An Empirical Investigation of the Demand for Bank‐Owned Life Insurance

Abstract

Key employee life insurance in the banking industry is called bank‐owned life insurance (BOLI). Banks use BOLI to provide financial support to help reduce disruptions due to the death of a key executive and as a part of the executive compensation package. We investigate the characteristics of banks related to the amount of BOLI purchased. We find that BOLI purchases are positively related to bank size and leverage and negatively related to tax rates and employee salaries. We also find that BOLI purchases are related to bank ownership structure and profitability.

Bank‐Owned Life Insurance and Bank Risk

“…As discussed in Section , there is a well‐developed literature on the corporate demand for insurance. It is possible that BOLI affects bank risk indirectly through one of the known determinants of the corporate demand for insurance identified by Davidson and Shelor () to also influence BOLI purchases. I investigate this possibility by adding five additional control variables to Equation , including the effective tax rate, failure probability from the failure prediction model of Cole and White (), an indicator variable equal to 1 if earnings before taxes are negative, an indicator variable equal to 1 if the bank is a mutual or cooperative bank, and salaries and employee benefits expense.…”

“…Brown () finds evidence that key employee insurance outside of the banking industry is used as a tax shield. Davidson and Shelor () find evidence that BOLI adoption is related to taxes. It is possible that banks with different effective tax rates use BOLI differently.…”

“…Brown () finds that board interlocks increase the probability of COLI adoption as a tax shelter, but she specifically excludes banks from her sample. Davidson and Shelor () examine the characteristics of banks that purchase BOLI and find many factors that influence the corporate demand for insurance are also relevant for BOLI purchases. The authors also provide evidence that an agency motive exists for the purchase of BOLI.…”