What is Company-Owned Life Insurance – COLI
Corporate owned life insurance which is also known as “dead peasant insurance” is the life insurance that is purchased by a business on the life of an employee.
The employee is the subject of insurance (insured) while the business or employer is the beneficiary.
If the employee that is insured dies, his employer will receive the death benefits from the insurer.
Even when the employee leaves the company, that particular company will still remain the beneficiary. Company-owned life insurance can be written for a group of workers or one worker as the case may be.
This is no surprise as stats reveal a rise in unexpected employee deaths. Hence, firms seek to protect their business due to the effects of losing important staffs.
The Corporate-owned life insurance was formed to protect the business from the effects that the deaths of executives and employees who are vital to the operation of the company.
When employees who play vital roles in a business dies, the business may face a lot of challenges and it will take a while for the business to adjust to the absence of this valuable employee, this insurance enables the company to weather the storm and get back on their feet.
Companies believe that the more important a person is and the role he plays in the organization, the more difficult it will be to replace the person when he dies.
The insurance policy will enable the company to foot the bill of finding a replacement for the deceased staff.
This is the major reason why Company-owned life insurance is commonly used for the top executives of a firm. These executives are harder to replace than other regular employees.
Certain people think that it is inappropriate for a business to cash in or benefit from the death of an employee especially when some employers take advantage of this to exploit tax loopholes.
But companies believe that it is just seeing that the demise of a top employee or executive can put the company in a tight spot.
The companies don’t consider this to be taking undue advantage of the death of the employees, it is however considered to be a way of ensuring that the finances and smooth running of the company are not affected by the death of an employee.
If the companies have to bear the cost of replacing dead employees from the pocket of the company, it may affect the finances of the company either immediately or in the long run especially when the loss of more than one top executive is experienced within a short time frame.
PURPOSE OF COLI
The original aim of the adoption of the Company-Owned Life Insurance was to hedge against the financial costs that came about as a result of the loss of life of key employees and the risk of recruiting and training the replacements for the deceased key employees.
COLI can be utilized to generate income for organizations which is then used to offset the benefits costs that spill over to the income statement. These death proceeds, which are gotten tax-free, can be used to recover expenses related to offering benefits.
It was also aimed at finding corporate obligations to redeem stock when the owner of a business dies.
When employees are being hired a part of the requirements for the firms that adopt COLI is that the employee has to write a written consent to the insurance policy.
Presently, the benefits from COLI can be paid to the family of the employees directly, but the company paying the premiums has the right to legally deduct from the earnings and the corporate profits.
Most people think that company-owned life insurance is the same as additional insurance coverage of companies which is geared at protecting the employees and their families.
Under the insurance coverage of companies, the family of the insured staff is the beneficiary of the benefits of the insurance but with the corporate-owned life insurance, the business are the beneficiaries of the insurance benefits.
As stated earlier, the company owned life insurance is required to enable the organization to pay for the cost of finding a replacement for a valuable employee who dies.
Most often this replacement process can be expensive and the insurance benefits will enable them to pay for the cost incurred without taking from the company’s account.
Another reason is that the benefits from the insurance will provide a way for the company to earn additional income which usually exceeds what the company pays in premiums.
HOW DOES COLI WORK?
To further understand what COLI entails; it is important to know how it works.
Company-Owned Life Insurance consists of two major parts namely: the cost of insurance and the cash value.
The cash value is the savings element (i.e. funds invested in assets such as stocks and bonds) of the policy while the cost of insurance consists of the amount that will be paid for the death benefit and the administrative expense.
The savings element of the cash value can be held in a general account or a separate account. When it is in a separate account, the policy holders control the assets and can decide on how to allocate the funds.
When the value of the underlying assets changes; the value of the savings portion also fluctuates.
On the other hand, when the company-owned life insurance is set up with a general account, the control of the assets is in the hands of the insurer, it is the insurer that will decide on how to allocate money among the assets held, he also is responsible for the declaration of the yearly application rate of return.
TYPES OF COLI
There are two types of Corporate-Owned Life Insurance.
The two types have varying modes of operation and they also have different advantages and disadvantages.
1. Superheated Account
The first type is the superheated account where professional brokers invest the cash value; the account holder is responsible for the risks of the investment.
2. The General Account
The second type is the general accounts where the insurance company in a general portfolio is responsible for investing the cash values of the policies.
The insurance company is responsible for the risks of the investment.
Before choosing which type to implement, the firm will examine the pros and cons of the two types and they will choose the one that serves the needs of the organization.
FORMS OF COLI
There are also two forms that the company-owned life insurance takes.
The first is key person insurance while the second is split-dollar life insurance.
1. The Key Person Insurance
Under the key person insurance, the company is compensated for the loss of a key person such as the president or a partner. Life or disability benefits are also provided under key person insurance.
