# OCC Interpretive Letter No. 1030: Letter concludes that national bank may continue to hold a separate account BOLI investment that in turns holds interests in instruments with characteristics of debt securities and a rate of return, a portion of which is linked to equity securities, provided the bank's EIC has no supervisory objection

> Federal · Agency guidance · In force

URL: https://www.frixlaw.com/law-library/statutes/OCC_INT1030

## Section

- **Citation:** OCC Interpretive Letter No. 1030
- **Heading:** Letter concludes that national bank may continue to hold a separate account BOLI investment that in turns holds interests in instruments with characteristics of debt securities and a rate of return, a portion of which is linked to equity securities, provided the bank's EIC has no supervisory objection
- **Jurisdiction:** Federal
- **Kind:** Agency guidance
- **Status:** In force
- **Text as of:** August 14, 2026
- **Source:** Compiled text
- **Location:** OCC Interpretive Letters / Letter concludes that national bank may continue to hold a separate account BOLI investment that in turns holds interests in instruments with characteristics of debt securities and a rate of return, a portion of which is linked to equity securities, provided the bank's EIC has no supervisory objection.

## Text

O

Comptroller of the Currency
Administrator of National Banks

Washington, DC 20219

Interpretive Letter 1030
June 2005
12 USC 24(7)
May 26, 2005

Subject: ( ), (“Bank”) Investment in Bank-Owned Life Insurance
(“BOLI”)

Dear ( ):

This is in response to your inquiry whether the Bank may continue to hold a separate account
BOLI investment that in turn holds interests in instruments with characteristics of debt securities
and a rate of return, a portion of which is linked to equity securities. For the reasons set forth
below, we conclude that the Bank’s investment, as described herein, may be permissible,
provided the Bank’s Examiner-in-Charge (“EIC”) has no supervisory objection.

Background

The Bank’s predecessor purchased a separate account policy from ( )
Insurance Company, which later merged with ( ) (“Co.”). The book
value of the Bank’s separate account policy was approximately $4.6 billion, as of March 31,
2005. In January 2002, the Bank reallocated nearly $900 million (amounting to $946 million as
of March 31, 2005) in the separate account policy to four issues of structured notes (“Structured
Notes” or “Notes”).

The Structured Notes

The separate account consists of four issues of Structured Notes and bank-eligible securities.
Bankruptcy-remote special purpose entities (“SPEs”) issued the Structured Notes under SEC
ank reallocated nearly $900 million (amounting to $946 million as
of March 31, 2005) in the separate account policy to four issues of structured notes (“Structured
Notes” or “Notes”).

The Structured Notes

The separate account consists of four issues of Structured Notes and bank-eligible securities.
Bankruptcy-remote special purpose entities (“SPEs”) issued the Structured Notes under SEC

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Rule 144A.1 All four issuances share essentially the same structure. The Bank’s separate
account holds roughly 80 percent of each issuance.

The Structured Notes have a maturity of 10 years and bear a coupon of either 1.75 or 2.25
percent, for a blended rate of approximately 2 percent, plus a potential or contingent, cumulative
coupon of approximately 10 percent, payable at maturity, depending on the performance of
assets in the SPE. At issuance, the Structured Notes were rated Aa3 (Moody's), and AA (S&P).
The ratings apply to the principal and 2% assured interest, but not the cumulative interest. The
assets of each SPE consist of a Balanced Portfolio and a Protection Agreement.

Balanced Portfolios

Balanced Portfolios hold two types of assets, the ( ) (“BS”)
and, when appropriate, fixed income instruments. ( BS ) represent five specific hedge fund
strategies applied by 50 hedge fund managers. Rather than hold a basket of hedge funds, (Co.)
may simply invest the Structured Note proceeds in mirror securities issued by a ( Co.) affiliate
that synthetically track the performance of the selected hedge fund categories. If a hedge fund
manager performs poorly, assets under the control of that manager are reallocated into fixed
income instruments. The fixed income instruments consist of notes issued by a ( Co .) affiliate,
up to a maximum of 25% of the principal value of the Structured Notes
ecurities issued by a ( Co.) affiliate
that synthetically track the performance of the selected hedge fund categories. If a hedge fund
manager performs poorly, assets under the control of that manager are reallocated into fixed
income instruments. The fixed income instruments consist of notes issued by a ( Co .) affiliate,
up to a maximum of 25% of the principal value of the Structured Notes. Should it be necessary
to reallocate additional assets to the fixed income instrument class, those assets must be invested
in U.S. Treasury Securities. Reallocation to fixed income instruments allows ( Co. ) to assure
that the SPE assets will be sufficient to meet ( Co. )'s obligations at maturity to assure repayment
of principal and the 2% coupon on the Notes.

