New guidelines require proper due diligence
For banks wishing to purchase insurance products, recent regulatory issuances have made it an opportune time to do so. The Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. issued regulatory releases last year which would enable a bank to more readily use life insurance as a means to protect itself against certain risks.
WHAT REGULATIONS SAID
On Sept. 20, 1996, OCC issued Bulletin 96-51 ("Guidelines"), which replaces Banking Circular 249 ("BC 249") as guidelines for national banks to follow in purchasing life insurance. The guidelines are expected to provide for more flexibility for banks in structuring a bank-owned life insurance ("BOLI") program. The guidelines define the parameters of permissible investments in insurance broadly, permitting a wide ]latitude for interpretations.
Similarly, on Aug. 13, 1996, FDIC proposed amendments to Part 362 ("Proposed Rule") of its regulations regarding activities and investments of insured state banks. The proposed rule would simplify the approval process for insured nonmember state banks to purchase insurance products that do not comply with OCC's regulations, but adhere to certain conditions. An insured state bank would need only to notify (not seek approval from) the FDIC that the bank intended to implement a program that did not meet the OCC's guidelines for national banks.
Although always present as a supervisory requirement, the recent trend among the federal bank regulatory agencies is to stress the need for banks to perform a due-diligence or pre-purchase analysis of the various risks associated with insurance prior to purchasing the product. Specifically, the guidelines state that bank management and the board of directors should consider six risks which could have an adverse impact on the bank's capital or earnings as a result of purchasing insurance. These risks are: transaction, credit, interest rate, liquidity, compliance, and price.
INITIAL DUE DILIGENCE
Some of the initial issues in a due diligence review of bank-owned life insurance involve management's determination of the bank's need for the purchase of BOLI, and the amount of insurance required. More specifically, the board or delegatee should do the following:
1. Establish the purpose for which the bank is purchasing the product. Under the new OCC guidelines, a national bank continues to be required to establish that the purchase of insurance is incidental to the business of banking. Therefore, a national bank will need to identify the obligations and risks for which the bank is purchasing insurance and determine that such purpose is incidental to banking.
OCC has historically permitted banks to purchase insurance for the following reasons: 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. The guidelines state that permissible uses of BOLI exist beyond those traditional purposes. Obviously, the more novel the purpose for purchasing the BOLI, the more analysis that is necessary to determine that the purchase is safe and sound. If the BOLI product is of first impression, the national bank should obtain an opinion of competent counsel that the BOLI complies with the "incidental to banking" requirement.
Insured state banks will not be limited by the "incidental to banking" requirement if FDIC's proposed rule is adopted. Further, even if the proposal is not adopted (or until it is), an insured state bank can apply for approval from FDIC to purchase insurance products that do not meet OCC standards.
2. Determine the amount of BOLI to purchase. OCC guidelines require a national bank to establish internal quantitative limits on the purchase of BOLI, considering the bank's lending limit (15% of the bank's capital and surplus per insurer) and concentration of credit guidelines (25% of the bank's capital). …