Business-Owned Life Insurance: More Data Could Be Useful in Making Tax Policy Decisions
Published: 2004-05-13T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Business-owned life insurance is permanent insurance held by employers on the lives of their employees, and the employer is the beneficiary of these policies. Its attractive features, common to all permanent life insurance, generally include both tax-deferred accumulation of earnings on the policies' cash value and tax-free receipt of the death benefit. Legislators have expressed concerns about the ability of employers to receive tax-favored treatment from insuring their employees' lives. GAO was asked to discuss (1) the prevalence and use of business-owned life insurance, (2) federal and state regulation and oversight of these policies, and (3) the potential usefulness of and costs associated with obtaining more comprehensive data on business-owned life insurance.
section_title: What GAO Found
paragraphs: Limited data are available on the prevalence and use of business-owned life insurance. Federal bank regulators have financial reporting requirements, but not all institutions holding policies meet reporting thresholds. The Securities and Exchange Commission (SEC), the Internal Revenue Service (IRS), and state insurance regulators told GAO that they generally have not collected comprehensive policy data because they have not had a need for such data in fulfilling their regulatory missions. GAO found, however, that some insurers have disclosed information about policy sales. Also, the Joint Committee on Taxation and the Office of Management and Budget have reported estimates of forgone tax revenues from these policies as $7.3 billion to $13 billion for the period 2004-2008, excluding forgone tax revenues on additional income from death benefit payments. Regulators said that they do not generally collect data on the intended use of policies, but that businesses can, for example, use business continuation policies to insure against the loss of a key employee or broad-based policies to fund employee benefits. The federal bank regulators told GAO that they have reviewed the holdings of institutions with significant amounts of business-owned life insurance against their guidelines and concluded that no major supervisory concerns exist. SEC officials said that the agency has relied on its broadly applicable requirement that public companies disclose information material to investors in their financial statements, which would include any material information related to business-owned life insurance; SEC did not have investor protection concerns about public firms' ownership of the insurance. IRS had some requirements related to the tax treatment of the insurance and is reviewing compliance with these requirements. State laws governing the insurance differed; the four states' regulators that GAO contacted described limited oversight of the policies, and these regulators and the National Association of Insurance Commissioners (NAIC) generally reported no problems with the policies. More comprehensive data could be useful to Congress in assessing the potential effects of legislative proposals that address the tax-favored treatment of business-owned life insurance. Costs would be incurred in obtaining the data. Such data would be most useful if reported separately for business continuation and broad-based policies because legislative proposals have generally treated these policies differently. Data on the amount of tax-free income that businesses received from death benefits could help explain the potential effect of changes to the tax treatment of policies on tax revenues. Businesses holding the policies or insurance companies that sold them could provide this and other data. SEC, Department of the Treasury (Treasury), and NAIC already collect financial information from businesses and insurers and could be required or asked to collect the data. Should Congress decide that the data would be useful, decisions would be required on, among other things, whether the benefits of collecting the data outweigh the costs of doing so.

section_title: Letter
paragraphs: Congress has debated the appropriate income tax treatment of business- owned life insurance since at least the mid-1980s and is likely to continue  doing so. Most recently, some members of Congress have expressed  concern that more complete data are not available describing the  prevalence and use of the insurance, information that could be used in  assessing its income tax treatment and related policy issues. Business- owned life insurance—including corporate-owned, bank-owned, and trust- owned life insurance—is permanent insurance that an employer  purchases on the lives of its employees, with the business as the policy  beneficiary. Attractive features of business-owned life insurance, which  are features common to all permanent life insurance, generally include  both tax-deferred earnings on the policies’ cash value and, if the policy is  held until the death of the insured, tax-free income from the death benefit  itself. Some business-owned life insurance protects against the death of  owners or key employees (business continuation insurance), while some of  it covers larger groups of employees (broad-based insurance). Generally,  businesses can retain ownership of these policies after the employment  relationship has ended.
Before 1986, businesses could take loans against the cash value of their  business-owned life insurance policies and deduct the interest expense  from their taxable income without limitation. To address concerns that  businesses were abusing their ability to deduct these interest expenses,  Congress passed legislation in 1986 and 1996 to limit this practice. The  Internal Revenue Service (IRS) and Department of Justice also pursued  litigation against some businesses. Nonetheless, public policy issues have  remained regarding the extent to which businesses should be allowed to  benefit from insuring their employees’ lives, with or without their consent,  and the extent to which they should be allowed to receive tax advantages  from holding these policies. Proponents of continuing the tax advantages  of broad-based business-owned life insurance assert that these advantages  are important to financing employee benefits because rules relating to  other tax-favored financing mechanisms for employee benefits are too  restrictive. Some proponents also assert that changing the tax treatment of  business-owned life insurance would affect businesses’ ability to provide  employee benefits. Opponents of continuing the tax advantages of broad- based business-owned life insurance, while not directly addressing the  potential effect of a change in tax treatment on the provision of employee  benefits, state that Congress has already provided specific tax-favored  financing mechanisms for these benefits and has determined the  appropriate scope of such financing. Some opponents are also concerned  that policy proceeds can be used for any purpose, even when the purchase  was justified based on projected employee benefit liabilities, and that the  tax-favored treatment of the policies gives them a competitive advantage  over other investments.
This report provides information for use in discussing the public policy  issues related to permanent business-owned life insurance and expands on  the preliminary observations we presented in October 2003 testimony  before the Senate Finance Committee. As agreed with your staff, the  report discusses (1) the prevalence and use of business-owned life  insurance, (2) federal and state regulatory requirements for and oversight  of business-owned life insurance, and (3) the potential usefulness of and  costs associated with obtaining more comprehensive data on business- owned life insurance.
To obtain information on the prevalence and use of business-owned life  insurance, we met with officials from federal agencies that require financial  reporting from businesses, including: the federal bank regulators— meaning for this report, the Board of Governors of the Federal Reserve  System (the Federal Reserve), Federal Deposit Insurance Corporation  (FDIC), Office of the Comptroller of the Currency (OCC), and Office of  Thrift Supervision (OTS); the Securities and Exchange Commission (SEC);  and IRS. We analyzed quarterly financial reports that banks and thrifts filed  with federal bank regulators and annual financial reports (Forms 10-K) that  publicly traded companies filed with SEC. In addition, we obtained some  information on the prevalence and use of such insurance from the National  Association of Insurance Commissioners (NAIC) and two life insurance  trade associations. We considered conducting a survey of life insurance  companies to gather additional data but did not do so after a survey pretest  in which insurance companies’ representatives told us that their companies  did not routinely maintain the data we sought. We did not verify the  accuracy of their statements. To describe federal and state regulatory  requirements for and oversight of business-owned life insurance, we  obtained information from officials of the federal bank regulators, SEC,  IRS, NAIC, and the insurance departments of four states with differing  business-owned life insurance provisions. To address the potential  usefulness of and costs associated with obtaining more comprehensive  data on business-owned life insurance, we reviewed legislative proposals  to determine the types of data that could be useful and IRS, SEC, and  NAIC’s reporting forms and instructions to understand what role these  organizations or the Department of the Treasury (Treasury) might play in  collecting more comprehensive data. We also discussed the challenges  insurers might face in providing data and organizations might face in  collecting it with insurance companies, Treasury (including IRS), SEC, and  NAIC representatives, as applicable. Appendix I provides detailed  information on our scope and methodology. We conducted our work  between February 2003 and December 2003, in accordance with generally  accepted government auditing standards.
subsections: section_title: Background
paragraphs: A business is generally allowed to insure an employee’s life when the  business has an insurable interest in the employee. Insurable interest is  defined by state law and, once established at the time of purchase,  continues for the life of the insured. Thus, a business generally may  maintain life insurance on employees even after their employment has  ended. Business-owned life insurance can refer to corporate-owned life  insurance (held by all types of corporations or only nonbank corporations),  bank-owned life insurance, trust-owned life insurance (held by business- established trusts), or all three.
Business-owned life insurance is permanent life insurance, which has an  insurance component and a savings component. The premium for a newly  issued permanent life insurance policy pays for the insurance component,  but the premium initially exceeds the cost of providing life insurance  protection for the insured person. The excess amount is added to the  policy’s cash value, which earns interest or other investment income— called inside buildup. The inside buildup is accrued income because the  policyholder does not receive cash payment as the policy earns income.
The Internal Revenue Code allows for the deferral of income tax on the  accumulated inside buildup on life insurance policies and some other  investments that appreciate in value, such as stocks, some bonds, and real  estate. However, the Internal Revenue Code provides for income tax-free  death benefit payments on life insurance, so that unlike other investments,  the accrued income is not taxed if the policy is held until the insured party’s  death. However, if a policy owner surrenders a policy before the death of  the insured, the owner may incur a tax liability to the extent that the  policy’s cash surrender value exceeds its cost base and may incur a tax  penalty.  The cost base is equal to the total premiums paid less dividends  and withdrawals received from the policy. Also, if a business owns life  insurance policies, the annual earnings and death benefit proceeds are  among the factors that could make the business subject to the alternative  minimum tax.
