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. 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. 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. 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.