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Testimony:

Before the Committee on Finance, United States Senate:

United States General Accounting Office:

GAO:

For Release on Delivery Expected at 2:00 p.m. EDT:

Thursday, October 23, 2003:

BusineSs-Owned Life Insurance:

Preliminary Observations on Uses, Prevalence, and Regulatory Oversight:

Statement of Davi M. D'Agostino, Director, Financial Markets and 
Community Investment:

GAO-04-191T:

GAO Highlights:

Highlights of GAO-04-191T, a testimony before the Committee on 
Finance, U.S. Senate 

Why GAO Did This Study:

Business-owned life insurance is held by employers on the lives of 
their employees, and the employer is the beneficiary of these 
policies. Unless prohibited by state law, businesses can retain 
ownership of these policies regardless of whether the employment 
relationship has ended. Generally, business-owned life insurance is 
permanent, lasting for the life of the employee and accumulating cash 
value as it provides coverage. Attractive features of business-owned 
life insurance, which are common to all permanent life insurance, 
generally include both tax-free accumulation of earnings on the 
policies cash value and tax-free receipt of the death benefit. 

To address concerns that businesses were abusing their ability to 
deduct interest expenses on loans taken against the value of their 
policies, Congress passed legislation to limit this practice, and the 
Internal Revenue Service (IRS) and Department of Justice pursued 
litigation against some businesses. But concerns have remained 
regarding employers ability to benefit from insuring their employees 
lives. 

This testimony provides some preliminary information from ongoing GAO 
work on (1) the uses and prevalence of business-owned life insurance 
and (2) federal and state regulatory requirements for and oversight of 
business-owned life insurance.

What GAO Found:

GAOs preliminary work indicated that no comprehensive data are 
available on the uses of business-owned life insurance policies; 
however, businesses can purchase these policies to fund current and 
future employee benefits and receive tax advantages in the process. 
Federal bank regulators have collected some financial information on 
banks and thrifts business-owned life insurance holdings, but the 
data are not comprehensive and do not address the uses of the 
policies. The Securities and Exchange Commission (SEC), the IRS, state 
insurance regulators, and insurance companies told GAO that they 
generally have not collected comprehensive data on the sales or 
purchases of these policies or on their intended uses, because they 
have not had a need for such data in fulfilling their regulatory 
missions. In an effort to collect comprehensive data, GAO considered 
surveying insurance companies about their sales of business-owned life 
insurance. However, based on a pretest with six insurance companies, 
GAO determined that it would not be able to obtain sufficiently 
reliable data to allow it to conduct a survey. GAO found, however, 
that some insurers have voluntarily disclosed information about sales 
of business-owned policies and that some noninsurance businesses have 
included examples of their uses in annual financial reports filed with 
SEC. 

As part of their responsibility to oversee the safety and soundness of 
banks and thrifts, the federal bank regulators have issued guidelines 
for institutions that buy business-owned life insurance. Also, they 
told GAO that they have reviewed the holdings of many institutions 
with significant amounts of business-owned life insurance and 
concluded that major supervisory concerns do not exist. SEC officials 
said that the agency has not issued specific requirements for holders 
of business-owned life insurance, relying instead on its broadly 
applicable requirement that public companies disclose information 
material to investors in their financial statements; SEC did not have 
investor protection concerns about public firms holding business-owned 
life insurance. The IRS had some requirements related to the tax 
treatment of business-owned life insurance and expressed some concerns 
about compliance with these requirements. State laws governing 
business-owned life insurance differed; the four states regulators 
that GAO interviewed described some limited oversight of the policies, 
and these regulators and NAIC reported no problems with them.

www.gao.gov/cgi-bin/getrpt?GAO-04-191T.

To view the full product, click on the link above. For more 
information, contact Davi M. D'Agostino at (202) 512-8868 or 
d'agostinod@gao.gov.