Protection Agreements

Protection Agreements are contracts between the SPEs and either ( )
(“Co.A”) or ( ) (“Co.B”) that guarantee the holders of the Structured Notes
repayment of principal and a coupon of either 1.75 or 2.25 percent. ( Co .) has issued a surety
bond to back the performance of its subsidiaries under the Protection Agreements, up to $3
billion. If either entity is downgraded to A- (S&P) or A3 (Moody's), ( Co. ) has 90 days
either to find a replacement credit protection provider or collateralize the exposure with Treasury
securities.

Stable Value Protection

A stable value protection (“SVP”) policy protects the Bank’s separate account in an amount
equal to the difference between the book value and the market value of the separate account.
The SVP in effect reduces the earnings volatility of the separate account for mark-to-market
accounting purposes, but does not provide an effective, economic hedge
asury
securities.

Stable Value Protection

A stable value protection (“SVP”) policy protects the Bank’s separate account in an amount
equal to the difference between the book value and the market value of the separate account.
The SVP in effect reduces the earnings volatility of the separate account for mark-to-market
accounting purposes, but does not provide an effective, economic hedge. To realize the
economic benefits of the SVP, the Bank must surrender the separate account policy, which
would trigger tax liability for the cumulative earnings of the policy, thus negating one of the
principal advantages of BOLI, tax deferral of earnings.

1 17 C.F.R. 230.144A.

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Discussion

Life Insurance

National banks may purchase and hold life insurance under 12 U.S.C. § 24 (Seventh), which
provides that national banks may exercise “all such additional powers as shall be necessary to
carry on the business of banking.” The OCC has found purchases of life insurance to be
incidental to banking in several situations, for example in connection with employee benefit
plans, key person insurance protection, recovering the cost of providing employee benefits,
obtaining coverage on borrowers, and as security for loans. The OCC may approve other uses
for insurance on a case-by-case basis. The OCC has indicated that national banks may not
purchase life insurance for speculative purposes, to acquire shares from the estates of
shareholders in order to control who owns the bank, or as an estate planning benefit to insiders
(unless the benefit is part of a reasonable compensation).2

Bulletin 2004-56

The OCC’s current guidance on purchases of life insurance by national banks is contained in
Bulletin 2004-56.3 National banks may purchase life insurance for a purpose that is incidental to
banking, but not purely as an investment.4 One of the purposes that the OCC has found to meet
that standard is in connection with employee compensation or b
easonable compensation).2

Bulletin 2004-56

The OCC’s current guidance on purchases of life insurance by national banks is contained in
Bulletin 2004-56.3 National banks may purchase life insurance for a purpose that is incidental to
banking, but not purely as an investment.4 One of the purposes that the OCC has found to meet
that standard is in connection with employee compensation or benefit plans. National banks may
purchase life insurance to fund or recover the cost of compensation or benefits for their
employees, officers or directors. However, if the separate account contains equity securities, the
OCC has imposed a further limitation; the equities in the account must effectively hedge the
bank’s liability under the compensation or benefit plan that the insurance is intended to fund.5
“An effective economic hedge exists when changes in the economic value of the liability or other
risk exposure being hedged are matched by counterbalancing changes in the value of the hedging
instrument.”6

Such a relationship would exist where the obligation under an insured institution’s
deferred compensation plan is based upon 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 economic

2 See Interpretive Letter No. 926 (Sept. 7, 2001) and Interpretive Letter No. 878 (Dec. 22, 1999).

3 Dec. 7, 2004 (“Bulletin”), issuing the Interagency Statement on the Purchase and Risk Management of Life
Insurance (“Interagency Statement”).

4 See Interpretive Letter No. 926, supra.

5 As long as the separate account holds debt, however, the holding is permissible and there is no inquiry concerning
the adequacy of the hedge that the separate account is intended to provide.

6 Interagency Statement at 18.
suing the Interagency Statement on the Purchase and Risk Management of Life
Insurance (“Interagency Statement”).

4 See Interpretive Letter No. 926, supra.

5 As long as the separate account holds debt, however, the holding is permissible and there is no inquiry concerning
the adequacy of the hedge that the separate account is intended to provide.

6 Interagency Statement at 18.

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hedge, the presence of equity securities in a separate account is impermissible,
and the agencies will require institutions to reallocate the assets unless retention
of the policy is permitted under federal law.7

The Bank bases its purchase of Notes on the authority of a national bank to purchase life
insurance. The Bank’s business purpose in holding the separate account policy is to defray the
costs of employee benefits such as active employee and retiree medical benefits and funding
401(k) company match and long-term disability payments. These are permissible purposes for
purchasing BOLI.