To qualify as life insurance for tax purposes, a contract must qualify as a  life insurance contract under applicable state law and meet one of two tests  defined in Internal Revenue Code section 7702 to ensure that the contract  is not overly investment oriented. In addition, 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 in connection with  policies covering employees, officers, and individuals financially interested  in the business was limited to loans up to $50,000 per policy by the Tax  Reform Act of 1986. The Health Insurance Portability and Accountability  Act of 1996 eliminated the interest deductibility for these individuals, except for policies on a limited number of key persons. Before the  limitations adopted in 1986 and 1996, some businesses purchased  “leveraged business-owned life insurance,” in which they leveraged their  life insurance ownership by borrowing against the policies to pay a  substantial portion of the insurance premiums and in doing so incurred a  tax-deductible interest expense while realizing tax-free investment  returns.
State and federal legislatures considered numerous proposals in 2003 and  early 2004 that would change the conditions under which businesses may  purchase business-owned life insurance, the consent requirements for such  purchases, or the tax treatment of the insurance. For example, California  considered and passed a law to prohibit businesses from purchasing life  insurance policies on employees that are not exempt from the state’s  overtime compensation requirements. Texas considered, but did not adopt,  a proposal to prohibit business-owned life insurance except in certain  cases, such as when an employee is eligible to participate in an employee  benefit plan and consents to being insured. Also, several members of  Congress introduced legislation in 2003 that would have required employee  consent or limited the tax-favored treatment of business-owned life  insurance on policies taken out on employees that were not key persons,  although none had been enacted by the end of the first session of the 108th  Congress. The legislation would have affected the tax-favored treatment of  such policies in various ways, such as taxing policy earnings and income  from death benefits except on key person policies, taxing the death benefit  payments on policies where the employee died more than 1 year after  leaving employment, and limiting allowed deductions for a business’s  general interest expenses based on its business-owned life insurance  holdings. In addition, pension legislation that the Senate Finance  Committee passed in February 2004 included provisions that would  generally limit the tax-favored treatment of business-owned life insurance,  except for policies on those individuals the legislation defined as key  persons; require employees’ written consent for a business to hold  insurance on their lives; and require businesses to report policy  information to IRS.
section_title: Available Information on the Prevalence and Use of Business- Owned Life Insurance Is Limited
paragraphs: In pursuing their regulatory missions, federal and state regulators have  collected limited information on the prevalence and use of business-owned  life insurance. Federal bank regulators have collected more data than other  regulators on the prevalence of business-owned life insurance; however,  the data are limited because the regulators did not require all banks and  thrifts to report it. While SEC has not specifically required reporting on  business-owned life insurance, we found that some life insurance  companies had reported information on policy sales in their Forms 10-K  and in a life insurance industry survey. Federal revenue estimators have  estimated the annual forgone tax revenue attributable to earnings on the  insurance, although IRS has not required businesses to report on the  prevalence of business-owned life insurance. Information at the state level  is limited, however, because state insurance regulators have not collected  information on the prevalence of the policies through their financial  reporting forms. Some state laws permit businesses to purchase business- owned life insurance for business continuation purposes or in connection  with employee benefit plans, but businesses generally are not obligated to  use the death benefit proceeds for a particular purpose. Although federal  and state regulators generally have not collected data on the uses of  business-owned life insurance, we found some examples of how  businesses said they intended to use such policies.
subsections: section_title: Federal Bank Regulators Have Collected the Most Data on the Prevalence of the Policies, but Not All Banks and Thrifts Provided Information
paragraphs: In monitoring the safety and soundness of individual institutions, federal  bank regulators have collected more financial information than other  federal and state regulators on business-owned life insurance policies. For  supervisory purposes, federal bank regulators have required that regulated  institutions disclose in quarterly financial reports earnings from and the  cash surrender value of business-owned life insurance if the amounts  exceed a certain threshold. As discussed below, the regulators have used  the amounts reported to determine the need for further review of  institutions’ risk exposure. Business-owned life insurance is an asset  reported at cash surrender value—that is, the sum of accumulated  premium payments and inside buildup, less accumulated insurance costs,  fees, and charges that the policyholder would be required to pay for  surrendering the policy. It does not take into account income tax liabilities  that might result from the surrender. The Federal Reserve, FDIC, and OCC  require the institutions they regulate to disclose the cash surrender value of  policies worth more than $25,000 in aggregate and exceeding 25 percent of  “other assets,” which include such items as repossessed personal property  and prepaid expenses. Through the end of 2003, OTS required the thrifts it  supervises to report the cash surrender value of policies if the value was  one of the three largest components of “other assets;” in 2004, OTS began  requiring all the thrifts it supervises to report the cash surrender value of  their policies.
We found that about one-third of banks and thrifts—3,209 of 9,439,  including many of the largest institutions—had disclosed the cash  surrender value of their business-owned life insurance holdings as of  December 31, 2002. The remaining two-thirds either did not hold  business-owned life insurance or held such insurance but did not meet the  reporting threshold. The total cash surrender value of reporting  institutions’ policies was $56.3 billion. A total of 259 banks and thrifts with  assets of $1 billion or more owned 88 percent ($49.4 billion) of the total  reported cash surrender value (fig. 1). These 259 institutions included 23  banks and thrifts that were among the top 50 largest institutions and that  owned 66 percent ($36.9 billion) of the total reported cash surrender value.  Because not all institutions that owned policies met the reporting  threshold, these data indicate the minimum number of institutions that  held business-owned life insurance and the aggregate cash surrender value  of their policies; with this data we could not estimate the prevalence of  business-owned life insurance or its value among institutions that did not  report on their holdings.
The federal bank regulators’ thresholds for reporting business-owned life  insurance earnings differed from the ones for reporting cash surrender  value, so not all of the same institutions reported earnings as reported cash  surrender value. We found that nearly one-fifth of banks and thrifts  reported their 2002 annual earnings on the cash surrender value of  business-owned life insurance. As of December 31, 2002, some 1,563  institutions reported $2.2 billion in such earnings.
section_title: SEC Has Not Specifically Required Reporting on the Policies, but Some Insurers Have Reported Sales
paragraphs: SEC officials told us that the agency has not specifically required  businesses to report on their purchases or sales of business-owned life  insurance because such data generally are not material to public  companies. According to SEC officials, agency regulations do not  specifically require public companies to disclose the value of their  business-owned life insurance in the financial statements submitted to the  agency. Similarly, SEC does not specifically require public companies that  sell business-owned life insurance to report on those sales. Rather, in  administering federal securities laws, SEC requires public companies to  prepare their financial statements in accordance with generally accepted  accounting principles, which would require them to disclose information  about business-owned life insurance policies that is material—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. According to SEC officials,  however, following generally accepted accounting principles would rarely  require holdings of and earnings from business-owned life insurance to be  shown as separate line items because they are unlikely to be financially  material to a company.
Although SEC does not explicitly require insurance companies to report  information on the business-owned life insurance policies they have sold,  some insurance companies have disclosed such information on their Forms  10-K. By reporting their revenue from business-owned life insurance  premiums, life insurance companies show how significant sales of such  policies are compared with total sales; they also provide an indication of  the level of demand for business-owned life insurance. We reviewed the  Forms 10-K of 32 life insurance companies that were among the 50 largest  such companies ranked by assets. We found that nine insurers reported  receiving, in aggregate, over $3 billion in total business-owned life  insurance premiums in 2002 from new and, in some cases, previous sales.  The amount of business-owned life insurance premiums received in 2002  ranged from 11 to 53 percent of each company’s 2002 total life insurance  premiums for the four companies that reported this information. In  addition, three insurance companies reported the accumulated cash  surrender value of business-owned life insurance policies they had  previously sold as totaling about $28 billion as of December 31, 2002.