[End of section]

Mr. Chairman and Members of the Committee:

I am pleased to be here today to discuss the preliminary results of 
GAO's work on business-owned life insurance, done at the request of 
Senators Akaka and Bingaman. Business-owned life insurance--including 
corporate-owned, bank-owned, and trust-owned life insurance--is held by 
employers on the lives of their employees. The employer is the 
beneficiary of these policies. Some of this insurance protects against 
the loss of key executives--called key-person insurance--while some of 
it covers larger groups of employees and is called broad-based 
insurance. Unless prohibited by state law, businesses can retain 
ownership of these policies regardless of whether the employment 
relationship has ended. Generally, business-owned life insurance is 
permanent rather than term life insurance, lasting for the life of the 
employee and accumulating cash value as it provides coverage. 
Attractive features of business-owned life insurance, which are 
features common to all permanent life insurance, generally include both 
tax-free accumulation of earnings on the policies' cash value and tax-
free receipt of the death benefit.

To address concerns that businesses were abusing their ability to 
deduct interest expenses on loans taken against the value of their 
policies, Congress passed legislation to limit this practice, and the 
Internal Revenue Service (IRS) and Department of Justice pursued 
litigation against some businesses. But concerns have remained 
regarding employers' ability to benefit from insuring their employees' 
lives--specifically, whether (1) employers should be considered to have 
an insurable interest in employees' lives that allows them to hold 
business-owned life insurance, (2) employers' insurable interest should 
continue after the employment relationship ends and, if so, under what 
circumstances, (3) employers should be required to obtain their 
employees' consent before purchasing business-owned life insurance, and 
(4) businesses should be allowed to receive tax advantages from owning 
these policies. Proponents of business-owned life insurance point out 
that, among its other purposes, businesses use these policies to fund 
broad-based benefits for their employees, including pre-and 
postretirement health care.

We currently have work underway, and today, I will provide some 
preliminary information on (1) the uses and prevalence of business-
owned life insurance and (2) federal and state regulatory requirements 
for and oversight of business-owned life insurance.

To obtain this information, we analyzed the financial reports that 
banks filed with their regulators as well as the corporate annual 
financial statements that publicly traded insurers and noninsurers 
filed with the Securities and Exchange Commission (SEC). In addition, 
we interviewed officials of the IRS, SEC, the federal bank regulators, 
four state insurance departments, the National Association of Insurance 
Commissioners (NAIC), two life insurance associations, and six life 
insurance companies. We began our work in February 2003, and it is 
still ongoing.

Summary:

Based on our preliminary work to date, no comprehensive data are 
available on the uses of business-owned life insurance policies; 
however, businesses can purchase these policies to fund current and 
future employee benefits and receive tax advantages in the process. 
Federal bank regulators have collected some financial information on 
banks' and thrifts' business-owned life insurance holdings, but the 
data are not comprehensive and do not address the uses of the 
policies.[Footnote 1] SEC, the IRS, state insurance regulators, and 
insurance companies told us that they generally have not collected 
comprehensive data on the sales or purchases of these policies or on 
their intended uses, because they have not had a need for such data in 
fulfilling their regulatory missions. In an effort to collect 
comprehensive data, we considered surveying insurance companies about 
their sales of business-owned life insurance. However, based on a 
pretest with six insurance companies, we determined that we would not 
be able to obtain sufficiently reliable data to allow us to conduct a 
survey. We found, however, that some insurers have voluntarily 
disclosed information about sales of business-owned policies and that 
some noninsurance businesses have included examples of their uses in 
annual financial reports filed with SEC. As part of their 
responsibility to oversee the safety and soundness of banks and 
thrifts, the federal bank regulators have issued guidelines for 
institutions that buy business-owned life insurance. Also, they told us 
that they have reviewed the holdings of many institutions with 
significant amounts of business-owned life insurance and concluded that 
major supervisory concerns do not exist. SEC officials said that the 
agency has not issued specific requirements for holders of business-
owned life insurance, relying instead on its broadly applicable 
requirement that public companies disclose information material to 
investors in their financial statements; SEC did not have investor-
protection concerns about public firms holding business-owned life 
insurance. The IRS had some requirements related to the tax treatment 
of business-owned life insurance and expressed some concerns about 
compliance with these requirements. State laws governing business-owned 
life insurance differed; the four states' regulators that we 
interviewed described some limited oversight of the policies, and these 
regulators and NAIC reported no problems with them.