2. The Split-dollar Life Insurance
The split-dollar life insurance, however, involves the splitting or sharing of the premium, the cash value of benefits of the insurance between the employee and the company.
There are various options available under the split-dollar life insurance, for example, all the death benefits of an employee can be paid to the beneficiaries of the employee or the company can receive the cash value of the amount it paid in premiums.
IMPORTANCE OF COMPANY OWNED LIFE INSURANCE
Below are the importance of Company Owned Life Insurance:
1. It Gives the Company a Cash Reserve
When a company purchases company-owned life insurance, it buys the traditional death benefit coverage amount while giving the company insurance coverage that can compensate the company for the loss of a valuable employee or executive.
The cash value of the policy enables the company to have access to funds that it can use to expand the business. The cash value from the insurance can become a saving from the company which will be used to carry out other business operations.
2. It Gives the Company Access to a Lower Premium Cost and Higher Cash Value
Having COLI gives a company the advantage of having good pricing on premiums.
If the company is buying cash policies it can be offered as special policies that are designed to generate cash value quickly and easier than other policies.
These policies are designed to show the cash value of the policy as an asset to the account books of the company especially in the early years of the policy.
3. Companies can use it to Retain Employees
Having a company-owned life insurance is often very enticing to employees especially since it gives them access to enjoying the benefits of group term coverage.
If an employee is concerned about the commitment of his employer to provide benefits and compensation over his salary, he can be retained in the company when the employer offers him COLI this will boost confidence in the company.
Some companies use this as a competitive advantage to keep the best employees in their company.
4. Pre-tax Premium Payments
Companies can make pre-tax premium payments on behalf of the employees on a pre-tax basis.
This gives the employees and the company the ability to buy more life insurance that they would legally buy if they were operating a private policy.
Organizations make use of the Company-Owned Life Insurance to soften the blow that taxes place on the finances of the organization. They are used to offset the costs of the expensive benefit packages of employees.
It is, however, important to note that the company-owned life insurance does not hinder or replace the personal insurance that the employees have.
The company-owned Life Insurance benefits the company more than the employee; it doesn’t really benefit the insured person or help his loved ones to pay the debts or final expenses he leaves behind so it is important that the employees have personal insurance which will be offered through the employer.
BACKGROUND OF COLI
As already seen COLI can be gotten on a group or individual basis, and the company generally becomes the owner, beneficiary, applicant and premium payer of the policy.
This is because the organization pays the premiums by itself and acquires all the benefits.
The individuals or the employees actually insured do not get any of the benefits. Hence, COLI isn’t for employee benefit. It is usually mistaken for group life insurance which employers offer their employees.
COLI take’s on numerous forms. Originally, narrow-based services termed “key man insurance” were utilized by organizations as a means to protect themselves against the effect of the death of important employees who are costly or especially difficult to replace.
What’s more, it was also used for the insurance of the life of top-level executives.
Other similar uses of narrow-based COLI services include the financing of deferred compensations for important employees or individual stock redemption agreements.
Based on news reports, some organizations, have acquired broad-based COLI services that do not just cover important employees, but for most or all of their employees.
This particular application of COLI principles was developed to create a funding source for various other purposes of an organization, such as supplemental pensions, broader employment related perks like retiree health plans, and executive benefits.
The use of company-owned life insurance to pay for retiree medical perks is largely linked to the promulgation of Financial Accounting Standards Board’s statement 106 ( FASB 106)
Under this statement post-retirement benefits, such as the retiree medical benefits, must be recognized as a cost due to the fact that they are acquired over the employee’s entire working lifetime, rather than like a payment after retirement.
If these benefits aren’t funded in some way, they develop into an expanding balance sheet liability.
The Company-owned life insurance benefits accruing to an organization from the death payouts of workers and the tax-free buildup within the policies can be utilized to develop a balance sheet asset that the organization can use in order to offset liabilities and finance the retiree benefits cost.
Individuals who support the use of COLI to pay for such retirement benefits costs, state that without the presence of such funding, a lot of company’s would have to discontinue that retirement medical benefits.
CRITICISMS OF COLI
However, critics are on the opposite side of the line, stating that the organizations should not make profits from the deaths of low ranking employees. These critics have termed COLI as “dead peasant insurance” or ” janitor’s insurance”.
Criticisms are also on the issue that although organization’s claim to utilize COLI for the purpose of financing employee benefits, there are no regulations of how it is done, as there are for the Employee Retirement Income Security Act benefit plans (ERISA).
What’s more, ERISA also makes provisions for tax-preferred investments for employee funding benefits.
Even though company-owned life Insurance isn’t well known, it has pulled the attention of both the print media and film. In the month of April 2002, a three-part series was initiated by the Wall Street Journal termed the “Janitors Insurance- Profiting from Employees Deaths”.
The articles were extremely critical of COLI and called out numerous organizations that had allegedly put in billions of dollars into the company-owned life insurance policies insuring a large number of employees.
