o f b a n k in c o m e o r a s s e ts . W h e n a s ta te m e m b e r b a n k p u r c h a s e s a s p lit- d o lla r life in s u r a n c e p o lic y a n d a rra n g e s f o r o n e o f its in s id e rs , r a th e r th a n th e b a n k , to re c e iv e a ll o r m o s t o f th e b e n e f its o f th e p o lic y in e x c e s s o f th e a m o u n t o f th e p r e m iu m p a id , th e s ta te m e m b e r b a n k , in e ffe c t, p ro v id e s a s ig n if ic a n t e c o n o m ic b e n e f it to its in s id e rs . In th o s e in s ta n c e s w h e r e th e b a n k p u r c h a s e s life in s u r a n c e in a m o u n ts th a t e x c e e d th e le v e ls n e c e s s a ry to p ro v id e re a s o n a b le c o m p e n s a tio n b e n e f its to th e b a n k in s id e r, th e p r e m iu m p a y m e n ts f o r s u c h p o lic ie s m a y b e v ie w e d a s a n in a p p r o p r ia te u s e o f b a n k f u n d s b e c a u s e th e b a n k lo s e s th e o p p o r tu n ity to u s e its a s s e ts in a p r o d u c tiv e m a n n e r .1 G u id a n c e o n th e s ta n d a r d s o f r e a s o n a b le c o m p e n s a tio n a s it a p p lie s to s p lit- d o lla r life in s u r a n c e a r r a n g e m e n ts c a n b e fo u n d in th e F D I C ’s A u g u s t 18, 1993 m e m o r a n d u m to its R e g io n a l D ir e c to r s a n d a c c o m p a n y in g s t a f f d is c u s s io n p a p e r, w h ic h is a v a ila b le fro m th e F D IC u p o n r e q u e s t to its O f f ic e o f C o r p o r a te C o m m u n ic a tio n s a t (2 0 2 ) 8 9 8 -8 5 6 3 . S p e c ific q u e s tio n s o n r e a s o n a b le c o m p e n s a tio n a s it a p p lie s to s p lit- d o lla r life in s u ra n c e a r r a n g e m e n ts s h o u ld b e d ir e c te d to th e a p p r o p r ia te F D IC R e g io n a l O ffic e . Y o u s h o u ld a ls o p r o m p tly c o n ta c t th is R e s e r v e B a n k in o r d e r to in fo rm u s th a t y o u a re s e e k in g th e F D I C ’s p e r m is s io n to re ta in o r e n te r in to a s p lit- d o lla r life in s u r a n c e a r r a n g e m e n t o r to s e e k th a t a g e n c y ’s g u id a n c e c o n c e r n in g s u c h a n a r r a n g e m e n t a s p a rt o f a r e a s o n a b le c o m p e n s a tio n p a c k a g e fo r a b a n k in s id e r. S p lit- D o lla r L ife I n s u r a n c e A rr a n g e m e n ts B e tw e e n a B a n k H o ld in g C o m p a n y a n d Its S u b s id ia r y B a n k It s h o u ld b e n o te d th a t s p lit- d o lla r life in s u ra n c e a r r a n g e m e n ts m a y e x is t b e tw e e n a b a n k h o ld in g c o m p a n y a n d its s u b s id ia r y b a n k . U n d e r s u c h an a r r a n g e m e n t, g e n e r a lly , th e s u b s id ia r y b a n k o w n s th e in s u r a n c e p o lic y , p a y s a ll o r s u b s ta n tia lly a ll o f th e p r e m iu m s , a n d is r e im b u r s e d fo r th e p r e m iu m p a y m e n ts o n ly w h e n th e p o lic y is c a s h e d in o r th e d e a th b e n e f it is p a id . T h e b u lk o f th e in s u r a n c e p r o c e e d s a re p a id to th e b a n k ’s p a re n t h o ld in g c o m p a n y o r its in s id e rs , a n d n o t to th e b a n k . S u c h a r r a n g e m e n ts m a y v io la te s e c tio n s 2 3 A a n d 2 3 B o f th e F e d e ra l R e s e r v e A c t b e c a u s e th e p a y m e n t o f th e e n tir e in s u r a n c e p r e m iu m b y a s u b s id ia r y b a n k -- w ith o u t its c o n c o m ita n t r e c e ip t o f a ll o f th e d e a th b e n e f it -- m a y r e p r e s e n t a n im p e r m is s ib le u n s e c u re d e x te n s io n o f c r e d it to th e b a n k ’s p a r e n t 'It sh o u ld be n oted th a t an in dividual w ho is a principal sh areh o ld er o f a state m em b er b ank and h olds no office at th e in stitu tio n is generally not en titled to com pensation and, th erefo re, sh o u ld n o t be a p arty to a splitd o llar life insurance arrangem ent. fO'/D&(d') 3 h o ld in g c o m p a n y , a n d b e c a u s e th e s u b s id ia r y b a n k m a y n o t r e c e iv e a f a v o r a b le r e tu r n o n its in v e s tm e n t. S u c h s p lit- d o lla r life in s u ra n c e a r r a n g e m e n ts m a y a ls o c o n s titu te a n u n s a fe a n d u n s o u n d b a n k in g p r a c tic e b e c a u s e th e a r r a n g e m e n ts m a y in v o lv e a n im p r o p e r d iv e r s io n o f b a n k in c o m e .2 In th e e v e n t th a t y o u h a v e a n y q u e s tio n s re g a r d in g s p lit- d o lla r life in s u r a n c e a r r a n g e m e n ts b e tw e e n a b a n k h o ld in g c o m p a n y a n d its