No Comprehensive Data Were Available on the Uses and Prevalence of 
Business-Owned Life Insurance:

Neither federal nor state regulators collected comprehensive data on 
the uses and prevalence of business-owned life insurance. Although no 
comprehensive data were available on the uses of such policies, 
businesses may purchase life insurance to ensure recovery of losses in 
the event of the untimely death of key employees and to fund pre-and 
postretirement employee benefits. Accounting standards require that the 
future costs of postretirement benefit plans be recorded as liabilities 
at their present value on current financial statements. The accounting 
standards do not require that such liabilities be directly offset with 
specified assets. However, businesses may choose to fund such future 
costs using life insurance, thereby becoming eligible for tax-free 
policy earnings and tax-free death benefit payments on the 
policies.[Footnote 2] When businesses use nonqualified plans to provide 
postretirement benefits, they avoid the funding and other restrictions 
of tax-preferred qualified plans, while retaining control over the plan 
assets.[Footnote 3]

Federal bank regulators did not collect comprehensive data on the uses 
and prevalence of business-owned life insurance by banks and thrifts, 
although they collected some financial information on such policies as 
part of monitoring the safety and soundness of individual institutions. 
Regulatory officials said that they collect this information to support 
their supervision of individual institutions. For supervisory purposes, 
banks and thrifts are only required to disclose the cash surrender 
value of business-owned life insurance and earnings from these policies 
in their quarterly financial reports to the regulators if the amounts 
exceed certain thresholds. For example, the Federal Deposit Insurance 
Corporation (FDIC), Federal Reserve Board, and Office of the 
Comptroller of the Currency (OCC) require the institutions they 
regulate to disclose the cash surrender value of policies worth more 
than $25,000 in aggregate and that exceed 25 percent of "other assets," 
which include such items as repossessed personal property.[Footnote 4] 
The Office of Thrift Supervision (OTS) requires the thrifts it 
supervises to report the cash surrender value of policies if the value 
is one of the three largest components of "other assets." In addition 
to the banks and thrifts that meet a disclosure threshold, other 
institutions sometimes voluntarily provide data on their business-owned 
life insurance policies.

Our preliminary results indicated that about one-third of banks and 
thrifts, including many of the largest institutions, disclosed the 
value of their business-owned life insurance holdings as of December 
31, 2002, either voluntarily or because they met the reporting 
threshold.[Footnote 5] The remaining two-thirds either did not meet the 
reporting threshold or did not own business-owned life insurance. We 
found that 3,209 banks and thrifts (34 percent of all institutions) 
reported the cash surrender value of their policies at $56.3 billion. 
Twenty-three of the top 50 banks and thrifts--ranked by total assets--
reported owning policies worth $36.9 billion, or 66 percent of the 
reported total of all banks and thrifts. Overall, 259 large banks and 
thrifts--those with assets of $1 billion or more, including those among 
the top 50--held 88 percent, or $49.4 billion, of the total reported 
cash surrender value of business-owned life insurance.

The quarterly reports that commercial banks and FDIC-supervised thrifts 
submitted did not require them to categorize business-owned life 
insurance policies according to their intended use. OTS-supervised 
thrifts, in contrast, were required to report the value of their key-
person policies and the value of business-owned life insurance policies 
held for other purposes as separate items, if they met the reporting 
threshold. However, since the disclosure threshold applied separately 
to the two categories, OTS-supervised thrifts could be required to 
report on only one type of policy, rather than the total value of their 
business-owned life insurance holdings, even if they held both key-
person and other policies.[Footnote 6]

According to SEC, agency regulations do not specifically require public 
companies to disclose the value or uses of business-owned life 
insurance in the financial statements submitted to the agency. The 
federal securities laws that SEC administers are designed to protect 
investors by requiring public companies to disclose information that is 
"material" to investors in their financial statements--that is, 
according to SEC, information that an investor would consider important 
in deciding whether to buy or sell a security or in making a voting 
decision related to a security that the investor owns. SEC officials 
said that for most companies, business-owned life insurance holdings 
are not likely to be material to the company's financial results, and 
therefore would not be subject to SEC reporting requirements.

