OCC 2000-23
OCC BULLETIN
Comptroller of the Currency
Administrator of National Banks
Subject:  Bank Purchases of Life Insurance
Description:  Guidelines for National Banks

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

PURPOSE

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.  It replaces Bulletin 96-51, dated September 20,
1996, which is hereby rescinded.

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 life insurance is
found in 12 USC 24(Seventh), which provides that national banks
may exercise "all such incidental powers as shall be necessary to carry on
the business of banking." Purchases of life insurance that the OCC has
found to be incidental to banking include key-person insurance, insurance
on borrowers, insurance purchased in connection with employee compensation
and benefit plans, and insurance taken as security for loans. [NOTE 1: The
appendix contains a discussion of each of these four uses of COLI.] The
OCC may approve other uses for bank-owned life insurance on a case-by-case
basis.  However, a purchase of life insurance must address a legitimate
need of the bank for insurance. Life insurance may not be purchased to
generate funds for the bank's normal operating expenses, for speculation,
or for the primary purpose of providing estate planning benefits for bank
insiders unless it is part of a reasonable compensation package. In
addition, the purchase of life insurance is subject to supervisory
considerations, and life insurance holdings must be consistent with safe
and sound banking practices.

SUPERVISORY POLICY

The purchase of permanent life insurance (permanent insurance) policies
subjects the policyholder to several risks. The cash surrender value (CSV)
of most life insurance products is subject to credit risk. [NOTE 2:
Permanent insurance and cash surrender value are described in the appendix
on page 1.] 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 divestiture 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. [NOTE 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.] 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.
[NOTE 4: Life insurance acquired through DPC is further discussed in the
appendix on page 7.]

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

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

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 [NOTE 7: Split-dollar insurance
arrangements are defined and discussed in the appendix on pages 3-4.]
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 prepurchase 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, a bank may choose to
generate the necessary funds through investments instead of by purchasing
insurance. 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, [NOTE 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.]
mortality cost, [NOTE 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.] 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 [NOTE 10: General account
products are defined in the appendix on page 2.] 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 [NOTE 11: Variable or separate account
products are defined in the appendix on page 2.] 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 its 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.

Banks may purchase separate account insurance products that hold equity
securities for the purpose of hedging their obligations under employee
compensation and benefit plans. [NOTE 12: An economic hedge exists when
changes in the value of the liability or other risk exposure being hedged
are offset by counterbalancing changes in the value of the hedging
instrument.] This lessens the effect of price risk on the bank's financial
statements because changes in the amount of the bank's liability will be
hedged by changes in the value of the separate account assets. An example
of such a relationship would be where the amount of the bank's deferred
compensation obligation is measured by the value of a stock market index,
and the separate account contains a stock mutual fund that mirrors the
performance of that index. If the insurance cannot be characterized as an
effective hedging transaction, the presence of equity securities in a
separate account is impermissible.

In addition to the general considerations discussed above, which are
applicable to any separate account product, further analysis should be
performed when purchasing a separate account product involving equity
securities. At a minimum, national banks should:

1. Analyze the bank liability being hedged (e.g., deferred compensation)
and the equity securities to be held as a hedge in the separate account.
Such an analysis usually documents the correlation between the liability
and the equity securities, expected returns for the securities (including
standard deviation of returns), and current and projected asset and
liability balances.

2. Determine a target hedge effectiveness ratio and establish a method for
measuring hedge effectiveness. Establish a process for altering the
program if hedge effectiveness drops below acceptable levels.
Consideration should be given to the potential costs of program changes.

3. Establish a process for analyzing and reporting the effect of the hedge
on the bank's income statement and capital ratios. Such an analysis
usually shows results both with and without the hedging transaction.  O

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 former Banking Circular (BC)-249,
Bank Purchases of Life Insurance

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

Policies Purchased before the issuance of former 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
Deputy Comptroller for Credit Risk at (202) 874-5170.

Emory W. Rushton
Senior Deputy Comptroller for Bank Supervision Policy

Date:  July 20, 2000