Generally one does not examine the assets in an insurance policy in reviewing permissibility
issues, in part because life insurance is considered a general obligation of the insurer. The
exception to this approach is when the bank holds a separate account policy. One looks through
the policy to the underlying assets in the account, if those assets are equity securities, to
determine whether the securities effectively hedge the liabilities the insurance is intended to
hedge. There is no hedging requirement under the OCC’s current guidance, however, if the
Notes are deemed to be debt securities. The debt securities in the separate account still must
qualify as bank permissible investments under 12 C.F.R. Part 1 or some other authority.

Debt v
y securities, to
determine whether the securities effectively hedge the liabilities the insurance is intended to
hedge. There is no hedging requirement under the OCC’s current guidance, however, if the
Notes are deemed to be debt securities. The debt securities in the separate account still must
qualify as bank permissible investments under 12 C.F.R. Part 1 or some other authority.

Debt v. Equity

Certain substantive characteristics distinguish common stock from debt securities.8 Common
stock usually is perpetual with broad voting rights, while debt securities generally have a limited
life and few, if any, voting rights. Common stock provides an ownership interest and
appreciation in the market value of the issuer and dividends. In contrast, debt securities offer
investors fixed or fluctuating periodic interest payments, and return of principal at maturity.
With debt securities, if the issuer should fail, the claims of the common stockholders are
subordinate to the debt holders’. Rating agencies may assign credit ratings to debt securities, but
typically do not rate equity instruments.

In this case, the separate account holdings more closely resemble debt than equity securities.
The Structured Notes possess the following characteristics typically associated with debt
securities. The Notes have a fixed maturity, pay regular periodic interest payments at a blended
rate of 2 percent, and return principal at maturity. The holders of the Notes have superior claims
to those of the SPE’s common stockholders. The Notes do not have voting rights. The Notes are
rated by rating agencies and are considered debt instruments for federal tax and accounting
purposes.

The Notes resemble equities in only one respect. In addition to the blended 2% coupon, the
Notes can pay a coupon of up to 10 percent, depending on the return of hedge fund assets held by

7 Id.

8 See, e.g., Landreth Timber Co. v. Landreth, 471 U.S. 681, 686-87 (1985); United Housing Foundation, Inc. v
encies and are considered debt instruments for federal tax and accounting
purposes.

The Notes resemble equities in only one respect. In addition to the blended 2% coupon, the
Notes can pay a coupon of up to 10 percent, depending on the return of hedge fund assets held by

7 Id.

8 See, e.g., Landreth Timber Co. v. Landreth, 471 U.S. 681, 686-87 (1985); United Housing Foundation, Inc. v.
Forman, 421 U.S. 837, 850-51 (1975); R. Hamilton, Fundamentals of Modern Business (1989).

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the SPE that issued the Notes. The variable portion of the return is more similar to the return of
shares of an investment company invested in hedge funds or equities, although we note that debt
obligations may have variable returns. Altogether the Notes more closely resemble debt in
sufficient respects to be classified as debt rather than equity.

Part 1

An investment security means a marketable debt obligation that is not predominantly speculative
in nature. A security is not predominantly speculative in nature if it is rated investment grade.
When a security is not rated, the security must be the credit equivalent of a security rated
investment grade.9 These requirements apply to both the principal and interest payable on the
debt security. The Structured Notes held in ( Bank )'s BOLI separate accounts may qualify as
investment securities under Part 1. The Notes were issued under SEC Rule 144A and thus are
marketable.10 The principal and blended 2% assured interest portions of the Structured Notes
bear investment grade ratings and thus meet the quality requirements of Part 1.11 The unrated
portion of the interest on the Notes may qualify as the credit equivalent of investment grade, as
discussed below.

The structured note in this situation raises the question of the permissibility of a debt instrument
that has a non-rated interest component
interest portions of the Structured Notes
bear investment grade ratings and thus meet the quality requirements of Part 1.11 The unrated
portion of the interest on the Notes may qualify as the credit equivalent of investment grade, as
discussed below.

The structured note in this situation raises the question of the permissibility of a debt instrument
that has a non-rated interest component. Because of the structured nature of the security, the
Bank may collect none, some, or all, of the contingent coupon. As a prudential matter, where a
part of the return on a debt security is not rated, and the bank seeks to demonstrate that it is the
credit equivalent of investment grade, the bank must document, through its own financial
analysis, that there is a high probability that the security will produce a reasonable investment
return over the life of the investment. For example, based upon an analysis of historical hedge
fund returns, the bank could simulate a probability distribution of future performance. Through
this analysis, the bank might be able to document that there is a high probability that the
structured note will have an investment return (including the 2% rated portion) equal to or
greater than the return for a similarly rated corporate exposure, with an appropriate spread
premium for security structure risk, of the same maturity. Whether the unrated portion of a
security may qualify as the credit equivalent of investment grade will depend on the facts and
circumstances of each case.