IRS officials told us that the agency has not collected comprehensive 
information on the value of or income from business-owned life 
insurance policies, and agency officials said that they do not need 
this information. Specifically, businesses are generally not required 
to include the earnings or death benefits from business-owned life 
insurance in their taxable income. Businesses that are subject to the 
alternative minimum tax include income from death benefits and earnings 
from insurance when calculating the tax, but they are not required to 
list the insurance-related values or the uses of the policies on the 
alternative minimum tax form. Also, businesses that are required to 
complete Schedule M-1, Reconciliation of Income (Loss) per Books with 
Income per Return, as part of their Form 1120, U.S. Corporation Income 
Tax Return, would report earnings on business-owned life insurance as 
part of the income recorded on their books but not on the tax return. 
However, according to IRS officials, these earnings might not be 
separately identified as they are often "lumped" with other 
adjustments.

State insurance regulators, concerned with state requirements, rates, 
and solvency issues, have collected extensive financial information 
from insurers, but not at the level of detail that would describe the 
uses or prevalence of business-owned life insurance policies.[Footnote 
7] State insurance regulators use insurers' financial statements to 
monitor individual companies' solvency, and aggregate information on 
business-owned life insurance has not, in state regulators' views, been 
necessary for such monitoring. Insurers' financial statements list the 
number of all policies in force and premiums collected during the 
reporting period, but broken out only by individual and group policies, 
not by whether businesses or individuals owned the policies.

In an effort to compile more comprehensive data on business-owned life 
insurance, we worked with the representatives of six insurance 
companies and the American Council of Life Insurers (ACLI) to develop a 
survey of the uses and prevalence of business-owned life insurance 
sales. Although the insurance companies' representatives cooperated in 
a pretest of the survey, and ACLI representatives said that they would 
encourage their members to participate in the survey itself, the 
results of the pretest led us to conclude that we would not be able to 
obtain sufficiently reliable data to allow us to conduct the survey. 
These representatives told us that they do not have a business need to 
maintain the comprehensive data on business-owned life insurance that 
we needed for the survey. They said that insurers do not routinely 
summarize information on the numbers of policies and insured 
individuals, cash surrender value of policies, and uses of business-
owned life insurance. They explained that various factors made it 
difficult to obtain summary information, including that individual 
businesses may own multiple policies; that the same individuals may be 
insured under multiple policies; and that when purchasing policies, 
businesses may state multiple policy uses or policy uses may change 
over time. They also explained that extensive efforts would be required 
for insurance companies to obtain information from their computer 
systems and, in some cases, paper files to identify business-owned 
policies on employees where the business is also the beneficiary.

Our preliminary review of the financial statements of 32 life insurance 
companies that filed 10-K annual reports with SEC and that were among 
the 50 largest such companies ranked by assets, disclosed some 
information on business-owned life insurance. Although SEC did not 
require insurance companies to identify business-owned life insurance 
sales in their annual statements to the agency, nine insurers reported 
over $3 billion in business-owned life insurance premiums from 2002 
sales. Five of the insurance companies also reported that total 
premiums from 2002 business-owned life insurance premiums ranged from 
10 to 53 percent of each company's 2002 total life insurance sales 
premiums. In addition, three insurance companies reported the value of 
their business-owned life insurance assets as totaling about $28 
billion as of December 31, 2002.

Insurance companies have also reported business-owned life insurance 
sales in response to industry surveys. CAST Management Consultants, 
Inc., conducts research on business-owned life insurance and, in a 
summary report, estimated 2002 annual business-owned life insurance 
premiums of $2.1 billion, based on the survey responses of 20 insurance 
carriers increased by CAST adjustments.[Footnote 8] CAST 
representatives declined to provide us any information about the 
complete survey, which is available only to "qualified market 
participants." We could not, therefore, determine whether CAST was able 
to collect the information we sought to obtain by conducting our own 
survey. In addition, a representative of the A.M. Best insurer rating 
company said that the company collects information on business-owned 
life insurance, but does not currently report the data. A.M. Best 
reported aggregate premiums from business-owned life insurance for 1998 
(the last year for which it reported data) as more than $10 billion for 
20 large insurers.[Footnote 9]

Some businesses included anecdotal information about how they intended 
to use business-owned life insurance in the annual financial statements 
they filed with SEC. Our preliminary analysis of 100 randomly selected 
Fortune 1000 public companies' financial statements filed with SEC 
showed that 15 of the selected businesses referred to owning such 
policies, including 11 that provided information about their intended 
uses of the policies. The most commonly cited use of business-owned 
life insurance was to fund deferred executive compensation.[Footnote 
10] One business reported using policies to help fund postretirement 
health care benefits, and another reported using the policies to help 
fund an employee benefit plan for management employees as well as 
executives.

