United States General Accounting Office 

GAO Testimony 

Before the Committee on Finance, 

United States Senate 

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 

Highlights of GAO-04-191T, a testimony 

before the Committee on Finance, U.S. 

Senate 

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 businessowned life insurance, which are 

common to all permanent life 

insurance, generally include both 

tax-free accumulation of earnings 

on the policies’ cash value and taxfree 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. 

October 23, 2003 

BUSINESS-OWNED LIFE INSURANCE 

Preliminary Observations on Uses, 

Prevalence, and Regulatory Oversight 

GAO’s 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 businessowned 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 businessowned 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. 
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 

Page 1 GAO-04-191T 
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.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 

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. 

Page 2 GAO-04-191T 
No Comprehensive 

Data Were Available 

on the Uses and 

Prevalence of 

Business-Owned Life 

Insurance 

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. 

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.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.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 

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. 

Page 3 GAO-04-191T 
thrifts are only required to disclose the cash surrender value of businessowned 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.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.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 

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. 

Page 4 GAO-04-191T 
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.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. 

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). 

Page 5 GAO-04-191T 
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.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. 

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. 

Page 6 GAO-04-191T 
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.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 businessowned life insurance for 1998 (the last year for which it reported data) as 

more than $10 billion for 20 large insurers.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 

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). 

Page 7 GAO-04-191T 
insurance was to fund deferred executive compensation.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. 

10SEC requires companies to disclose information pertaining to the compensation of top 

officers. Therefore, the fact that companies most frequently disclosed the use of businessowned life insurance to fund executive compensation does not mean that this is necessarily 

the most common use of such policies. 

Page 8 GAO-04-191T 
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.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 riskbased 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 

11Department 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. 

Page 9 GAO-04-191T 
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.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 businessowned 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 businessowned 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 

12The 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. 

Page 10 GAO-04-191T 
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 264.13 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.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 businessowned life insurance and that banks and other highly leveraged financial 

institutions may be indirectly borrowing to purchase policies on 

employees.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.16 These 

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

1986. 

14In 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). 

15The 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). 

16In 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. 

Page 11 GAO-04-191T 
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.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 

17Mayo, 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. 

Page 12 GAO-04-191T 
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 

Page 13 GAO-04-191T 
if they observed a pattern of consumer complaints about such sales.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. 

18New 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. 

(250164) Page 14 GAO-04-191T 
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