Can Your Employer Make Money on Your Death? Corporate-Owned Life Insurance Policies

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If you saw Michael Moore's documentary Capitalism: A Love Story, you may have been surprised to learn about a common practice among large companies: corporate-owned life insurance (COLI) policies, also called corporate death insurance, "dead peasant," or "dead janitor" policies.

COLI policies are life insurance policies taken out by employers on their employees; upon the death of the employee, benefits are payable to the company—not to the family or any other beneficiaries that might be designated by the employee.

Below you'll find more information on COLI policies, including their origins, development, and current use among corporations.

Evolution of Corporate-Owned Life Insurance Policies

Originally COLI policies came into being so companies could protect themselves against the deaths of key employees, i.e., high-ranking executives whose demises could cause great losses in revenue. Moreover, such employees would be costly for the company to replace as they would have to recruit and train new employees to fill the positions.

As time wore on and legal restrictions were lifted, however, companies began expanding the coverage to include rank-and-file workers, sometimes without the employee's knowledge or consent, and continuing even after the employee stopped working for them. This is where the practice became controversial, not only for those questioning the ethics of such policies, but also for Congress and the IRS, who acted quickly to close up tax loopholes related to this concept.

During the 1980s, large corporations began taking out COLI policies on hundreds of thousands of workers regardless of how important their skills and expertise were to the overall business structure. When employees died, life insurance benefits went untaxed, which meant great windfalls upon employees' deaths for employers. Moreover, companies could borrow against the policies, and then deduct the interest they paid as legitimate business expenses.

In the mid-1990s, though, the IRS started denying those deductions and making corporations reconsider their use of COLI policies; Congress also passed legislation to make the practice less desirable for corporations seeking to cover rank-and-file workers in the COLI Best Practices provision of the Pension Protection Act of 2006.

The legal system also had to deal with COLI policies through lawsuits of families of deceased employees challenging the practice as well as corporations suing their insurers for allegedly misrepresenting what the policies offer. Many cases have settled out of court, including a 2004 class action suit against Wal-Mart that settled for $10.3 million and another in 2006 that settled for $5 million.

Current Status of COLI

So where do we stand? COLI policies are still available and being used; a 2006 report found that one-fifth of all life insurance sold is in the form of COLI policies.

Still, in recent years, the practice has been curbed by the IRS cracking down on deductions, by Congress's stricter consent laws, and also by state law. Insurance law is regulated by states, and some have responded by passing "insurable interest" laws, which require that employers have the possibility of financial loss because of an employee's death before they can take out a life insurance policy on them.

The biggest hit to COLI policies still may be on the horizon, however, as President Obama's proposed 2011 budget included further decreases in the amount of allowable interest deductions for borrowing against the policies. Indeed, if the past two decades are a guide, this is an area of insurance, tax, and law that will likely continue to see changes in the years to come.

More Info:

Companies Profit on Workers' Deaths Through 'Dead Peasants' Insurance from the Wall Street Journal

'Secret' Life Insurance Triggers Suits from the National Law Journal

Obama Tax Proposal Zooms in on COLI Policies from InsuranceNews.net