Moreover, where part of the investment return is unrated and based on equity returns, the bank
must also establish to the satisfaction of the bank’s EIC the adequacy of the bank’s reviews of
the investment and risk management controls, and limit the total amount of any securities
acquired under Part 1 with unrated, equity-based returns, to no more than 10 percent of the

9 See 12 C.F.R. 1.2(e).

10 See 12 C.F.R. 1.2(f)

11 See 12 C.F.R. 1.2(e).
based on equity returns, the bank
must also establish to the satisfaction of the bank’s EIC the adequacy of the bank’s reviews of
the investment and risk management controls, and limit the total amount of any securities
acquired under Part 1 with unrated, equity-based returns, to no more than 10 percent of the

9 See 12 C.F.R. 1.2(e).

10 See 12 C.F.R. 1.2(f)

11 See 12 C.F.R. 1.2(e).

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bank’s capital and surplus.12 Accordingly, the Bank must establish, to the satisfaction of the
Bank’s EIC, that the contingent portion of the interest on the Notes meets these criteria.

Safety and Soundness

As Bulletin 2004-56 makes clear, in addition to credit and interest rate risks, BOLI exposes
national banks to liquidity, transaction, reputation, and compliance risks, which often are
difficult to measure and control. National banks that acquire BOLI must undertake a thorough
prepurchase analysis and have a sound risk control framework to assess BOLI exposures on an
ongoing basis. National bank purchasers of BOLI should develop and implement comprehensive
policies that articulate their tolerance for the risks that BOLI presents. Bank management
should conduct an analysis to support that acquisitions of BOLI do not give rise to imprudent
capital concentration. Also, bank management should obtain approval from the board of
directors or a designated board committee prior to the acquisition of BOLI beyond established
limits or the capital concentration threshold.
The BOLI described herein presents a very complex transaction that is appropriate only in a
well-diversified portfolio for institutions with superior credit and investment expertise, as well as
sophisticated risk management processes. Where the separate account holds complex
instruments with unrated, equity-based returns, review of the specific instruments by the OCC
will be needed in order to determine that the holding is consistent with Bulletin 2004-56
at is appropriate only in a
well-diversified portfolio for institutions with superior credit and investment expertise, as well as
sophisticated risk management processes. Where the separate account holds complex
instruments with unrated, equity-based returns, review of the specific instruments by the OCC
will be needed in order to determine that the holding is consistent with Bulletin 2004-56.
Because of the complexity of the instruments, an appropriate level of diligence will be expected
of the bank, and supervisory non-objection from the bank’s EIC should be obtained. An
appropriate exercise of due diligence should include:
• A review by outside counsel of the legal documents involved in the transaction.
• An initial assessment and ongoing monitoring of the performance of the underlying
hedge funds, so that the bank will know at all times its credit exposure under the SVP
policy.
• A review of BOLI holdings by an independent control or risk management unit to ensure
compliance with OCC Bulletin 2004-56.
In addition, the bank should establish a compliance process to determine and monitor bank
compliance with the supervisory conditions contained in this Letter.

Conclusion

We conclude that the Bank’s investment in BOLI, as described herein, may be permissible as an
investment in life insurance under section 24(Seventh). The separate account holdings more
closely resemble debt than equity securities so the hedging accuracy standards for equity
holdings in separate account BOLI do not apply. The Notes have a limited term, are rated, have

12 See 12 C.F.R. 1.5, which requires that a national bank adhere to safe and sound banking practices as well as the
specific requirements of Part 1 in purchasing and holding investment securities.
dings more
closely resemble debt than equity securities so the hedging accuracy standards for equity
holdings in separate account BOLI do not apply. The Notes have a limited term, are rated, have

12 See 12 C.F.R. 1.5, which requires that a national bank adhere to safe and sound banking practices as well as the
specific requirements of Part 1 in purchasing and holding investment securities.

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7
a fixed coupon, offer holders claims superior to common shareholders, and do not provide voting
rights. Although the Notes’ contingent coupon may resemble the return on an investment in
equity securities, the Notes more closely resemble debt in sufficient respects to be classified as
debt rather than equity.

Where, as here, the separate account holds complex instruments with unrated, equity-based
returns, the Bank should conduct an appropriate level of due diligence, provide the OCC an
opportunity to review the specific instruments to determine that the holding is consistent with
Bulletin 2004-56 and obtain supervisory non-objection from the Bank’s EIC. If you have
questions concerning this matter, please contact Donald Lamson, Securities and Corporate
Practices Division, at 202-874-5210 or Kurt Wilhelm, NBE, Treasury and Market Risk Division,
at 202-874-5670.

Sincerely,

/s/ Daniel P. Stipano

Daniel P. Stipano
Acting Chief Counsel

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Source: Frix Law Library, https://www.frixlaw.com/law-library/statutes/OCC_INT1030. Check the current official text before relying on it. Not legal advice.