Separate from reporting to SEC, some 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 has reported on premiums paid on new  policies. A life insurance industry association and life insurance companies  cited CAST’s surveys as the only currently available information on  aggregate business-owned life insurance premiums. CAST estimated that in  2001, premiums from new sales of business-owned life insurance totaled  $9.3 billion: $5.2 billion in bank-owned life insurance premiums and $4.1  billion in corporate-owned (excluding bank-owned) life insurance  premiums. CAST also estimated that in 2002, premiums from new sales of  corporate-owned (excluding bank-owned) life insurance totaled $3.2  billion. CAST did not estimate bank-owned life insurance premiums for  2002. CAST’s estimates were based on responses to a 2003 survey  concerning corporate-owned life insurance premiums and a 2002 survey  concerning bank-owned life insurance, increased by CAST adjustments.  Each survey received responses from 20 life insurance companies,  although not all of the same companies responded to both surveys. 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. Because  these surveys did not use statistical samples of insurers, the resulting  estimates made from the limited number of respondents do not represent  statistically valid estimates of all business-owned life insurance sales and,  therefore, our interpretation of the resulting data is limited. The statistics  from these surveys are meant to indicate only that some large insurance  companies have had active sales in recent years and that the premiums in  the aggregate are significant.
section_title: IRS Has Not Collected Information on the Policies, but Federal Revenue Estimators Have Estimated the Forgone Tax Revenues
paragraphs: IRS officials told us that the agency has not generally required businesses  to report on the value of, earnings on, or death benefit income from  business-owned life insurance policies. The officials noted that these  amounts are not typically included in taxable income and that, therefore,  the information is generally not needed. 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 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 identified as earnings from business-owned life  insurance, as they are often lumped together with other adjustments.
Federal revenue estimators have estimated that the current tax treatment  of earnings on the cash value of business-owned life insurance results in  over a billion dollars in forgone tax revenues annually. In its “Estimates of  Federal Tax Expenditures for Fiscal Years 2004-2008,” prepared for  congressional use in analyzing the federal budget, the Joint Committee on  Taxation estimated that the forgone tax revenues resulting from the tax  treatment of investment income on life insurance for corporations would  total $7.3 billion for 2004 through 2008. Similarly, OMB, in its fiscal year  2005 budget “Analytical Perspectives,” reported Treasury’s estimate of  forgone tax revenues resulting from the tax treatment of life insurance as  $13 billion for 2004 through 2008. These estimates assumed policies would  be held until the insureds’ deaths, making the current tax-deferred earnings  tax-free. The estimates did not reflect the forgone tax revenues on the  additional income from death benefit payments in excess of the premiums  paid and the accumulated tax-deferred earnings. Officials involved in  preparing these estimates said that, lacking comprehensive data on the  earnings on business-owned life insurance, they developed their estimates  using available data on life insurance companies’ investment income and  assumptions about business-owned life insurance’s share of the total life  insurance market.
section_title: State Insurance Regulators Have Not Collected Data on the Prevalence of the Policies
paragraphs: State insurance regulators, concerned with state requirements, rates, and  solvency issues, have collected extensive financial information from  insurers through NAIC’s standardized financial reporting forms, but not at  the level of detail that would describe the prevalence of business-owned  life insurance policies. State insurance regulators use insurers’ financial  statements to monitor individual companies’ solvency. According to the  four state regulators we contacted and NAIC, information on business- owned life insurance is not required or necessary for regulating solvency.  Insurers’ financial statements list the number of policies and premiums  collected during the reporting period, but the amounts are broken out only  by individual and group policies, not by whether businesses or individuals  owned the policies.
section_title: Businesses May Purchase Business-Owned Life Insurance for Various Purposes but Generally Are Not Required to Use Policy Proceeds for Those Purposes
paragraphs: Under state laws that define insurable interest, businesses may purchase  life insurance for various purposes, including for business continuation— that is, to ensure that a business can continue to operate when a key  employee or owner dies. Historically, insurable interest reflected a family  or business’s dependency on an individual and the risk of financial loss in  the event of that individual’s death. Accordingly, a traditional use of  business-owned life insurance is as key-person insurance, which is  intended to ensure recovery of losses—such as a loss of earnings or added  hiring costs—in the event of the death of key employees. In addition,  businesses may use business-owned life insurance as part of “buy-sell  arrangements” that allow the surviving owners to use the death benefits to  purchase a deceased owner’s share of the business from the estate or heirs.
In the 1980s and 1990s, several states expanded their definitions of  employers’ insurable interest to permit purchases of broad-based business- owned life insurance in connection with employee compensation and  benefit programs. Several of these states limit the aggregate amount of  insurance coverage on nonmanagement employees to an amount  commensurate with the business’s employee benefit plan liabilities or  require that insured employees be eligible to receive employee benefits.
Information we obtained from officials of large banks and from our  analysis of a sample of public companies’ Forms 10-K indicates that firms  have related their purchases of broad-based business-owned life insurance  to various types of employee benefit costs, including health care for  current or retired employees, life and disability insurance for current or  retired employees, workers’ compensation, qualified retirement plans— including defined benefit and defined contribution plans, such as 401(k)  plans—and nonqualified retirement plans, such as supplemental executive  retirement plans. Consistent with this expanded use of business-owned  life insurance, NAIC has observed that many products sold by life insurers  have evolved to become primarily investment products. Also, consulting  firms that specialize in business-owned life insurance transactions, life  insurance brokers, and industry experts have emphasized the potential use  of broad-based business-owned life insurance as a profitable long-term  investment strategy to finance employee benefit costs and not merely as  protection against financial losses that a business would incur in the event  of the death of key persons.
According to bank regulators and life insurance industry representatives,  when purchasing life insurance, businesses generally relate the amount of  coverage they purchase on a group of employees to the value of their  projected employee benefit costs. For example, a business might insure the  lives of a group of employees such that the present value of expected cash  flows to be received from the policies over time, net of premiums, would  cover some portion or all of the present value of the business’s employee  benefit expenses over the same period of time. When calculating the  expected future cash flows from the insurance, businesses would not  generally assume policies will be surrendered if employees leave or retire  because surrendering the policies would result in taxation and possibly  surrender charges; rather, businesses would assume that they will hold the  policies until the insured employees die.
Because businesses may hold business-owned life insurance policies for  many years before receiving death benefit payments, businesses do not  necessarily receive the cash flows from business-owned life insurance at  the same time that they must pay their employee benefit expenses.  According to insurance industry representatives, when businesses use the  insurance in connection with health care benefits for retired employees,  the death benefit proceeds are well timed for reimbursing the benefit costs,  because retirees tend to incur their largest medical expenses in the last  months of their lives. However, we found examples of businesses that said  they used the insurance in connection with current employee benefit costs,  such as active employee health care. In such cases, the timing of the death  benefit payments would not necessarily correspond to the timing of  employee benefit expenses because businesses must pay those expenses  years before receiving death benefits on most insured employees.
Regardless of a business’s reported purpose for purchasing business- owned life insurance, the business generally does not have an obligation to  restrict its use of the life insurance proceeds to these purposes. Although  the expected income from broad-based business-owned life insurance  policies over time might be commensurate with a business’s expected  employee benefit costs at the time of the insurance purchase, businesses  are generally not required to use the proceeds from the policies to pay for  employee benefits. Unless the policies were placed in a trust that restricted  their use to employee benefit payments, the life insurance policies would  be part of the unrestricted general assets of the business and, as such,  could be used to pay any obligations of the business.
section_title: Limited Data Show That Some Businesses Use Life Insurance in a Variety of Ways
paragraphs: Of the federal and state regulators we contacted, only OTS has required the  institutions it regulates to provide information that distinguishes among the  uses of business-owned life insurance. Through the end of 2003, OTS  required the thrifts it supervises to report the value of their key-person  policies and the value of business-owned life insurance policies purchased  for other purposes as separate items, if the amounts met the reporting  threshold. Of the $3.3 billion cash surrender value that 249 OTS-supervised  thrifts reported owning as of December 31, 2002, about $400 million was for  key-person insurance and $2.9 billion was for other business-owned life  insurance. However, these amounts may not be representative of the  proportions of key-person and other business-owned life insurance that  these thrifts held. OTS’s disclosure threshold applied separately to each  category, so that OTS-supervised thrifts could have been required to report  on only one type of policy rather than the total value of their business- owned life insurance holdings. Beginning in 2004, OTS eliminated its  reporting threshold so that all the thrifts it supervises are required to report  the value of both their key-person and other business-owned life insurance  policies. The new requirement will allow OTS to determine the cash  surrender value of all key-person and other business-owned life insurance  held by the institutions it supervises.
Although SEC did not specifically require them to do so, we found that  some businesses included information on how they intended to use  business-owned life insurance in the Forms 10-K they filed with SEC. We  reviewed the Forms 10-K of 100 randomly selected Fortune 1000 public  companies. Of these, 11 provided information on the intended use of their  business-owned life insurance policies. All 11 businesses reported using  these policies to provide deferred compensation or benefits for executives;  1 also reported using them to provide postretirement health care. For  example, 1 of the 11 businesses reported having a supplemental executive  retirement plan financed by life insurance that had a cash surrender value  of about $66 million as of December 31, 2002. The amount of insurance  coverage was designed to cover the full cost of the plan, which at that time  was estimated to have a present value of about $69 million. Another 1 of the  11 businesses reported that it had purchased policies with a cash surrender  value of about $161 million as of February 28, 2003, with the intention of  using the policies’ proceeds as a future financing source for postretirement  medical benefits, deferred compensation, and supplemental retirement  plan obligations aggregating $241.3 million. However, the business noted  that the life insurance assets did not represent a committed financing  source and that the business could redesignate them for another purpose at  any time.