Some businesses have also provided survey responses on their uses of 
business-owned life insurance to fund executive benefit plans. Clark/
Bardes Consulting conducts an annual executive benefits survey and 
reports on the uses of business-owned life insurance by companies to 
fund nonqualified deferred compensation plans and supplemental 
executive retirement plans. In the 2002 results from its survey of 
Fortune 1000 corporations, Clarke/Bardes reported that 65 percent of 
those companies that fund nonqualified deferred compensation plans and 
68 percent of those that fund nonqualified supplemental executive 
retirement plans do so using business-owned life insurance.

Finally, the federal government estimated that the current tax 
exclusion of earnings on the cash value of business-owned life 
insurance results in over a billion dollars in foregone tax revenues 
annually--these estimates do not reflect the exclusion of additional 
income from death benefit payments. In its "Estimates of Federal Tax 
Expenditures for Fiscal Years 2003-2007," the Joint Committee on 
Taxation estimated that the foregone tax revenues resulting from the 
tax exclusion of investment income on life insurance for corporations 
would total $7.2 billion for 2003 through 2007. Similarly, the Office 
of Management and Budget, in its fiscal year 2004 budget "Analytical 
Perspectives," estimated foregone tax revenues of $9.3 billion for 2003 
through 2007 resulting from the tax exclusion of life insurance.

Regulators Had Guidelines or Requirements Applicable to Business-Owned 
Life Insurance but Did Not Identify Significant Regulatory Concerns:

The federal bank regulators, SEC, the IRS, and state insurance 
regulators had guidelines or requirements applicable to business-owned 
life insurance but did not identify significant regulatory concerns. 
The federal bank regulators had guidelines for purchases of business-
owned life insurance by banks and thrifts. OCC and OTS guidelines 
describe the permissible uses of business-owned life insurance and 
require national banks and OTS-supervised thrifts to perform due 
diligence before purchasing policies and to maintain effective senior 
management and board oversight.[Footnote 11] According to agency 
officials, FDIC and the Federal Reserve Board follow OCC's guidelines. 
The guidelines that are common among the regulators state that banks 
and thrifts can only purchase life insurance for reasons incidental to 
banking, including key-person insurance, insurance on borrowers, and 
insurance purchased in connection with employee compensation and 
benefit plans. Before purchasing policies, a bank's or thrift's 
management must conduct a prepurchase analysis that should, among other 
things, determine the need for insurance, ensure that the amount of 
insurance purchased is not excessive in relation to the estimated 
obligation or risk, and analyze the associated risks and the bank's or 
thrift's ability to monitor and respond to those risks. The guidelines 
also state that a bank or thrift should consider the size of its 
purchase of business-owned life insurance relative to the institution's 
capital and diversify risks associated with the policies. The 
guidelines require banks and thrifts to document their decisions and 
monitor their policies on an ongoing basis. In addition, banks and 
thrifts using business-owned life insurance for executive compensation 
should ensure that total compensation is not excessive under regulatory 
guidelines.

The federal bank regulators we spoke with said that their risk-based 
examination programs target any aspect of banks' and thrifts' purchases 
of business-owned life insurance that would raise supervisory concerns. 
The regulators monitor institutions' safety and soundness through their 
risk-based examinations, which they said assess banks' and thrifts' 
compliance with guidelines on business-owned life insurance on a case-
by-case basis. For example, all of the regulators said that if the 
value of the policies exceeded 25 percent of the regulator's measure of 
the institution's capital, they would consider whether further 
supervisory review or examination of these holdings was warranted. The 
regulators said that additional review or examination would be likely 
if the policies were held with one or very few insurers.

