Here’s the rumor: Large corporations, such as Wal-mart or other Fortune 500 companies, take out life insurance policies on low-level employees, and use the payout to fund executive bonuses.
If you think this sounds shady, then it’s time you got to the bottom of this business strategy—because your boss might be in on it.
This post will uncover details of what’s informally known as “dead peasant” insurance and formally titled corporate-owned life insurance (COLI). We’ll pull back the curtain to unveil what’s happening on the backstage of corporate America and how it impacts you.
What Is “Dead Peasant” aka COLI Insurance?
The concept of corporate-owned life insurance is nothing new. It’s been around for many decades, starting with the Russian upper class “buying” deceased feudal serfs in the 19th century. Hence, the name “dead peasant” insurance.
What’s more; is that massive chains, such as Nestle, Pitney Bowes, and Winn-Dixie, are all proponents of this business structure.
Michael Moore’s 2009 release of Capitalism: A Love Story spurred on many people’s curiosity in COLI. The linked scene is known as the “Wal-Mart ‘Dead Peasant’ Scene,” which portrays the story of deceased cake-maker and her family.
But let’s back up; here’s the gist of how COLI all started.
Aside from the Russian upper class, of course, corporations would purchase whole or universal life insurance policies on their employees. In the beginning, the employees wouldn’t have a clue that they were worth as much (or more) dead than alive to their employer.
Of course, that element changed in the 80s when the IRS cracked down by capping deductible interest at $50K per policy. (More on this below.)
Still, most of these large companies used COLI to fund employee pension programs. Keep in mind that this strategy offered a tax advantage, too, so a company would benefit from the “dead peasant” insurance method. COLI also served as a type of “key man” insurance, which is coverage that backstops a company against financial loss if a top executive passes away. You can read a bunch more about this in an older article from the Wall Street Journal here.
“Dead peasant” insurance became exceptionally messy and, some would argue, highly immoral in the 70s and 80s. Companies would increase their key person policies to skyrocketing amounts, and then enjoy the massive interest write-offs when they borrowed against a plan.
As mentioned, after the IRS reformation in the mid-80s, corporations couldn’t leverage and deduct premiums of COLI policies for tax benefits. Plus, the idea of key man insurance (temporarily) went out of the window, making insurance for rank-and-file employees more attractive to corporations.
The backlash of this reformation was that corporations no longer took out two or three extensive policies. Instead, they opted for 20,000 or 30,000 on their many employees. Congress restricted COLI programs even more in the Pension Protection Act of 2006, which required companies to:
- Inform employees when they purchase policies to insure them.
- Obtain employee’s consent (in writing) for an active policy during and after employment.
- Only use COLI for the top 35% of the company’s workforce or shareholders with at least a 5% ownership stake.
- Submit detailed COLI reports to the IRS each year.
How Does COLI Work?
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.
Are There Different COLI Types?
Along with various purposes, several types of COLI exist, as well. Aside from the traditional COLI policy where the company pays all and gets all for monetary profit, here are the two most commonly used:
As mentioned, key person insurance is a widespread use for COLI policies. To protect the company’s survival, it will take out a life insurance policy on top executives. If they pass away unexpectedly, the insurance payout will help to keep the company on track financially and replace those crucial roles quickly.
Split-dollar life insurance is another favored COLI life insurance. As the name suggests, the company and the employee share the policy’s premium, death benefit, and cash value. The arrangement is typically versatile, too. For example, sometimes, the employee will pay the entire premium, leaving the company to choose between the death benefits or the cash value.
What’s the Point of COLI?
Over 100 years ago, the point of COLI was so the ruling class of Russia could “buy” dead feudal serfs who were already included in the previous census. These individuals aimed to acquire collateral to obtain loans so that they could build their property portfolio.
As COLI made its way to the United States, the purpose of its existence changed a bit. Instead of inflating the bank account of the Russian upper class, COLI served to safeguard massive corporations from financial harm.
Still, COLI is geared toward the company as opposed to the employee. As a result, many companies were able to exploit an IRS tax loophole for decades on end. This approach had little to do with caring for employees.
Today, one of the goals of COLI is to protect the company from the calamity of losing a prominent executive. Another COLI aim is to regulate a company’s balance sheet. Although corporations must follow stringent rules and regulations, many continue to take out “dead peasant” insurance policies on as many employees as possible—but only with their consent.
Lastly, because of the investment component, COLI policies help to fund employee benefit and pension plans. Keep in mind that COLI policies aren’t the same as group coverage. Even though they have similar purposes, they’re two separate policies entirely.
What’s the Harm of COLI?
Most people find the idea of COLI offensive and morbid. After all, would you like a life insurance policy to be taken out on you for your employer’s gain? Granted, COLI serves a multitude of purposes, but the whole deal is macabre. And that’s just for starters.
Since COLI is frequently used to plump a company’s balance sheet, it creates a moral issue. We’ve watched too many episodes of Law & Order not to consider the ulterior motives of money-hungry people.
For example, who’s to say that a company won’t kill off a few insured employees when the bottom line takes a dip? It’s a gruesome thought to have, but it’s not unrealistic. In 2011, an Ohio oil-change business owner was arrested for allegedly planning a murder-for-insurance scheme.
This situation isn’t something you can merely forget when you’re presented with a COLI consent form.
A chief principle of life insurance is that the policyholder and the beneficiary should have an “insurable interest” in the insured individual. What this means is that the insured isn’t merely a bag of money walking around; they’re a human being.
When people lose sight of this concept, Law & Order-type monstrosities happen. In the past, only close blood relatives, important employees, and debtors (up to the amount owed) were considered insurable interests. But in today’s world, the definition is much broader.
Take the Next Step
It’s tough knowing how to protect your family after you’re gone, especially with such a vast amount of information out there. But we can help!
To support you as you safeguard your financial security, I’ve created an up-to-date guide for parents who need life insurance. My guide can help you with your long term life insurance goals, especially with a family to nurture at home.
Here at CB Acker Associates, we want to help you take care of your family. If you’re ready to find a policy that fits your needs and your budget, we can help!
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