Some large businesses have also provided survey responses suggesting that  some business-owned life insurance is used to finance executive benefit  plans. Clark Consulting has conducted annual executive benefits surveys of  Fortune 1000 corporations and reported on respondents’ use of business- owned life insurance to informally fund nonqualified deferred  compensation and supplemental executive retirement plans. Businesses  informally fund such plans by planning to have assets available to pay for  them, although the assets would not generally be protected in bankruptcy.  From its 2003 survey, which had a 22 percent response rate, Clark  Consulting reported that 93 percent of the respondents offered  nonqualified deferred compensation plans, 69 percent of those with  nonqualified deferred compensation plans informally funded them, and 55  percent of those that informally funded the plans used business-owned life  insurance to do so. Similarly, 71 percent of the respondents offered  supplemental executive retirement plans, 53 percent of those respondents  informally funded the plans, and 61 percent of those that informally funded  the plans used business-owned life insurance to do so. Because the survey  did not use a statistical sample of businesses and may be subject to other  sources of error such as nonresponse bias, respondents’ answers cannot be  projected to all Fortune 1000 companies or to all businesses in the United  States. The statistics reported here are meant to indicate only that some  large businesses are using life insurance in a variety of ways.
section_title: Regulators Have Applied Their Guidelines or Requirements and Have Generally Not Had Significant Regulatory Concerns about Business-Owned Life Insurance
paragraphs: Banks and thrifts are required to follow federal regulatory guidelines in  purchasing business-owned life insurance. Officials from federal bank  regulators that had examined some institutions’ purchases told us that  these purchases had not raised major supervisory concerns. SEC’s general  disclosure requirements apply to business-owned life insurance; the agency  has not had specific investor-protection concerns about such policies. The  Internal Revenue Code includes statutory requirements, and IRS has issued  regulatory requirements related to the tax treatment of the insurance. IRS  officials told us that the agency was studying potential concerns. States had  differing laws concerning insurable interest and consent requirements for  business-owned life insurance. The insurance regulators of the four states  we contacted described limited oversight of business-owned life insurance  sales, and the four state regulators and NAIC generally did not have  concerns about the policies.
subsections: section_title: Federal Bank Regulators Examined Some Institutions’ Purchases of Business-Owned Life Insurance and Have Not Had Major Supervisory Concerns
paragraphs: Federal bank regulators have issued guidelines for purchases of business- owned life insurance that they have used in overseeing banks and thrifts’  holdings of such policies. The regulators’ oversight, consistent with their  missions, includes assessing the safety and soundness of supervised  institutions, and regulatory officials said that the agencies generally have  not had major supervisory concerns about banks and thrifts’ business- owned life insurance holdings. They said that while business-owned life  insurance carries some risk, policies that were purchased in accordance  with their guidelines are generally not a major threat to an institution’s  safety and soundness. The regulators cited other types of activities—such  as commercial real estate, specialized, and subprime lending—as generally  raising more supervisory concerns than business-owned life insurance  because of increased risk or volatility.
OCC and OTS guidelines describe the permissible uses of business-owned  life insurance. According to Federal Reserve and FDIC officials, their  agencies generally follow OCC’s guidelines. The OCC and OTS guidelines  state that banks and thrifts may purchase life insurance only for reasons  incidental to banking, including insuring key persons and borrowers and  purchasing insurance in connection with employee compensation and  benefit plans. The guidelines require that, before purchasing policies, a  bank or thrift’s management conduct a prepurchase analysis that, among  other things, determines the need for insurance and ensures that the  amount of insurance purchased is not excessive in relation to the estimated  obligation or risk. For example, the guidelines state that when purchasing  life insurance on a group of employees, the institution may compare the  aggregate obligation to the group (such as employee benefit costs) with the  aggregate amount of insurance purchased.
The guidelines require that the prepurchase analysis determine the amount  of insurance needed using “reasonable” financial and actuarial  assumptions, such as those for the time period or the discount rate used to  calculate the present value of expected employee benefit costs. However,  the guidelines do not specify parameters for the assumptions, such as the  discount rate or time period, to be used in the prepurchase analysis— parameters that affect the amount of insurance that can be purchased.  OCC officials stated that specifying such parameters would have little or no  effect because banks tend to purchase less insurance than they could  justify based upon their expected employee benefit expenses, regardless of  the assumptions used in prepurchase analyses. In addition to the  requirements for determining the need for insurance, the guidelines state  that banks and thrifts using business-owned life insurance for executive  compensation should ensure that total compensation is not excessive— that is, unreasonable or disproportionate to the services performed, taking  into account factors such as the financial condition of the institution and  compensation practices at comparable institutions.
The OCC and OTS guidelines also require the bank or thrift’s prepurchase  analysis to consider the risks associated with business-owned life  insurance and to maintain effective senior management and board  oversight of the purchases. In addition, the guidelines 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 OCC and OTS guidelines require banks and thrifts to  document their decisions and continue to monitor, on an ongoing basis, the  financial condition of the insurance companies that carry their policies. For  example, the guidelines state that institutions should review an insurance  company’s ratings and conduct further independent financial analysis, with  the depth and frequency of such analysis determined by the relative size  and complexity of the transaction.
OCC officials explained that the agency’s guidelines do not require  institutions to continue to compare their projected employee benefit costs  with the projected cash flows from the insurance after purchasing the  policies. However, purchases of additional insurance would require a  prepurchase analysis, so that institutions would be required to update their  comparisons at such times. Officials at three large banks said that their  banks had not compared the projected employee benefit costs and  projected insurance cash flows after purchasing the insurance. Officials at  a fourth large bank said their bank had updated the comparison annually in  conjunction with additional insurance purchases in recent years.
Federal bank regulators told us that their risk-based examination programs  are designed to target aspects of banks and thrifts’ purchases of business- owned life insurance that would raise supervisory concerns about  institutions’ safety and soundness. They specifically identified the credit  and liquidity risks associated with business-owned life insurance as  concerns that could warrant attention during an examination. Credit risk  arises from the potential failure of an insurance carrier that might then be  unable to pay death benefits or return the cash surrender value of policies  upon request. OCC and Federal Reserve officials said they were less  concerned about credit risk when it was diversified—for example, when  institutions held policies with several highly rated insurers. Liquidity risk  arises from the long-term nature of life insurance and the cost to the bank  or thrift of surrendering policies.
OCC officials emphasized that other risks associated with business-owned  life insurance could also raise supervisory concerns, particularly among  institutions with relatively large holdings. Specifically, OCC officials said  that the potential risk to institutions’ reputations could be of concern as a  result of negative perceptions of their holding the policies. For example,  the officials noted that under California’s new law, businesses must  disclose to insured employees the existence and face amount of insurance  policies purchased on their lives by the end of March 2004, which could  negatively affect the businesses’ reputations if employees were unaware  that the policies existed. The officials also cited potential concerns about  transaction risk, which arises from an institution not fully understanding or  properly implementing a transaction. For example, if an institution did not  comply with applicable insurable interest laws in purchasing a policy, it  may not be able to collect the death benefits on the policy. Finally, OCC  and Federal Reserve officials cited potential concerns about tax risk—the  risk that Congress could change the tax treatment of business-owned life  insurance. If any such changes were applied to previously purchased  policies, banks might not receive the returns on the policies that they had  expected, which could, in turn, raise supervisory concerns with respect to  certain institutions.
The federal bank regulators explained that they determined whether to  include business-owned life insurance in the scope of an examination  based not only on their preliminary assessment of the level of risk  associated with business-owned life insurance but also on the size of an  institution’s holdings relative to capital. The regulators’ examination  procedures, in general, direct examiners to identify concentrations of  credit—instances where the institution’s exposure to a creditor or, in some  cases, a group of creditors (such as an insurance company or companies  from which the institution has purchased policies) exceeds 25 percent of  the regulator’s measure of the institution’s capital. All of the regulators said  that, if the cash surrender value of a bank or thrift’s policies exceeded this  threshold, they would consider whether further supervisory review of  these holdings was warranted. Such a review would help to ensure that the  institution was not unduly exposed to credit or liquidity risk and that it was complying with the guidelines on business-owned life insurance. OCC  officials also said that the difficulty of quantifying the reputation,  transaction, and tax risks associated with the policies underscored the  importance of examiners considering whether institutions had overly  concentrated holdings of business-owned life insurance.