s u b s id ia r y b a n k o r y o u n e e d to n o tif y u s a b o u t y o u r c o n ta c t w ith th e F D IC c o n c e r n in g a s p lit- d o lla r life in s u ra n c e a r r a n g e m e n t, p le a s e c o n ta c t D o n a ld E . S c h m id , M a n a g e r o f o u r D o m e s tic B a n k in g D e p a r tm e n t, a t ( 2 1 2 ) 7 2 0 - 6 6 1 1 . C h e s t e r B. F e l d b e r g Executive Vice President 2A gain, it sh o u ld be no ted th at an individual w ho is a principal sh areh o ld er o f a bank h o ld in g co m p an y and holds no office at th e in stitu tio n is g en erally not en titled to com p en satio n and, therefo re, sh o u ld n o t be a party to a sp lit-d o llar life insurance arrangem ent. FDIC Federal D eposit In s u ra n c e C orporation W a s h in g to n , D C 2 0 4 2 9 Office of the Director Division of Supervision FIL-60-93 August 31, 1993 BANK PURCHASES OF LIFE INSURANCE TO: CHIEF EXECUTIVE OFFICER SUBJECT: Supervisory Considerations Relating to Purchases of Life Insurance bv Banks An increasing number of state nonmember banks have purchased various forms of life insurance contracts covering key employees. . . The policies are generally purchased as either a compensation benefit for the employee, or as key-person protection for the bank. In certain instances, the policies provide a benefit to executive officers who are also majority stockholders. Many of these policies are structured as whole life, universal life, or other cash value policies that require large single premiums or periodic premiums of a substantial amount. These premiums may result in the build-up of significant cash surrender/investment values that cannot be easily liquidated without adverse tax consequences. Various supervisory concerns arise when banks engage in these insurance activities. During the course of safety and soundness examinations, several broad areas of possible supervisory concern may be evaluated by FDIC examiners when considering the appropriateness of a state nonmember bank's involvement in these insurance arrangements. To assist FDIC examiners in analyzing insurance policies purchased by state nonmember banks, the FDIC Division of Supervision issued a memorandum to its Regional Directors on August 18, 1993 (Transmittal No. 93-125) . Attached to the memorandum is an August 1993 staff discussion paper that addresses the following subjects as they relate to bank purchases of life insurance: (1) Impermissible activities, (2) Reasonableness of benefits, (3) Compliance with laws and regulations, (4) Concentrations and other risk considerations, and (5) Accounting considerations. For example, in reviewing life insurance policies for impermissible activities, examiners will evaluate a bank's compliance with Section 24 of the Federal Deposit Insurance Act (FDI Act) . Sec tion 24, in part, prohibits FDIC-insured state banks from engaging as principal in any activity that is not permissible for a national bank unless the bank is in compliance with the applicable capital standards and the FDIC determines that the activity will not pose a significant risk to the deposit insurance fund. The Office of the Comptroller of the Currency's Banking Circular 249 provides M / m o l d 2 general guidelines for national banks to use in determining whether such banks may legally purchase a particular insurance product. Thus, if an insured state bank plans to purchase an insurant product that does not meet the guidelines contained in Banicing Circular 249, the bank will need to obtain the FDIC's prior consent under Section 24 of the FDI Act. Insured state banks holding insurance products acquired prior to December 20, 1992, that do not meet the guidelines contained in Banking Circular 249, or that have purchased such products without prior approval since that date, must obtain the FDIC's permission under Section 24 of the FDI Act to retain the insurance product. Any requests to purchase or retain a nonconforming insurance product should be addressed to the appropriate FDIC Regional Director. In evaluating whether to approve such a request, the FDIC will consider the safety and soundness of the activity as one of the factors to be assessed in determining whether the activity may involve a significant risk to the insurance fund. The appendices to the August 1993 Division of Supervision staff discussion paper contain suggested examination procedures for reviewing insurance arrangements, a copy of OCC Banking Circular 249, and regulatory guidance issued by other federal agencies. For example, one of the