As of December 31, 2002, 467 banks and thrifts reported business-owned 
life insurance holdings in excess of 25 percent of their tier 1 
capital.[Footnote 12] We asked the bank regulators to explain their 
oversight of 58 institutions with the largest concentrations, all in 
excess of 40 percent of tier 1 capital. Bank regulatory officials said 
that their agencies were monitoring these institutions' levels of 
holdings, had conducted preliminary reviews or detailed examinations, 
and concluded that major supervisory concerns do not exist.

SEC officials said that the agency's regulations for public companies 
do not specifically address business-owned life insurance; rather, SEC 
has relied on its broadly applicable disclosure requirements to surface 
any investor protection concerns. SEC requires public companies to 
prepare their financial statements in accordance with generally 
accepted accounting principles (GAAP), which would require them to 
disclose information about business-owned life insurance policies when 
such information is material. According to SEC officials, however, 
following GAAP would rarely require purchases of and earnings from 
business-owned life insurance to be shown as separate line items 
because they typically are not financially material to the company. SEC 
officials also said that the agency would have an oversight concern if 
it became aware of a public company's failure to disclose material 
purchases of or earnings from business-owned life insurance, or if 
problems developed in accounting for these policies. However, they said 
that, to date, such problems have not arisen, and they have not had 
investor-protection concerns about public companies holding such 
insurance.

The IRS had some requirements related to the tax treatment of business-
owned life insurance. The Internal Revenue Code defines life insurance 
for tax purposes and sets out the current limitations on permissible 
tax deductions that businesses can claim for the interest on policy 
loans against life insurance policies. Federal laws and IRS regulations 
have changed some aspects of the tax treatment of business-owned life 
insurance. While policy owners may access the cash value of their 
policies by borrowing against them, policy owners' ability to deduct 
the interest on such loans was limited by the Tax Reform Act of 1986 
and further limited by the Health Insurance Portability and 
Accountability Act (HIPAA) of 1996, which amended Internal Revenue Code 
section 264.[Footnote 13] Before these limitations, some businesses 
were leveraging their life insurance ownership by borrowing against the 
policies to pay a substantial portion of the insurance premiums. Known 
as leveraged business-owned life insurance, these arrangements created 
situations where businesses incurred a tax-deductible interest expense 
while realizing tax-free investment returns.[Footnote 14] Various 
sources have reported that HIPAA curtailed new sales of leveraged 
policies, although such policies that were purchased in the past remain 
part of the life insurance policies currently in force. However, IRS 
officials expressed concern that HIPAA did not eliminate the tax 
arbitrage opportunities available through business-owned life 
insurance and that banks and other highly leveraged financial 
institutions may be indirectly borrowing to purchase policies on 
employees.[Footnote 15] IRS officials said that the agency is also 
concerned that banks are using separate account policies to maintain 
control over investments in a way that is inconsistent with the 
Internal Revenue Code.[Footnote 16] These officials said that the 
agency is continuing to study these business-owned life insurance 
issues at selected banks. Finally, in September 2003, the IRS issued 
final regulations on the tax treatment of split-dollar life insurance 
policies--policies in which the employer and employee generally share 
costs and benefits. Under the regulations, corporations cannot provide 
tax-free compensation to executives using split-dollar policies.

State law requires that one party have an insurable interest in another 
to be able to take out a life insurance policy on that person and 
defines the conditions for one party to have an insurable interest in 
the life of another person. Historically, insurable interest related to 
a family's dependency on an individual and a business's risk of 
financial loss in the event of the death of a key employee. The 
significance of employers having an insurable interest in their 
employees is illustrated by the 2002 decision of a federal district 
court in Texas. The court found that Wal-Mart did not have an insurable 
interest in employees' lives under Texas law, given the nature of the 
policies taken out on each of 350,000 Wal-Mart employees, and that 
under Texas law, Wal-Mart could not collect on the death benefits paid 
under policies covering deceased employees.[Footnote 17]

NAIC, a membership organization of chief state insurance regulators 
that helps promote coordination among the states, initially developed 
model guidelines for business-owned life insurance in 1992 and revised 
them in 2002. The 1992 guidelines suggested that states consider 
including in their laws provisions that recognize employers' insurable 
interest in employees, including nonmanagement employees who could 
expect to receive benefits. The 2002 revision added a recommendation 
for states to consider requiring employee consent to be insured and 
prohibiting employers from retaliating against employees who refused to 
grant their consent.