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. 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 through reviews of quarterly financial  reports and had conducted reviews of the holdings as part of their  examinations at many of the institutions. Officials from each regulator told  us their agencies had concluded that major supervisory concerns did not  exist about the amount of insurance the institutions owned, although the  Federal Reserve and OCC had cited the need for some institutions to  improve their oversight or internal controls related to the policies.
Specifically, Federal Reserve officials said that the agency had reviewed  business-owned life insurance holdings as part of its examinations of the  nine Federal Reserve-supervised banks that we identified (table 1). Federal  Reserve officials said that the agency’s examinations did not raise concerns  about the nine banks’ total holdings of business-owned life insurance.  However, the officials said that the Federal Reserve had made  recommendations to four of the banks, including that they conduct more  diligent prepurchase analyses, communicate more information to board  members, enhance internal controls, and conduct quarterly reviews of  insurance carriers’ financial condition. Based on a review of examination  summary reports, FDIC officials said that FDIC had criticized the level of  business-owned life insurance at only 1 of the 32 FDIC-supervised  institutions we identified; the officials said that the summaries might only  note the results of a review of business-owned life insurance if examiners  identified problems, so it was unclear how many of the other institutions’  holdings had been reviewed. OCC officials told us that OCC did not have  safety and soundness concerns about the amount of holdings at any of the  15 OCC-supervised banks we identified. The officials distinguished  between community banks (4 of the 15 we identified) and large banks (11  of the 15 we identified), noting that OCC’s primary supervisory concern has  been with the effectiveness of community banks’ ongoing oversight of their  business-owned life insurance. They said that OCC had reviewed the  holdings of at least three of the community banks we identified and had  cited the need for one of these banks to improve ongoing risk management  of the policies. In contrast, the OCC officials said that large banks generally  have sophisticated risk management systems and manage their insurance  investments well. Although the officials did not report how many of the  large banks’ business-owned life insurance holdings had been reviewed  during examinations, they said that these banks sometimes approach OCC  examiners before making new insurance purchases and that, in this  respect, OCC monitors some banks’ business-owned life insurance  programs on an ongoing basis. OTS officials told us that OTS had examined  both of the thrifts we identified and did not have supervisory concerns  about their current holdings or policy oversight.
section_title: SEC Has Applied Its Disclosure Requirements and Has Not Had Investor- Protection Concerns about Business-Owned Life Insurance
paragraphs: 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 identify any investor  protection concerns. As discussed, SEC, whose mission is to protect  investors and maintain the integrity of the securities markets, requires  public companies to disclose material financial and other information so  that investors can make informed decisions. SEC officials said that  business-owned life insurance is unlikely to be a material item. However,  they added 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. For example, a senior SEC official said that  SEC might become aware of a failure to disclose material information if it  was examining a poorly performing business and found that its  management had not disclosed that the business was using business-owned  life insurance to sustain itself. SEC officials said that, to date, no such  problems have arisen, and the agency has not had investor-protection  concerns about public companies holding business-owned life insurance.
section_title: IRS Has Issued Requirements for the Tax Treatment of Policies and Is Studying Potential Concerns
paragraphs: IRS, whose mission includes administering the tax law, had some  requirements related to the tax treatment of business-owned life insurance.  The Internal Revenue Code defines life insurance for tax purposes,  establishes its tax treatment, and limits the deductibility of interest on  loans taken against policies. In addition, in September 2003, IRS and  Treasury 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 as part of an executive compensation  arrangement. Because none of IRS’s prior rulings regarding the taxation  of split-dollar arrangements had directly addressed the types of  arrangements that have been widely used in recent years, IRS and Treasury  issued interim guidance in 2001 and 2002 that culminated in the final  regulations. Under the final regulations, corporations cannot provide tax- free compensation to executives using split-dollar policies, and a business’s  premium payments are treated as loans to an executive who owns the  policy. If the employer owns the policy, the regulations treat the executive’s  interest in the policy’s cash value and current life insurance protection as  taxable economic benefits to the executive.
IRS officials said that the agency was studying some possible remaining  issues related to business-owned life insurance that is held by highly  leveraged financial institutions such as banks and thrifts. Various sources  have reported that the limitation on the deductibility of policy loan interest  adopted in 1996 curtailed new sales of leveraged business-owned life  insurance policies. However, IRS officials expressed concern that this  limitation had not eliminated the tax arbitrage opportunities available  through business-owned life insurance and that, for this reason, highly  leveraged financial institutions such as banks and thrifts might be  borrowing to indirectly finance their policies. Borrowing to indirectly  finance policies can occur when businesses pay the premiums on life  insurance policies by increasing debt that is not directly linked to the  policies and then deducting the interest they pay on that debt from their  taxable income. Although the Internal Revenue Code limits the amount of  deductible interest that is linked directly to business-owned life insurance,  establishing such a link is difficult because businesses may incur debt for  many purposes. Borrowing to indirectly finance policies presents a tax  advantage to businesses because they receive tax-deferred inside buildup  from life insurance policies indirectly financed with debt on which the  interest expense is tax-deductible.
In addition, IRS officials said that the agency is concerned that banks may  be using separate account policies to maintain excessive control over  investments, which is inconsistent with the Internal Revenue Code  treatment of life insurance. Internal Revenue Code provisions were  intended to ensure that the primary motivation in purchasing life insurance  would be the traditional economic protection provided by such policies,  while discouraging the use of tax-preferred life insurance as primarily an  investment vehicle. In separate account life insurance, an asset account is  maintained independently from the insurer’s general account. Compared  with a general account policy, which offers either a guaranteed rate of  return or a rate that varies at the insurer’s discretion, a separate account  policy permits the policy owner latitude in the choice of investments,  particularly equities. Businesses may also purchase private placement  policies, or separate account policies that allow policyholders to negotiate  key terms of the policies—such as who will act as investment adviser— with the insurance company. These policies also offer investment  alternatives that traditional separate account policies do not, including  privately traded investments in start-up businesses and private venture  capital funds. Based on IRS revenue rulings, the agency decides on a case- by-case basis whether the purchaser of a policy has excessive control over  separate account assets. These revenue rulings have identified factors to  consider, such as whether the purchaser directs the account to make a  particular investment, sells or purchases assets in the account, or  communicates with the investment adviser about the selection or quality of  specific investments, and whether the account’s investment strategies are  broad enough to prevent the purchaser from making particular investment  decisions by investing in a subaccount. IRS officials said that the agency  was studying its concerns about indirectly financing policies through  borrowing and about using separate account policies at five banks that IRS  had identified through routine examinations. The officials said that IRS had  not taken action against any of these banks.
section_title: State Laws Differ, and Four States with Limited Oversight of Business- Owned Life Insurance Have Not Had Significant Concerns
paragraphs: Although NAIC has developed model legislative guidelines for business- owned life insurance, the states are not required to follow them. NAIC  initially developed model guidelines for business-owned life insurance in  1992 and revised them in 2002 (fig. 2). 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. However, states have passed a variety of  laws regulating insurable interest and consent requirements for business- owned life insurance (see app. II).
While some states have followed NAIC’s guidelines, state consent  requirements still differ. Since NAIC revised its guidelines in 2002, several  states have passed legislation requiring employers to obtain employees’  written consent before taking insurance on their lives (others already had  such requirements). Also, while some states have consent provisions that  specifically address business-owned life insurance, in some states consent  provisions apply to life insurance policies in general. Compendiums of  state laws prepared by NAIC and the American Council of Life Insurers and  our review of selected state statutes indicated that, as of December 31,  2003, 35 states had laws requiring written consent (either for life insurance  in general or specifically for business-owned life insurance), and another 4  states had consent requirements that were satisfied if an employee did not  object to a notice of the employer’s intent to purchase a policy. However, at  least 18 of these states exempted group life insurance policies from  consent requirements. Additionally, 1 state required employers to notify  employees when purchasing business-owned life insurance, but did not  require employee consent.
We spoke with insurance department officials from California, Illinois, New  York, and Texas. The insurable interest and consent provisions of the four  states differed, but all allowed some purchases of business-owned life  insurance and three required some form of consent; two required the  amount of coverage to be related to employee benefit costs (table 2). The  insurance department officials told us that they conduct limited oversight  to test compliance with their states’ insurable interest and consent laws.  They said that their primary method of addressing this issue was through  policy form reviews, or assessments of the proposed forms that insurers  would provide to policyholders when selling policies in their states. For  example, New York insurance department officials said that department  officials review policy forms for compliance with the state’s requirements  and that, for policies on non-key employees, the form must describe  insured employees’ right to discontinue the coverage on their lives and  must note the statutory limitations on the coverage amounts. Also, a  submittal letter that insurers must provide to the department along with the  policy form must explain how the insurer will verify that New York’s  insurable interest requirements are satisfied and, for non-key employees,  whether the employer or the insurer will prepare the required employee  consent notices. In Illinois, insurance department officials said that they  review policy forms to ensure that the forms include the state’s statutory  requirements related to business-owned life insurance, but the forms need  not detail procedures for obtaining consent or determining appropriate  amounts of coverage.