appendices provides supervisory guidance issued by the Federal Reserve Board's Division of Banking Supervision andRegulation on the applicability of Sections 23A and 23B of the Federal Reserve Act to split-dollar life insurance arrangements between bank holding companies and their subsidiary banks. Examiners have been directed to consider the supervisory concerns and suggested examination procedures addressed in the staff discussion paper when reviewing the appropriateness of a bank's purchases of life insurance. In order to ensure that those involved in such purchases are also aware of the FDIC supervisory guidance on these matters, the August 18 memorandum to Regional Directors and the accompanying staff discussion paper are available to state nonmember banks and other interested parties upon request from the FDIC's Office of Corporate Communications (202-898-8563) . State nonmember banks with specific supervisory questions concerning their particular insurance policies are encouraged to contact their appropriate FDIC Regional Office. However, general questions may be directed to Examination Specialist Stephen G. Pfeifer or Section Chief Robert F. Storch of the Division's Accounting Section at 202-898-8914. Distribution: FDIC-Supervised Banks (Commercial and Savings) ) BC - 249 (Rev.) Comptroller of the Currency 'Administrator of National Banks Type: Banking Circular Subject: Bank Purchases of Life Insurance TO: Chief Executive Officers of all National Banks, Department and Division Heads, and all Examining Personnel EPREOSE This circular provides general guidelines for national banks to use in determining whether they may legally purchase a particular life insurance product. BACKGROUND In the past, bank purchases of term life insurance and traditional forms of permanent life insurance have raised few legal questions or supervisory concerns. Recently, however, the OCC has become concerned about bank purchases of insurance products with a significant investment component, such as single premium life insurance. In some cases, those purchases have raised serious questions about whether the bank has made an illegal investment in the cash surrender value (CSV) of life insurance. The OCC is also concerned because the unsecured cash surrender value of these policies has sometimes constituted a significant percentage of the bank's capital. LEGAL AUTHORITY FOR PURCHASING LIFE INSURANCE The authority for national banks to purchase and hold an interest in life insurance is found in 12 U.S.C. S 24(7). The lav 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. There is no authority under 12 U.S.C. S 24(7) for national banks to purchase life insurance for their own account as an investment. D te: a May 9, 1991 Page £_Pages iu m o a 0 BC - 249 (Rev.) banking issuance Comptroller of the Currency Administrator of National Banks Type: Banking Circular Subject: Bank Purchases of Life Insurance POLICY GUIDELINES A national bank may purchase or take an interest in life insurance for a purpose incidental to the business of banking. The amount, of" such insurance must closely approximate the bank's risk of loss or* obligation arising from its relationship with the insured. National banks may not purchase life insurance as an investment. A life insurance policy will be considered to be purchased and held for non-investment purposes if it satisfies either of the following tests: (A) When the bank purchases life insurance to indemnify itself against the death of an individual (as in the case of key-person insurance or insurance purchased on a borrower), the amount of insurance coverage must closely approximate the risk of loss. For purposes of measuring insurance coverage, the OCC considers the amount of insurance to be the total death benefit co be received upon the death of the insured. This includes the face amount of the policy, any premium to be returned, and accrued interest and/or dividends. or (B) When the bank purchases life insurance in conjunction with providing employee compensation or benefits, or when the insurance constitutes all or part of the benefit (as in so-called "split dollar* or other life insurance plans), the following condition must be satisfied: Based upon reasonable actuarial benefit and financial assumptions, the present value of the projected cash flow from the policy must not substantially exceed the present value of the projected cost of the associated compensation or benefit program liabilities. The bank may include the insurance premiums paid and the associated time