Since NAIC adopted the revised guidelines, several states have passed 
legislation requiring employers to obtain employees' written consent 
before taking insurance on them. In some states consent provisions 
apply to life insurance policies in general, while in others these 
provisions specifically address business-owned life insurance. Our 
preliminary analysis indicated that, as of July 31, 2003, more than 30 
states required written consent, including several states with 
provisions specific to business-owned life insurance. However, most of 
these states exempted group life insurance policies from consent 
requirements. Also, in some states consent requirements were satisfied 
if an employee did not object to a notice of the employer's intent to 
purchase a policy. Additionally, at least one state required employers 
to notify employees when purchasing business-owned life insurance, but 
did not require employee consent.

Officials of NAIC and four state insurance departments--California, 
Illinois, New York, and Texas--stated that, in recent years, some state 
legislatures adopted laws broadening the definition of employers' 
insurable interest to include broader groups of employees in order to 
permit using business-owned life insurance to finance employee benefit 
programs, such as current employee and retiree health care. The 
officials said that such laws responded in part to Financial Accounting 
Standard 106, which took effect in 1992 and requires businesses to 
report the present value of future postretirement employee benefits as 
employees earn them. Also, our preliminary analysis showed that several 
states limit the aggregate amount of insurance coverage on 
nonmanagement employees to an amount commensurate with the business's 
employee benefit liabilities. In addition, a few states recognize an 
employer's insurable interest in employees, provided that businesses 
use the proceeds solely to fund benefit programs.

Insurance department officials from the four states also told us that 
they primarily address compliance with their respective laws through a 
review of the proposed policy forms that insurers must submit for 
approval before marketing policies in their states. For example, in New 
York, the insurance department developed a checklist of items that must 
be included on forms that will be used for business-owned life 
insurance policies to ensure that the forms comply with the state's 
notification, consent, and other requirements. While NAIC officials 
said that state insurance regulators would generally have the authority 
to review policies currently in force for compliance with any state 
requirements, the officials from the four states said that they had not 
examined policies sold to confirm that employees consented to be 
insured or, where applicable, to test whether the amounts of coverage 
were appropriate. Officials in the four states said that their 
departments would investigate business-owned life insurance sales 
through their market conduct examinations of insurers if they observed 
a pattern of consumer complaints about such sales.[Footnote 18] 
However, the officials said that generally they had not received 
complaints about business-owned life insurance. Also, NAIC officials 
told us that the organization maintains a national database of consumer 
complaints made to state insurance regulators and that business-owned 
life insurance has not been a source of complaints.

Mr. Chairman, this completes my prepared statement. I would be happy to 
respond to any questions you or other Members of the Committee may have 
at this time.

FOOTNOTES

[1] "Banks and thrifts," as referred to in this testimony, are the 
commercial bank and thrift institutions regulated by the Federal 
Deposit Insurance Corporation, the Federal Reserve Board, the Office of 
the Comptroller of the Currency, and/or the Office of Thrift 
Supervision. However, our testimony does not cover bank holding 
companies and foreign banks with domestic branches.

[2] If a business owns life insurance policies, the earnings and death 
benefit proceeds are among the factors that could make the business 
subject to the alternative minimum tax. In general, the alternative 
minimum tax is based on a corporation's regular taxable income adjusted 
for certain tax preference income items, such as exclusions, 
deductions, and credits. The amount due is the amount by which the tax 
computed under this system exceeds a corporation's regular tax.

[3] Nonqualified employee pension benefit plans, unlike qualified 
plans, are not subject to the requirements of the Internal Revenue Code 
and the Employee Retirement Income Security Act of 1974 as to who can 
participate, the amount of benefits provided, and how the plan is 
funded. Further, in contrast to qualified employee benefit plans, the 
assets of nonqualified plans are not beyond the reach of a business's 
creditors in bankruptcy proceedings.

[4] FDIC, the Federal Reserve Board, and OCC regulate commercial banks, 
and FDIC regulates some thrifts. 

[5] The data do not include bank holding companies or foreign banks 
with domestic branches. The Federal Reserve Board started collecting 
data on business-owned life insurance from bank holding companies in 
2003, but the data were not available at the time of our analysis. The 
federal bank regulators did not collect business-owned life insurance 
data on foreign banks with domestic branches. 