NAIC staff said that state insurance regulators generally have the authority  to review policies currently in force for compliance with any state  requirements. But the officials from the four states we contacted said that  their departments had not routinely verified that employees covered by the  policies had consented to being insured or, where applicable, tested  whether coverage amounts were appropriate. An official from California’s  insurance department said that the department did not routinely review  business-owned life insurance sales, but added that the department had  recently received complaints about at least one insurer and multiple  employers. The official noted that the department was investigating these  complaints, including reviewing documentation for the policies in question,  and that any policies that were found to violate state provisions could be  voided. Officials in Illinois, New York, and Texas said that a pattern of  consumer complaints about business-owned life insurance would cause  their departments to investigate the insurance sales during market conduct  examinations of insurers or refer the matter to their legal division for an  enforcement action. However, the officials said that generally they had  not received complaints about business-owned life insurance. In addition,  NAIC staff told us that the organization maintains a national database of  consumer complaints made to state insurance regulators and that business- owned life insurance had not been a significant source of complaints. As a  result, NAIC had not developed a separate category for tracking such  complaints. However, relying on complaints may not be an effective means  of identifying violations of state law related to business-owned life  insurance, because employees who are not aware of their state’s  notification and consent requirements and whose employers have not  provided the required notification or obtained the required consent, would  not know that they have a basis for complaining to their state insurance  regulators.
section_title: More Comprehensive Data Could Be Useful to Congress; Costs Would Be Incurred in Obtaining the Data
paragraphs: More comprehensive data on the prevalence and use of business-owned life  insurance could be useful to Congress in assessing the potential effects of  legislative proposals that address the tax-favored treatment of this  insurance. Data would be most useful if reported separately for business  continuation and broad-based policies because legislative proposals that  would further limit the tax-favored treatment of business-owned life  insurance generally have treated the policies differently—they have applied  primarily to broad-based policies. Data on business continuation versus  broad-based insurance would be useful in understanding the proportion of  the total business-owned life insurance market that might be affected by  future legislative proposals. Useful data that are not available include the  amount of tax-free income received from the death benefit payments on  business continuation and broad-based policies—data that could help  Congress better understand the potential effect of changes to the tax  treatment of these policies on tax revenues.
Other data on the prevalence and use of business-owned life insurance,  further broken down or identified by business continuation and broad- based policies, might also be helpful to Congress in evaluating the potential  effects of legislative proposals on businesses, their employees, and  insurance companies. The cash surrender value of business-owned life  insurance policies could help assess whether the value of assets invested in  such policies is consistent with the behavior that Congress wishes to  encourage through tax preferences. The annual premiums paid on new  policies could be used to determine the demand for business-owned life  insurance and the potential effect of proposed legislative changes on the  market for business-owned life insurance. The number of businesses that  hold business-owned life insurance policies could provide information on  how many businesses might be affected by proposed legislative changes.  Additional information on the size, type, and geographic location of  businesses holding the insurance could be used to characterize the  businesses that might be affected. Finally, although obtaining an  unduplicated count of the total number of people covered by business- owned life insurance might be impractical, data on the number of each  business’s employees insured under such policies could be used, for  example, to determine the average number or percentage of employees  covered by businesses that reported owning policies. Although more  costly to obtain, data collected over multiple periods could help identify  trends that might provide additional insights into the effects of legislative  proposals.
Businesses that hold business-owned life insurance or insurance  companies that sold the policies could provide the data for Congress’s use,  but both types of entities would incur administrative costs in extracting the  required information from their records and summarizing it. We did not  discuss these costs with businesses, however, we expect that they would  maintain financial records and insurance policy statements from which the  required data could be extracted. Also, some businesses already aggregate  this information for use in completing their income taxes or Forms 10-K  filed with IRS and SEC, respectively, suggesting that some businesses  would not have difficulty providing the data. Nonetheless, businesses might  differ in their willingness to voluntarily provide the data, depending at least  in part on the cost and their perception of the benefits of doing so. While  we did not independently determine the costs that insurers would incur in  collecting the data, officials from several insurance companies told us that  extensive effort would be required to identify policies as business-owned  life insurance, as opposed to policies in which a business is the owner but  not the beneficiary, and extract the data that we identified as being useful  for decision making. These officials also told us that it would be difficult  for them to distinguish between business continuation and broad-based  policies. Consistent with these concerns, three life insurance industry trade  associations recently supported proposed legislation that would require  businesses that hold business-owned life insurance to report some  information on their policies to IRS. While businesses might be able to  provide data on the policies they own more easily than insurance  companies could provide information on the policies they have sold,  requiring insurance companies to report would substantially limit the  number of reporting entities. About 1,200 companies sell life insurance,  according to NAIC, while many more businesses purchase it.
The organization collecting, analyzing, and reporting the data would also  incur costs. SEC, Treasury, and NAIC are candidates for this role, because  each already collects financial information from businesses that purchase  business-owned life insurance, insurers, or both. One of the agencies or  NAIC could collect the data by modifying existing reporting instruments,  such as the SEC Form 10-K, applicable IRS tax forms, or insurance  company annual reporting forms. Alternatively, the agencies or NAIC could  collect the data through a survey. We did not determine the resources that  would be required for the agencies or NAIC to modify their existing  reporting instruments or conduct a survey. Beyond the costs, other factors  could be considered in selecting one of these or another organization to  lead the effort. Either SEC or Treasury might be able to combine data on  business-owned life insurance with other data that businesses already  report to them, such as business size, type, or location. SEC currently  collects information only from publicly traded companies, whereas  Treasury, through IRS, requires all businesses, including life insurance  companies, to file tax returns. While taxpayer information is confidential  and would not be publicly available except in the aggregate, Congress  would likely need only aggregate information. Collecting business-owned  life insurance data through NAIC, a membership organization of chief state  insurance regulators, assumes the data would be collected from insurance  companies and would involve the organization’s voluntary cooperation.
section_title: Conclusions
paragraphs: The use of life insurance, which receives tax-favored treatment, has  expanded from its traditional coverage of a family’s principal wage earners  and a business’s key employees to broad-based coverage of a business’s  other employees. Although recent legislative proposals have sought to limit  the tax-favored treatment of business-owned life insurance, comprehensive  data on the prevalence and use of such insurance have not been available  for use in assessing the impact of these proposed changes. Should  Congress conclude that such data would facilitate its ongoing deliberations  on the appropriate tax treatment of business-owned life insurance,  decisions would be required on what data are needed, who should provide  the data (insurance buyers or sellers), who should collect the data (SEC,  Treasury, NAIC, or another organization), how to collect the data  (additional reporting or a survey), what it would cost to collect the data,  and whether the benefits of collecting additional data warrant the cost of  doing so. Important data for understanding the tax and other implications  of changes in the tax-favored treatment of business-owned life insurance  would be the amount of tax-free income received from death benefit  payments, reported separately for business continuation and broad-based  policies. Additional data of value could include the cash surrender value of  policies, the annual dollar amount of premiums paid on new policies, the  number of businesses that hold business-owned life insurance, the  characteristics of businesses that own the policies, and the number of  employees insured under such policies.
section_title: Matter for Congressional Consideration
paragraphs: If Congress decides that it needs more comprehensive data on the  prevalence and use of business-owned life insurance, such as the tax-free  income from death benefit payments and/or other select data reported  separately for business continuation and broad-based policies, Congress  could, among other alternatives, obtain the data by  assigning responsibility to SEC or Treasury to (1) require purchasers of  business-owned life insurance or insurers to report the data in their  financial statements or federal tax returns, respectively, or (2) conduct a  survey of the purchasers or insurers to obtain the data; or   encouraging NAIC to (1) require insurers to report the data in the annual  reports they file with NAIC or (2) conduct a survey of insurers to obtain  the data.
section_title: Agency Comments and Our Evaluation
paragraphs: We received written comments on a draft of this report from Treasury, IRS,  SEC, and NAIC that are reprinted in appendixes III–VI, respectively.  Treasury commented that the report is well-researched and informative,  but together with SEC expressed reservations about the matter for  congressional consideration. Both agencies were reluctant to have a  potential role in collecting data on business-owned life insurance, stating  that having such a role would not be necessary to fulfill their regulatory  missions. NAIC did not express such reservations, but said that it would  like to evaluate the need for and utility of the data and favored using a  survey as an initial step in the data gathering process. In addition, we  received technical comments from Treasury, the federal bank regulators,  SEC, and NAIC that we incorporated into the report where appropriate.