value of money in its calculation of the total cost of the liabilities. Date: May 9, 1991 Page &_Pages m /o m 4 /) BC “ 249 (Rev.) 2 SS5D (C ^M Comptroller ot the Currency Administrator ot National Banks Type: Banking Circular Subject: Bank Purchases of Life Insurance The following sections provide more detailed guidance on the specific purposes for which national banks may purchase life insurance. KEY-PERSON INSURANCE Interpretive Ruling 7.7115 (Insuring lives of bank officers), 12 C.F.R. S 7.7115r addresses those situations in which a national bank may obtain life insurance to protect itself against the loss of "key persons" in bank management. The ruling allows a national bank to purchase insurance on. the life of an officer whose death would be of such consequence to the bank as to give it an insurable interest in his or her life.. Interpretive letters have expanded the scope of this ruling to recognize the possibility that certain directors of the bank may also be key persons. Key-person insurance must comply with non-investment test (A) of these guidelines. The bank's board of directors must adequately document the basis on which it determines an officer or director to be a key person. Similarly, the board of directors must adequately document the basis for determining the amount of insurance needed to indemnify the bank against the death of each key person. Interpretive Ruling 7.7115 does not authorize the purchase of life insurance on an individual who is not demonstrably a key-person. Nor does the Ruling permit the purchase of life insurance in an amount that is not reasonably related to the bank's potential loss. The bank's authority to hold life insurance on a key person lapses if the individual, because of retirement, resignation, discharge, change of responsibilities, or for any other reason, is no longer a key person for the bank. The desire to obtain the return of the premium paid, interest, or dividends on the policy does not provide an independent basis under 12 U.S.C. S 24(7) and Interpretive Ruling 7.7115 for retaining life insurance on an individual who no longer qualifies as a key person. Therefore, the economic consequences of terminating the insurance, or the ability to transfer the coverage to another key person, should be considerations in selecting a key-person insurance policy. D te: a May 9* 1991 Page __Pages M io r o g .( J ) / BC - 249 (Rev.) o * . J Comptroller ot the Currency Administrator of National Banks Type: B a n k in g C i r c u l a r Subject: B an k P u r c h a s e s o f L i f e In su r a n c e LIFE INSURANCE ON BORROWERS S t a t e la v g e n e r a l l y r e c o g n iz e s t h a t a le n d e r h a s an in s u r a b le i n t e r e s t in t h e l i f e o f a borrow er t o t h e e x t e n t o f th e b o r r o w e r 's o b lig a t io n t o t h e le n d e r . I n t e r p r e t iv e R u lin g s 7 .7 4 9 5 (D eb t c a n c e lla t io n c o n t r a c t s ) , 12 CFR S 7 .7 4 9 5 , and 12 CFR S 2 . 6 ( c ) and ( f ) (Methods o f s e l l i n g c r e d i t l i f e in s u r a n c e ) a r e r e l e v a n t f o r n a t io n a l b an k s. They r e c o g n iz e t h a t n a t io n a l banks may p r o t e c t th e m se lv e s a g a in s t th e r i s k o f l o s s from th e d e a th o f a b o r r o w er . T h at p r o t e c tio n may be p r o v id e d through s e l f - i n s u r a n c e i n th e form o f d e b t c a n c e lla t io n c o n t r a c t s , o r by th e p u rch ase o f l i f e in s u r a n c e p o l i c i e s on b o rrow ers. Life insurance purchased on borrowers must comply with non-investment test (A) of these guidelines. For borrowers who are in good standing, a bank's potential loss is generally the principal balance of the borrower's obligations to the bank, including the maximum amount that could be borrowed under a line of credit, at the time the insurance is purchased. That amount would, therefore, be the maximum insurance coverage the bank could purchase on the borrower. The purchase of life insurance on a borrower is not an appropriate mechanism for effecting a recovery on obligations that have been (or are expected to be) charged-off. Such life insurance purchases are not incidental to banking within the meaning of 12 U .S .C . S 2 4 (7 ) because the insurance does not protect the bank against a risk of loss. In the case of charged-off loans, the bank has already realized the loss, and the purchase of life insurance more closely resembles an investment to recover on that loss. LIFE INSURANCE PURCHASED IN CONNECTION WITH COMPENSATION AGREEMENTS