Corporate-owned life insurance (abbreviated COLI) is life insurance purchased by a business on the life of an employee. The business is the beneficiary and the employee is the insured (subject of insurance). When the employee dies, the business receives death benefits from the insurer. The company may remain the beneficiary even after the insured employee has left the firm. COLI may be written on one employee or a group of workers.
Dead Peasant Insurance
Corporate-owned life insurance was created to protect businesses from the deaths of executives who were essential to the companies' operations. The coverage is controversial as some people think businesses should not benefit from the deaths of their employees. COLI was abused in the 1980s and 1990s when large companies purchased policies on thousands of low-level employees without their knowledge to exploit tax loopholes. Congress closed the loopholes in 2006 by passing the Pension Protection Act. COLI is sometimes referred to by the derogatory term "dead peasant insurance."
How It Works
COLI is usually based on either whole life or universal life insurance. The premium consists of two parts:
- The cost of insurance, which is the cost of keeping the policy in force
- The cash value. This represents the savings element of the policy.
The cost of insurance includes an amount for the death benefit plus administrative expenses. The savings portion consists of funds invested in assets like stocks and bonds. COLI may be set up so that the assets are held in either a separate account or a general account. When COLI is written with a separate account, the policyholder has control of the assets and can choose how to allocate the funds among them. The value of the savings portion fluctuates as the values of the underlying assets change. When COLI is set up with a general account, the insurer controls the assets. Under this type of setup, the insurer decides how to allocate money among the assets held. The insurer declares the applicable rate of return each year.
Types of COLI
There are several types of corporate-owned life insurance. One is key person insurance, which compensates a company for the loss of an individual (such as a partner or president) who is essential to the firm's survival. Depending on the policy purchased, key person insurance may provide life or disability benefits.
Another type of COLI is split-dollar life insurance. As its name suggests, it involves an arrangement whereby the company and an employee share the premium, death benefits, and cash value of the policy. Many options are available. For example, the employer might pay the entire premium. When the employee dies, his or her beneficiaries receive the death benefit. The company receives either cash value of the policy or the amount it paid in premiums, whichever is greater.
Why Employers Buy COLI
COLI is often used to purchase employee benefit plans, such as non-qualified executive health plans or deferred compensation plans. The employer (COLI owner) can pay for benefits by withdrawing the cash value of the insurance or borrowing against it. COLI offers tax advantages for employers since the investment returns (increase in cash value) and the death benefits are tax-free. Under IRS rules, benefits are tax-free only if the insured worker qualifies as a company director, a highly-compensated employee, or a highly compensated individual as these terms are defined by the IRS. The premiums paid for the policy are not tax deductible.
Under federal law, employers that purchase COLI must provide written notice to all employees whose lives are insured. The notice must state that the company is the beneficiary and specify the amount of insurance purchased. Employees must provide their written consent to the arrangement before the policy is issued.
Any company that purchases corporate-owned life insurance must file IRS tax form 8925 at the end of each year in which a COLI is in force. The company must report the number of employees covered by the insurance and the total amount of insurance in force at the end of the tax year. Policyholders must also indicate whether a valid consent has been received from each covered employee. If any employees have not consented, the company must report how many have not agreed. A company is entitled to the proceeds of the policy on a tax-free basis only if it has properly filed form 8925.