The first step in any discussion of insurable interest is to consider the language of OCC Bulletin 2000-23 ("Bulletin"). With regard to compliance risk, the Bulletin explicitly warns that bank management must be mindful of state laws, including specifically state insurable interest laws. Given the "significance of the compliance risk" created by failure to comply with applicable state law, the Bulletin encourages banks to seek the advice of counsel.
Having established that a BOLI program must comply with state insurable laws, the next consideration for a bank is identifying precisely which state laws are relevant. The laws of the state where the bank is located is obvious, but what about the laws of the states where the insured employees reside? At least one jurisdiction, New York, has expressed its concern about out-of-state entities obtaining coverages on New York residents. Even trickier, many institutions establish a trust to hold their BOLI contracts. Typically, these trusts are established out-of-state for purposes of holding multiple BOLI policies, or sometimes to avoid unfavorable insurable interest laws in a bank’s home state. The use of a trust raises some interesting jurisdictional issues, none of which have been addressed directly by regulators or courts: Can a bank in State X establish a trust in State Y for purposes of holding BOLI? If so, which state’s insurable interest laws apply? Finally, what if there are no insurable interest statutes in State X? Has the bank circumvented its compliance problems through the establishment of the trust in State Y, or by doing so has it essentially engaged in an ultra vires act which threatens the viability of the entire BOLI program?
Because a BOLI program can touch many states (either by virtue of the residency of the insured population or the home state of the bank), it is always a good idea to inventory the insurable interest laws of all potentially relevant jurisdictions. Such research quickly reveals that insurable interest laws can vary widely by state. They can be established or modified by statute, regulation, or through the common law.
While most states have formal insurable interest statutes for corporations (including banks), some states don’t. The scope of existing statutes also varies. Some states simply grant an insurable interest to employers in all of their employees. Some state statutes differentiate between employees and more senior-level management personnel, like directors and officers.
Also be aware that many states have notice and consent requirements which a bank must fulfill before obtaining coverage on any employee. Care must always be exercised when soliciting the participation of an employee in a BOLI program. This includes not only the written language used to obtain consent, but the solicitation approach of management. Other procedural requirements may also exist which will require close monitoring of a BOLI program for continued compliance with state law. For example, New York has a particularly convoluted insurable interest statute that addresses procedures for when an insured employee leaves the company.
Perhaps the most critical consideration for any BOLI program is the problem of determining the proper amount of the insurance purchased. In the past, some have argued that the BOLI program should be sized to fit the bank’s benefit obligations. While useful for establishing the legitimacy of the business purpose, this approach does not definitively measure an institution’s insurable interest in the employee pool. In other words, in addition to determining the existence of the insurable interest in its employees, a bank should also consider the extent of such interest in each employee. Most state laws do not specifically address the extent of insurable interest. At best, several state statutes provide that a company has an insurable interest in its officers and directors, but that the insurable interest in other (i.e., non-management level) employees is limited to the extent of the company’s projected, unfunded benefit obligations for such employees. This is the most direct limitation on the extent of insurable interest to be found in current state statutes.
The question remains, therefore, what is the proper amount of insurance to obtain on any given employee? While the statutes may be silent, state case law is replete with decisions as far back as the 1800s in which courts have voided life insurance policies due to a lack of insurable interest, citing as support the state’s public policy against the wagering on human life. The OCC Bulletin itself admonishes that BOLI may not be purchased "for speculation." While a state statute may give a corporation an insurable interest in its employees, it would be foolhardy to interpret such a law as granting an unlimited insurable interest. This is a critical consideration, because many banks size their BOLI purchase by obtaining the same amount of coverage on every employee without reference to factors such as the employee’s position, salary, duties, abilities, or tenure with the institution (i.e., some determination of the employee’s "value" to the institution).
To put the issue in practical perspective, consider this hypothetical: a bank determines that it will purchase BOLI to fund its unfunded employee benefit obligations over the next 70 years, which it calculates to be $100 million. Accordingly, the bank obtains $1 million of BOLI coverage on each of 100 employees. The bank teller, who has been employed for two years and makes $50,000 per year, and the bank CEO, who has been with the bank for 10 years and has a current salary of $250,000, are each insured for $1 million dollars. Should this shock the conscience? If not, consider this extreme alternative: to minimize the hassle of implementation, the bank decides to insure twenty employees for $5 million each. The question of whether this would pass judicial, OCC or IRS scrutiny remains unresolved, but banks should be aware that a few recent cases have suggested that it is possible for an employer to hold too much insurance on an employee. Simply put, and at the risk of sounding inappropriately blunt, the question becomes: at what level of insurance coverage does an employee become more valuable to an employer dead than alive? If such a point can be determined, and is exceeded, has the bank violated state insurable interest law? If so, this would be an unsafe and unsound practice which could jeopardize an entire BOLI program.
A few additional observations about the extent of insurable interest need to be made. First, it is common within the industry for a bank purchasing BOLI to obtain from the carrier a representation that the carrier will waive "lack of insurable interest" as a defense against paying a claim. While many banks take comfort from this, it must be understood that such a representation only means that the carrier is promising to pay a valid death benefit claim. It does not necessarily mean that the carrier is promising to pay the proceeds to the insured bank. Other parties can challenge insurable interest, including, most notably, the estate of the deceased. The spouse of a deceased employee may be very interested to learn that the bank received $1 million when his wife died, though she never made more than $50,000/year working for the bank.
Another approach that has been used to support particularly high insurance coverages on certain employees is to characterize such insurance as "key person" coverage. This label should only be used with extreme care. First, the OCC Bulletin warns that key person coverage necessitates key person succession planning, which is to say that the need for such coverage can be eliminated before the employee dies. Furthermore, there is no consistent definition of what constitutes a "key employee" among the states. Most definitions have emerged from case law, where such phrases as "indispensable," "profitable," and "necessary for the continued success of the business" are used to describe the employee. The "key person" label should only be used after careful consideration of the employee in question, and clearly should not be used to describe all of the bank’s officers and directors.
As the above hopefully demonstrates, there are a host of insurable interest issues that need to be considered beyond the plain reading of a state statute. There is little formal guidance on how to properly size BOLI programs, and the current approaches have all evolved as a set of "common business practices" within the industry. Given the heightened interest of the IRS in BOLI programs, including insurable interest, the method by which an institution determined both the existence and extent of insurable interest in its employees should be thoroughly reviewed, understood, documented, and capable of clear articulation by bank management.
Copyright © 2007, Mayer, Brown, Rowe & Maw LLP. and/or Mayer Brown International LLP. This Mayer Brown article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.
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