[6] OTS has proposed requiring all the thrifts that it supervises to 
report the value of both their key-person and other business-owned life 
insurance policies, beginning in 2004. "Proposed Agency Information 
Collection Activities; Comment Request--Thrift Financial Report," OTS, 
68 Fed. Reg. 3318 (Jan. 23, 2003). 

[7] In commenting on this testimony, New York state insurance 
regulators said that while they did not collect detailed information on 
the prevalence or uses of business-owned life insurance, information 
about insurers that have a high volume of business-owned life insurance 
sales would be useful to them in conducting market conduct 
examinations. They also referred to survey data that they have 
collected since 2000 on business-owned life insurance, and we have 
requested this information from them. 

[8] "CAST 2002 Corporate-Owned Life Insurance Market Survey, Respondent 
Summary," CAST Management Consultants, Inc. (Apr. 2003). 

[9] Cynthia Crosson, "Capturing COLI/BOLI," Best's Review, Vol. 100, 
No. 9 (2000).

[10] SEC requires companies to disclose information pertaining to the 
compensation of top officers. Therefore, the fact that companies most 
frequently disclosed the use of business-owned life insurance to fund 
executive compensation does not mean that this is necessarily the most 
common use of such policies.

[11] Department of Treasury, OCC, "Bulletin 2000-23" (July 20, 2000). 
Department of Treasury, OTS, "Regulatory Bulletin RB 32-26" (July 31, 
2002). These bulletins rescinded previous guidelines. 

[12] The ratio of cash surrender value to tier 1 capital illustrates 
the institution's overall exposure to risk, including credit risk (the 
risk of counterparty default), since tier 1 capital is a measure of the 
equity cushion that banks have available to absorb loss, including 
credit losses from their holdings of business-owned life insurance.

[13] The limit on interest deductibility does not apply to policies 
purchased before June 20, 1986.

[14] In addition to the legislation addressing leveraged business-owned 
life insurance plans, the IRS and Department of Justice prevailed in 
three cases involving the proper treatment of loan interest related to 
such plans. These plans covered over 55,000 employees. The courts found 
that the leveraged plans lacked economic substance, making the interest 
deduction unallowable. See In re C.M. Holdings, Inc., 301 F.3d 96 (3rd 
Cir. 2002); Am. Elec. Power v. United States, 326 F.3d 737 (6th Cir. 
2003); Winn Dixie Stores v. United States, 254 F.3d 1313 (11th Cir. 
2001), cert. denied, 535 U.S. 986 (2002). The taxpayer prevailed in a 
fourth case. See Dow Chemical Co. v. United States, 250 F Supp. 2d 748 
(E.D. Mich. 2003).

[15] The Congressional Research Service has reported that businesses 
could use overall indebtedness to indirectly support tax-preferred 
investment in business-owned life insurance. Since debt is fungible and 
businesses can deduct interest expenses to support investments, some 
businesses may borrow for purposes unrelated to life insurance and 
thereby have funds available to purchase these policies. Under such 
circumstances, it would be difficult to distinguish debt that is used 
to finance business-owned life insurance from that which is not. 
Congressional Research Service, The Library of Congress, Corporate-
Owned Life Insurance: Tax Issues (Washington, D.C.: updated June 26, 
2003). Congressional Research Service, The Library of Congress, 
Taxation of life Insurance Products: Background and Issues (Washington, 
D.C.: July 18, 2003).

[16] In separate account life insurance, an asset account is maintained 
independently from the insurer's general investment account. This 
arrangement permits wider latitude in the choice of investments, 
particularly equities.

[17] Mayo, et al., v. Hartford Life Insurance Company, et al., 220 F. 
Supp.2d 794 (2002). Texas law on insurable interest was changed after 
Wal-Mart purchased the policies in question to grant an insurable 
interest to third parties who take out life insurance on those giving 
informed consent.

[18] New York insurance department officials said that other factors 
might also cause the department to investigate an insurer. For example, 
they said that the department would investigate, as part of its market 
conduct examinations, insurers that sell a significant amount of 
business-owned life insurance.