AND BENEFIT PLANS Under 12 U .S .C . S 2 4 (5 ) and 12 CFR S 7 .5 2 2 0 , n a t i o n a l banks may e n te r in t o employment agreem en ts w ith t h e i r o f f i c e r s and e m p lo y ees upon r ea so n a b le term s and c o n d i t i o n s . I t i s th e r e s p o n s i b i l i t y o f th e board o f d i r e c t o r s t o e s t a b l i s h and be a b le t o j u s t i f y t h e r e a so n a b le n e ss o f t h e com p en sation p ro v id ed t o bank em p lo y ees under t h e s e a g r ee m e n ts. Date: May 9 , 1991 Page 4 of 6 Pages BC “ 249 (Rev.) - Comptroller of the Currency Administrator of National Banks Type: Banking Circular Subject: Bank Purchases of Life Insurance A national bank xaay provide life insurance benefits to its employees through individual or group policies for vhich the bank pays all or part of the premium. A national bank also may provide deferred compensation and retirement programs for bank employees. Similarly, a national bank may establish programs that permit directors to defer payment of all or a portion of their director fees. Interpretive letters have established that a national bank may protect itself against its contractual obligations under such agreements through the purchase of life insurance. However, except as part of a reasonable compensation agreement or benefit plan, a national bank may not purchase life insurance as an estate management device for the benefit of officers, directors, or employees who are also controlling shareholders of the.bank. Life insurance purchased in connection with compensation agreements and benefit plans must comply with non-investment test (B) of these guidelines. Such policies may be held for as long as the bank continues to have any liability under the compensation or benefit plans.for which the policies were initially purchased. A bank may, therefore, purchase insurance on a group of persons and continue to hold the insurance as long as it has any liability under the associated compensation or benefit plan. LIFE INSURANCE AS SECURITY FOR LOANS National banks may take an interest in an existing life insurance policy as security for a loan. National banks may also make loans to individuals for the purpose of purchasing life insurance, taking a security interest in the insurance policy. As with any other type of lending, extensions of credit secured by life insurance must be made on terms that are consistent with safe and sound banking principles. For instance, the borrower must be obligated to repay the loan according to an appropriate amortization schedule. Generally, a national bank may not rely on its security interest in a life insurance policy to extend credit on terms that excuse the borrower from making interest and principal payments during the life of the borrower with the result that the bank is repaid only when the policy matures at the death of the insured. Lending on such terms Date: May 9 , 1991 Page of £ __Pages ttMozyj i BC - 249 (R ev .) 0 Comptroller of the Currency Administrator of National Banks - Subject: Bank P u rch a ses o f L if e In su ra n ce Type: Banking C ir c u la r may be t r e a t e d a s an i l l e g a l in v e s tm e n t i n l i f e in s u r a n c e un der 12U .S .C . s 2 4 ( 7 ) s i n c e t h e bank w ou ld b e lo o k in g t o t h e l i f e in s u r a n c e b e n e f i t s a s i t s s o l e r e tu r n on t h e fu n d s i t ad van ced . OTHER CONSIDERATIONS Life insurance death benefits and cash surrender values are unsecured obligations of the insurance company. Cash surrender value of insurance should be reported as an "Other asset" on the bank's financial statements. Before purchasing a life insurance policy, the bank should evaluate the financial condition of the insurance company and continue to monitor its condition on an ongoing basis. The bank should consider the effect of any significant holdings of this ordinarily long-term asset on the bank's capital and liquidity. It should also determine the tax and other economic consequences of surrendering the insurance before the death of the insured should that become necessary. APPLICATION OF THE GUIDELINES . Examiners will evaluate all current holdings and future purchases of life insurance by national banks in light of the guidelines in this circular. ORIGINATING OFFICE Questions about this circular should be directed to the Office of the Chief National Bank Examiner (202) 447-1164. CL Donald G. Coonley Chief National Bank Ex Date: May 9 , 1991 iner Page & __Pages
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