In addressing their concern about collecting the data described in our  matter for congressional consideration, SEC and Treasury commented that  because they do not need the data to fulfill their regulatory missions, they  do not believe it would be appropriate for them to collect the data.  Specifically, SEC expressed concern about collecting data for purposes  other than protecting investors. Similarly, Treasury expressed concern  about collecting information not directly needed to calculate tax liabilities  or enhance IRS’s ability to audit tax returns. However, as discussed in our  report, Treasury provides OMB the estimate of forgone tax revenues  resulting from the tax treatment of life insurance, and OMB reports this  estimate in its budget documents. As we also report, this estimate is not  complete because it does not reflect the forgone tax revenues on the  additional income from death benefit payments in excess of the premiums  paid and the accumulated tax-deferred earnings. Accordingly, Treasury  might find that gathering additional data would allow the agency to provide  OMB with a more complete and accurate estimate. NAIC reiterated that  collecting the data described in our matter for congressional consideration  would go beyond what is needed to support states’ regulation of insurers’  solvency. But NAIC did not explicitly express reservations about being  charged with collecting the data should Congress request that it do so. We  recognized in the report that none of the potential candidates that we  identified for collecting additional data on business-owned life insurance  needs the data to fulfill its missions and that the data would be used  primarily for making tax policy decisions rather than for providing  regulatory oversight. As discussed in the report, if Congress decides that it  needs more comprehensive data on business-owned life insurance, among  its alternatives would be to turn to SEC, Treasury, NAIC, or another entity  to collect the data.
Addressing the issue of how to collect the data, Treasury commented that it  would be costly to design and distribute a survey, that response rates might  be low without a penalty for noncompliance, and that Treasury would not  be the best candidate to conduct a survey because it is not a “statistical  gathering agency.” Regarding the latter, Treasury said that a survey of  insurance products could be better performed by other organizations or  agencies. As discussed in the report, we agree that collecting the required  data would involve an investment of resources, whether it is done through  a survey or via existing reporting mechanisms. We also agree that obtaining  an adequate survey response rate presents a challenge. However, according  to professional literature, congressional action making the survey mandatory should significantly improve the response rate. Also,  according to this literature, government surveys that have employed  response improvement methods continue to achieve acceptable response  rates. Additionally, the surveyed entities may be more likely to respond if  they believed that doing so would be in their interest. For example, they  might conclude that congressional action would be more favorable to them  if it was based on more complete data. Further, although Treasury is not a  statistical gathering agency, it has chosen to conduct surveys to provide  required information to Congress, as well as for other purposes, such as to  study the growth of investment in foreign securities. Treasury has also  contracted out surveys, as have other federal agencies. NAIC also  commented that collecting the data could entail significant costs. NAIC  said that it would like to evaluate the need for and utility of collecting the  data and suggested that an initial study sampling the data described in our  matter for congressional consideration might be a cost-effective way to  assess the need for broader data collection. We agree that such a strategy  could be one way of approaching the data collection effort.
We are sending copies of this report to the Chairmen of the Senate  Committee on Finance, House Committee on Financial Services, Joint  Committee on Taxation, and other interested congressional committees.  We will send copies to the Chairman of the Board of Governors of the  Federal Reserve, Secretary of the Treasury, Chairman of FDIC,  Commissioner of Internal Revenue, Comptroller of the Currency, Director  of OMB, Director of OTS, Chairman of SEC, Executive Vice President of  NAIC, and other interested parties. We also will make copies available to  others upon request. In addition, the report will be available at no charge  on the GAO Web site at http://www.gao.gov.
If you have any further questions, please call me at (202) 512-8678,  dagostinod@gao.gov, or Cecile Trop at (312) 220-7600, tropc@gao.gov.  Additional GAO contacts and staff acknowledgments are listed in appendix  VII.
section_title: Scope and Methodology
paragraphs: To obtain information on the prevalence and use of business-owned life  insurance, we analyzed the quarterly financial reports—the Call Report and  Thrift Financial Report—that banks and thrifts filed with their respective  regulators. We obtained the data from the Federal Deposit Insurance  Corporation (FDIC), which compiles Call Report and Thrift Financial  Report data collected by the Board of Governors of the Federal Reserve  System (the Federal Reserve), FDIC, the Office of the Comptroller of the  Currency (OCC), and the Office of Thrift Supervision (OTS). We also  obtained additional Thrift Financial Report data from OTS. Because  regulators only began collecting the information in a consistent format at  the beginning of calendar year 2001, our analysis covered the eight quarters  ending March 31, 2001, through December 31, 2002. Although we did not  independently verify the accuracy of the data, we assessed its reliability by  discussing the data system with bank regulatory officials and examining  the data for missing or unreasonable values. We concluded that the data  were reliable for purposes of this report.
To obtain further information on the prevalence and use of business-owned  life insurance, we reviewed the most recent annual Form 10-K financial  reports that publicly traded companies had filed with the Securities and  Exchange Commission (SEC) between January 2002 and September 2003.  To identify information about insurance companies’ sales of such policies,  we reviewed the Forms 10-K of 32 life insurance companies that were  among the 50 largest such companies ranked by assets. We also searched  for references on how businesses used such policies in the Forms 10-K that  a random sample of 100 Fortune 1000 public companies filed with SEC.  Although the examples that we identified were not necessarily  representative of all businesses that own these policies, they illustrated  some uses of business-owned life insurance. We also reviewed industry  literature, including studies by life insurance industry consultants and  brokers, and interviewed experts to identify other surveys related to  business-owned life insurance sales and use. We reviewed surveys  conducted by CAST Management Consultants, Inc. that estimated 2001 and  2002 business-owned life insurance premiums and by Clark Consulting that  reported on businesses’ use of business-owned life insurance in 2003. We  did not fully assess the quality of these surveys, but we determined that  despite some limitations, the surveys illustrated the amount of some recent  sales and some businesses’ uses of business-owned life insurance.
We also obtained information concerning the prevalence and use of  business-owned life insurance from officials of relevant federal regulatory  agencies: four federal bank regulators (the Federal Reserve, FDIC, OCC,  and OTS), SEC, and the Internal Revenue Service (IRS). In addition, we  reviewed the Joint Committee on Taxation’s and the Office of Management  and Budget’s reported estimates of forgone tax revenues attributable to  business-owned life insurance and obtained information from officials of  both entities about the development of these estimates. We also obtained  information about the prevalence and use of business-owned life insurance  from the National Association of Insurance Commissioners (NAIC), two  life insurance trade associations (the American Council of Life Insurers and  the Association for Advanced Life Underwriting), and four large banks that  held business-owned life insurance.
In an effort to better describe the prevalence and use of business-owned  life insurance, we also considered the possibility of conducting a survey of  life insurance companies, but did not do so. Although representatives of six  life insurance companies cooperated in a survey pretest, and American  Council of Life Insurers 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 warrant conducting the survey. The insurance company  representatives told us that their companies do not have a business need to  maintain the comprehensive data on business-owned life insurance that we  needed for the survey. We did not verify the accuracy of these statements.  Still, for the reasons the insurance company representatives cited, we were  uncertain whether we would receive an acceptable response rate to a  survey. Also, insurance companies’ requests for anonymity would have  precluded us from determining the percentage of total life insurance sales  the survey respondents represented.
To describe federal and state regulatory requirements for and oversight of  business-owned life insurance, we met with officials of federal and state  agencies that have regulatory authority related to business-owned life  insurance to discuss their requirements and oversight activities and  reviewed agency documentation and applicable federal and state laws.  Specifically, we discussed requirements and oversight with officials at each  of the four federal bank regulators and reviewed their guidelines,  regulations, and reporting forms and instructions. We also discussed these  topics with officials at SEC and IRS and reviewed their regulations,  reporting requirements, and applicable sections of the Internal Revenue  Code. We also interviewed NAIC staff to gain a perspective on state  approaches to regulating business-owned life insurance and to discuss the  organization’s model guidelines for state laws concerning such policies. To  understand more about how states oversee compliance with their statutes,  we obtained information from officials of insurance departments in  California, Illinois, New York, and Texas. We selected these states because  they represented different geographical regions of the United States and  had differing insurable interest and consent provisions for business-owned  life insurance; we did not select states whose provisions did not  specifically address business-owned life insurance because we concluded  that their insurance departments would not have specific oversight  activities or requirements for business-owned life insurance. We did not  conduct a comprehensive evaluation of the quality of federal and state  regulators’ oversight activities. For example, we did not review records  from federal examinations of banks and thrifts or state examinations of  insurers. In addition, although we did not review every state statute that  could affect business-owned life insurance, we reviewed each state’s  statutes that related specifically to business-owned life insurance. Further,  to better understand differences in state laws concerning insurable interest  and consent requirements for business-owned life insurance, we analyzed  compendiums of state statutes from NAIC and the American Council of Life  Insurers.