After the Wall Street Journal articles, other major press co-operations, like the Washington Post, released articles which were critical of BOLI and COLI. In May 2009 the Wall Street Journal again focused on COLI, reporting on bank filings which reported their utilization of COLI.
What’s more, in 2008, banks reported COLI totaling up to $122.8 billion. Asides from this COLI pulled public attention due to how the heavy criticisms it received in Capitalism: A Love Story, a Michael Moore Movie.
BANKS AND COLI
When a bank purchases COLI policies, it is sometimes termed as bank-owned life insurance (BOLI). The Comptroller of the Currency (OCC), in 1996, outline general guidelines for banks in the United States to ascertain that BOLI purchases are consistent with safe banking practices.
The OCC stated that buying BOLI is incidental to banking, therefore, making it legally acceptable, if it is useful or convenient in relation to the conduct of the banks business.
The office of the Comptroller of the Currency guidelines particularly makes emphasis on the fact that national banks are allowed to use COLI as a cost recovery vehicle or as financing for post-retirement employee benefits.
Also, that the COLI value is an organizational asset even after the severance of the employee and employer relationship.
Furthermore, it states that employees do not have interest in COLI other than their claim that the organization’s assets arise from the bank’s obligation to offer the stated benefits.
The Life Insurance Employee Notification Act (H.R.130) was introduced on January 5, 2011, by Representative Gene Green. The aim of this bill was to require that the employee is notified of COLI. This includes the beneficiary of the policy, the benefit amount and violating this would result in unfair trade practice.
These requirements were to be enforced by the Federal Trade Commission (FTC). This legislative proposal is quite similar to the Pension Protection Act limitations of 2006.
However, these requirements are to be enforced by the FTC and not the Internal Revenue Code as is the case of fur Pension Protection Act limitations.
PREVIOUS LIMITATIONS ON COLI
The 2006 Pension Protection Act was inclusive of additional tax-code requirements with the aim of ensuring the COLI policy enjoys the normal tax positives of life insurance.
These specific requirements stated that these policies have to rest on highly compensated personalities or directors and that all insurance employees have to be notified and give written consent in the same period the life insurance is acquired.
The phrase “highly compensated” employees are inclusive of any worker who gets payouts in the top 35% of the organization. Organizations were also demanded to file yearly returns with the Secretary of the Treasury with details of their utilization of the COLI policies.
Keep in mind, however, that the information of these returns is just as confidential as any tax information. The recent interest in COLI is mainly due to the recent congressional focus on insurance.
Since 1986, the tax benefits of company-owned life insurance in relation to on tax deductibility of COLI related to loan interest has been under limitations by legislation.
In 1986, the Congress slated a deductible interest for all indebtedness which exceeded $50,000 for each singular contract.
Only loan interests which were related to policies bought after the 20th of June 1986, were covered.
It has been stated that the organizations reacted to this limitation by broadening their specification of life insurance benefits from the executives to regular employees.
This, in turn, generated more COLI-related loans, however at the capped amount.
Congress in 1996 passed legislation that totally eliminated (inclusive of a phase-out rule) all interest deduction for policy loans which cover officers or employees except for important personalities.
Going even further, Congress capped the deductible interest rates on top executives and also the pre-1986 contracts which were hinged on the typical corporate bond rate.
Certain business responded by proposing to broaden the coverage of life insurance contracts as well as related tax-advantaged loans in order to cover customers and mortgagors specifically.
In 1997 Congress addressed this particular reaction by placing more limitations on interest expense deductions.
The 1997 ruling required that all interest deductions be diminished via pro-rata calculations based on the cash value ratio of an organization’s life insurance policy to the total assets of the corporation.
Nevertheless, policies for directors, employees, owners, and officers were removed from this calculation, which suggested that the 1997 change was aimed at addressing particular policies, like those covering borrowers.
This approach produced the effect of preventing the interest deduction for cases like lender policies which cover mortgagors.
Adding to the increased limitations Congress forced on company-owned life insurance interest deduction, the IRS as well, successful embarked on several cases which were considered to be a play of the system.
Furthermore, the Internal Revenue Service provided a settlement initiative with the aim of encouraging the disclosure of shady transactions as well as to cause payment of a part of the presumed tax liability.
The company-owned life insurance is utilized extensively by numerous organizations to aid them in achieving their financial goals.
Based on various industry surveys, 75% of Fortune 1000 corporations have running COLI programs. What’s more, of the 50 leading banks and thrift institutions in America, 43 of them have gotten Life Insurance.
A lot of organizations are currently purchasing Company-owned life insurance policies.
Presently, major companies engaged in purchasing COLI include: Citi Baker, Bank of America, Win-Dixie, Walt Disney, American Electric Company, Morgan Chase, Wells Fargo, Procter and Gamble, Dow Chemical and numerous others.