Knowing the backstory of “dead peasant” insurance helps to make sense of its prevalence in today’s business world. Over 200 companies in America still use COLI for various reasons. However, as imagined, it’s not always straightforward to employees.
Many times, new employees are assigned a stack of paperwork to sort through and sign before they officially start the job. Hidden amid this mess of hardcopies is often a COLI policy consent form and information sheet. It’s a sneaky approach—but that’s somewhat of a generalization. Not all COLI-using companies are devious.
That said, companies now typically use COLI to hedge against situations such as the unexpected death of a distinct employee (aka key person). This approach seems justified since losing a top executive could wreak havoc on a business’s overall structure and strategy.
When it comes to lower-level employees, though, it’s crucial to point out that most COLI-using companies declare the pension fund to be the official beneficiary. However, few individuals have witnessed a separation in pension accounts and the general company account. Funds sort of get sloshed together, creating many blurry lines between insurance payouts and business revenue.
As a result, the corporation is the only one deciding what to do with the insured’s cash value, borrowing or making withdrawals against it. Some companies use the money to fund employee benefits, such as medical costs. Still, family members of the insured deceased often face disappointment when they learn that their loved one had a life insurance policy, but they can’t touch it.
Many other life insurance products offer some tag-a-long benefits—saving components, tax-free growth, etc.—and COLI isn’t any different. The tax implications are a chief reason why so many corporations go the COLI route, after all.
As mentioned, the mid-80s saw a peak in COLI use when corporations would take out COLI policies on its hundreds of employees. Corporations would then borrow against the cash value of the policies, flying under tax radars when deducting the loan interest.
Remember, unless the policy is surrendered before the insured’s death, investment earnings on insurance premiums can grow without the threat being taxed. Death benefits aren’t taxable, either.
The tax-free approach makes it easier to see why corporations would be so excited about using COLI policies to beef up their bottom line.