To address the potential usefulness of and costs associated with obtaining  more comprehensive data on business-owned life insurance, we reviewed  state and federal legislative proposals for changing the tax treatment of  business-owned life insurance or addressing other public policy issues  related to this insurance and determined the types of data that could be  useful in considering these kinds of proposals. We also assessed the extent  to which the information we obtained on the prevalence and use of  business-owned life insurance provided a comprehensive basis for decision  making. In addition, we reviewed IRS, SEC, and NAIC’s reporting forms and  instructions to understand what role these organizations or Treasury might  play if Congress wanted them to collect, analyze, and report more  comprehensive information on business-owned life insurance. We also  discussed with representatives of six insurance companies the challenges  insurers might face in providing data, including what data they would be  able to readily provide and what data would be difficult to provide. Finally,  we discussed challenges that might be faced in collecting the data with  Treasury (including IRS), SEC, and NAIC representatives.
We conducted our work between February 2003 and December 2003,  primarily in Washington, D.C., in accordance with generally accepted  government auditing standards.
section_title: State Insurable Interest and Consent Provisions
paragraphs: Table 3 provides information on state insurable interest and notification  and consent provisions applicable to purchases of business-owned life  insurance by employers or employer-sponsored trusts.
section_title: Comments from the Department of the Treasury
paragraphs: The Department of the Treasury (Treasury) commented on our matter for  congressional consideration, which suggested that, among other  alternatives, Congress could assign responsibility to Treasury for collecting  data on business-owned life insurance. We discuss these comments in the  Agency Comments and Our Evaluation section of this report. We also  modified the report based on the technical comments that Treasury  provided, as appropriate. In addition, discussed below is GAO’s detailed  response to another comment from Treasury’s April 23, 2004, letter.
subsections: section_title: GAO Comments
paragraphs: 1. Treasury commented that the report leaves the impression that interest  not linked directly to business-owned life insurance is almost always  deductible, noting that the Internal Revenue Code generally allocates a  portion of the interest expense of a business to its unborrowed policy  cash values. However, Treasury also noted that this provision does not  apply to contracts that cover the life of a person who is an officer,  director, or employee of the business. Our report addresses business- owned life insurance as permanent insurance that an employer  purchases on the lives of employees, with the business as the  beneficiary. Because the provision cited by Treasury does not apply to  this type of insurance, we do not discuss it in the report.
section_title: Comments from the Internal Revenue Service
section_title: Comments from the Securities and Exchange Commission
paragraphs: The Securities and Exchange Commission (SEC) commented on our matter  for congressional consideration, which suggested that, among other  alternatives, Congress could assign responsibility to SEC for collecting  data on business-owned life insurance. We discuss these comments in the  Agency Comments and Our Evaluation section of this report. We also  modified the report based on the technical comments that SEC provided,  as appropriate. In addition, discussed below is GAO’s detailed response to  another comment from SEC’s April 13, 2004, letter.
subsections: section_title: GAO Comments
paragraphs: 1. SEC commented that the efficacy of an information collection program  through SEC filings would be constrained by the federal securities law’s  limitations on those companies that are required to file information  with SEC. Our report recognizes on page 36 that SEC only collects data  from public companies. As Congress evaluates the need for additional  data, it might determine that data from a subset of all companies would  provide adequate information.
section_title: Comments from the National Association of Insurance Commissioners
paragraphs: Ms. Davi M. D’Agostino  Director, Financial Markets and Community Investment  441 G Street, NW  Dear Ms. D’Agostino:  Thank  you  for  the  opportunity  to  provide  you  with  feedback  on  the  GAO’s  draft  report  entitled,  Business-Owned  Life  Insurance:  More  Data  Could  Be  Useful  in  Making Decisions About Its Tax Treatment. The NAIC appreciates the opportunity  to  respond  to  your  findings  in  this  report.  We  also  appreciate  the  opportunity  to  have  assisted  during  the  development  of  the  report  by  meeting  with  the  GAO  to  provide background information.
The NAIC has been interested in this issue for some time and has also reviewed the  subject.  During  2002,  the  NAIC  appointed  a  working  group,  chaired  by  Commissioner  Jim  Poolman  of  North  Dakota,  to  review  the  NAIC’s  earlier  guidance  and  to  recommend  an  appropriate  state  response.  The  NAIC’s  COLI  Working  Group  reviewed  the  model  guidelines  mentioned  in  your  report  and  recommended  an  additional  provision  that  requires  written  affirmative  consent  prior to purchase of coverage on an employee. The changes to the model guidelines  also  acknowledged  that  coverage  might  continue  after  the  person  was  no  longer  employed  by  that  company  and  prohibited  the  employer  from  retaliating  in  any  way against an employee who chose not to give that consent. The working group  also  considered  requiring  notification  of  the  employee’s  spouse  and  including  a  provision  that  would  require  employers  to  make  notification  to  all  existing  employees  where  coverage  was  already  in  place.  These  provisions  were  not  ultimately included because of the negative effect they would have on employers in  relation to the benefit that would be provided.
As  mentioned  in  the  report,  the  majority  of  states  do  define  insurable  interest  in  such a way as to allow employers to purchase life insurance coverage on some, if  not all, employees. Many states also require getting consent prior to that purchase.
Ms. Davi M. D’Agostino  Director, Financial Markets and Community Investment  fund employee benefits and some state laws require that the policies be segregated into a trust for  that  purpose.  Page  5  of  your  report  may  mislead  readers  by  specifying  that  four  insurance  regulators  have  issued  guidelines  applicable  to  business-owned  life  insurance.  Readers  may  assume  that  the  report  is  referring  to  the  four  states  interviewed,  or  may  be  confused  by  the  wording to believe that only four states have such requirements. A reading of the chart contained  in Appendix II will clarify that, in fact, most states have guidelines.
The report correctly states that insurance regulators have collected little data on business-owned  life  insurance  because  concerns  about  abuse  or  misuse  of  the  policies  have  not  been  previously  forthcoming. The GAO suggests that the NAIC might be a source of information about the extent  of  business-owned  life  insurance  by  adding  the  reporting  of  that  information  to  the  annual  statement that insurers are required to file with the NAIC. As you are aware, the NAIC collects a  large  amount  of  data  from  the  insurance  industry,  a  large  portion  of  which  is  included  in  the  annual and quarterly financial filings submitted to the states to support solvency regulation. The  current  statutory  filing  requirements  do  not  require  the  level  of  detail  for  business-owned  life  insurance,  or  any  other  specialty  line  of  business,  contemplated  by  the  GAO  in  this  report.  We  believe  that  what  the  GAO  is  suggesting  by  the  collection  of  more  detailed  information  on  business-owned life insurance goes beyond that needed to support solvency regulation. We agree  there may be a significant cost associated with the collection of this data, both from the reporting  entity and collecting organization standpoint; however, the NAIC would like to better understand  the  type  of  information  to  be  collected  to  further  evaluate  the  need  for  and  utility  of  this  information. Perhaps instead of an ongoing data collection effort, a study sampling this data may  be more cost effective in assessing the larger need for ongoing data collection.
Thank  you  again  for  the  opportunity  to  respond  to  the  findings  in  your  report.  We  hope  these  comment are helpful and that you will contact us if we can be of further assistance.
The National Association of Insurance Commissioners (NAIC) commented  on our matter for congressional consideration, which suggested that,  among other alternatives, Congress could encourage NAIC to collect data  on business-owned life insurance. We discuss these comments in the  Agency Comments and Our Evaluation section of this report. We also  modified the report based on the technical comments that NAIC provided,  as appropriate. In addition, discussed below is GAO’s detailed response to  another comment from NAIC’s April 19, 2004, letter.
subsections: section_title: GAO Comments
paragraphs: 1. NAIC commented that a statement on page 5 of our draft report may  lead readers to believe that only four states have issued guidelines  applicable to business-owned life insurance. We modified that  statement to clarify that we are referring only to the four states we  contacted. Although many other states have issued guidelines and  requirements that are applicable to business-owned life insurance, we  only discussed regulatory oversight of such policies with officials from  the four states that we contacted.
section_title: GAO Contacts and Staff Acknowledgments
subsections: section_title: GAO Contacts
section_title: Staff Acknowledgments
paragraphs: In addition to those individuals named above, Joseph Applebaum, Emily  Chalmers, Rachel DeMarcus, Daniel Meyer, Marc Molino, Carl Ramirez, and  Julianne Stephens made key contributions to this report.
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