Did you know that, up until 2006, your life might have been insured with coverage you did not know about or pay for, and that your family was not the beneficiary of this insurance? Well, it’s true. This type of policy is known as Corporate Owned Life Insurance (COLI). It still exists today – but since 2006, you must be notified and consent to this coverage.
Is your company trying to bump you off to gain benefits? Probably not. As opposed to group life insurance which protects the employees, COLI is used in several ways to benefit the corporation; many of which involves using tax policy to the company's advantage, and none of which involve company sharpshooters or poisoning the tuna in the company cafeteria.
For COLI policies, the corporation is both the purchaser and beneficiary of the policy. These policies can be structured many different ways, depending on what the company wants to achieve.
It could be a policy where benefits are split between the corporation (to the amount of the premiums paid in) and the insured employee's beneficiary (getting whatever is left). It could be used to buy back the decedent's stock, partnership, or ownership. Another use is to effectively fund pensions or other benefits by providing a means of recovering costs.
Some corporations formerly insured many lower-tier, non-essential employees (as stated above, without their permission) and used the sizable cash value of the policies to take out huge loans for whatever purpose the corporation chose. Deductible interest on the payments was paid back to the policy – and those payments were not considered income to the policyholder who is…you guessed it. The premiums in some cases were less than the tax deductions gained by the corporation. This practice earned COLI the nickname of "janitor's insurance".
COLI has also been called "Dead Peasant's Insurance" – but don't take it personally, this nickname comes from 19th century Russia, where the meaning was literal at the time. Deceased serfs were "sold" to the wealthy so they could in essence be used as loan collateral. Same principle, different time.
Congress and the IRS cracked down on these practices, limiting COLI to the upper one-third of employees with respect to compensation, and the insured must now have written notification of the existence of the policy, the amount, and who the beneficiaries are. However, if the corporation follows these rules, the tax-advantaged status of the death benefits still exists.
A particularly egregious part of the old policies was that the corporation could collect death benefits years, even decades, after the employee last worked there. The loophole was also closed in 2006, limiting the tax benefits of holding the policy unless the employee worked at the company within one year prior to his or her death.
However, older policies were grandfathered in place – so some corporations are likely still benefiting from policies on employees that have long since left or retired. Currently there are legal battles from relatives of some decedents claiming the company had no reasonable interest in insuring them and that the relatives are entitled to some of the benefits.
Since insurance is involved, state regulations may further limit COLI policies – but generally, these policies are win-win for both the corporation and the insurance company. However, taxpayers are not so fortunate. Expect these policies to continue in some form for quite some time.
Most importantly, make sure to obtain the life insurance your family needs directly, as corporate owned policies are a very different animal.