Corporate-owned Life Insurance: Another Financial Scheme that Takes Advantage of Employees and Shareholders

For many years corporations have been buying life insurance on the lives of their key employees to protect the corporations from economic losses in the event of the deaths of such employees. Insurance companies encouraged the corporateowned life insurance (COLI) programs by emphasizing their tax advantages. Corporations began to maximize the tax benefits by taking large loans to pay for policy premiums and then obtaining large income tax deductions for the interest payments. When the Tax Reform Act of 1986 curtailed these unintended tax benefits by imposing a $50,000 per-insured-employee limit on the amount of indebtedness for which interest was deductible, insurance companies created new kinds of COLI policies. One kind has been called “dead peasant policies” or “janitors insurance.” These are life insurance policies that corporations purchase for rank-and-file employees naming the corporation as the beneficiary when the employee dies. There is widespread use of janitors insurance by corporations and by banks (BOLI) because it creates significant improvements in their bottom lines. However, the current arrangement takes advantage of uninformed employees and misleads shareholders. Shareholders also pay for hidden executive compensation when corporations buy “split-dollar” life insurance policies for top executives. These arrangements, in which the premiums are split between the corporation and the executive, create millions of dollars of tax-free compensation for the executives without shareholder knowledge. Insurance companies have been very successful in marketing these products to corporations and to banks and, now, even to charities (CHOLI) with the public and Congress initially paying little attention. The intense focus on corporate scandal after the Enron, Tyco, Adelphia, and WorldCom debacles, however, has created interest in these insurance schemes in the business press and among legislators. Reporters for the Wall Street Journal have been writing regularly about these issues since the beginning of 2002. The Internal Revenue Service has been disallowing more deductions taken with respect to these schemes, and courts have been upholding the disallowances. It is important that remaining loopholes are plugged while the public’s attention is on overreaching by corporations. When no one is watching, it is difficult for rank-and-file employees and noninstitutional shareholders to know that they are being taken advantage of by large corporations, aided and abetted by large insurance companies. Employees should not be worth more to their employers, or former employers, dead than alive. Not only should their consent be required for such an arrangement, but the consent has to be meaningful so they fully comprehend the entire scope of their employers’ benefits from insuring their lives. Similarly, shareholders must be able to know when the companies’ earnings are being increased by COLI rather than from business activities and when the company’s payments for life insurance premiums for executives increase executives’ pay and benefits beyond what is clearly reported. This article first explores the issue of insurable interest, that is, why employers may be allowed to insure the lives of employees whose deaths, individually, have no particular effect on the financial well-being of the company. The article then discusses employees’ rights, with respect to COLI, and relevant litigation. The fourth section reviews the tax considerations of COLI and relevant litigation. The fifth section describes how corporations profit from COLI and discusses shareholders’ rights to know the sources of corporations’ income. The sixth section summarizes split-dollar arrangements that hide executive compensation and their future viability in light of recent legislation. The final section concludes that no one should be able to insure the life of another without the consent of the insured; that corporations should not be able to shift the cost of employee benefit programs to the taxpayer through tax-advantaged COLI programs; and that a corporation should be required to indicate clearly to shareholders the total compensation it is granting top management and the profit it enjoys that is directly attributable to COLI programs.