Life Insurance Provider: Serving Large Corporations Better

Corporate-owned life insurance (COLI) is a type of insurance policy taken out by companies on their employees, typically senior-level executives. The company is responsible for making the premium payments, and if the employee dies, the company receives the death benefit. This type of insurance has a long history, particularly for companies looking to protect themselves financially from the death of a key executive. COLI can also be used to fund supplemental executive retirement plans (SERPs). While COLI can offer tax advantages, it is a complex and controversial topic, with some companies having insured their employees without their knowledge or consent.

Corporate-owned life insurance (COLI)

COLI is designed to protect the company in the event of the death of a key employee, such as a top-level executive, by helping to cover the costs associated with replacing them. It can also be used to fund corporate obligations, such as redeeming stock upon the death of an owner. In some cases, COLI policies can be used to provide benefits directly to the families of deceased employees.

COLI policies can be structured in various ways to accomplish different objectives. One common use is to fund certain types of non-qualified plans, such as split-dollar life insurance policies, which allow the company to recoup its premium outlay. Other forms of COLI include key person life insurance and buy-sell agreements, which facilitate the buyout of a deceased partner or owner of a business.

COLI has existed in some form for over 100 years, with its nickname, "dead peasant insurance", originating in 19th-century Russia. In the United States, COLI was originally used to hedge against the financial cost of losing key employees and to fund corporate obligations. However, in the 1980s and 1990s, some companies began insuring a broad base of employees, often without their knowledge or consent, to exploit tax loopholes. This led to increased regulation and the introduction of the COLI Best Practices Act in 2006, which sets out conditions that must be met for companies to receive tax-free benefits.

Key person insurance

Corporate-owned life insurance (COLI) is a type of insurance that companies purchase for their employees, with benefits payable to either the employer or the employee's family. One of the most common uses of COLI is key person insurance, which is a life insurance policy that a company purchases for an owner, a top executive, or another individual considered critical to the business. This type of insurance is necessary if the loss of that person would be devastating to the company's future.

The cost of key person insurance will depend on the size and nature of the business, the key person's role, their health, gender, age, and the type of policy chosen. When determining how much coverage is needed, it is recommended to purchase a policy that is eight to ten times the key person's salary or the monetary value of the key person.

In addition to life insurance, key person insurance can also be purchased as disability coverage in case the individual is incapacitated and can no longer work.

Tax advantages of life insurance

Life insurance is one of the most tax-advantaged financial vehicles available. Here are some of the key tax benefits of life insurance, particularly whole life insurance:

Tax-Free Death Benefit:

Both term and permanent life insurance policies offer a death benefit that is generally paid to the beneficiary free of federal income tax. This provides a tax-efficient way to ensure your family can maintain their standard of living, pay off debts, or carry out education plans.

Tax-Deferred Cash Value Growth:

Permanent life insurance allows you to build a cash value account that grows tax-deferred as long as the policy remains in force. This means you won't owe taxes on the growth of your policy's cash value, allowing you to accumulate more savings over time. This can be particularly beneficial for retirement planning, especially for those expecting to be in a lower tax bracket during retirement.

Tax-Advantaged Withdrawals and Loans:

Similar to a Roth IRA, permanent life insurance allows you to access the cash value of your policy through tax-advantaged loans or withdrawals. You can supplement your retirement income, pay unexpected medical bills, or prepare for future expenses like education funding. Withdrawals up to the total amount of premium payments can be made tax-free. Additionally, loans against the cash value are not considered taxable income, even if they exceed the cost basis. However, careful consideration is needed as loans may affect the death benefit and could require additional premiums.

Estate Tax Strategies:

While estate taxes may apply to life insurance death benefits, the exemption threshold is typically high, and proactive strategies can be employed to mitigate these concerns. One approach is to gift cash to heirs, who can then purchase a life insurance policy on the owner's life, reducing the taxable estate. Another strategy is to establish an irrevocable life insurance trust (ILIT), which purchases a permanent survivorship life insurance policy outside of the policyholder's personal estate, shielding the death benefits from estate and income taxes.

Tax-Advantaged Investments:

Whole life insurance policies offer investment opportunities with tax advantages. For example, with variable universal life insurance (VUL), policyholders can invest in diverse assets, and reallocations within the policy remain non-taxable. Additionally, there are no restrictions on contribution amounts, allowing continued accumulation of funds beyond the limits of traditional retirement accounts.

Split-dollar life insurance

A split-dollar life insurance agreement specifies each party's rights and responsibilities for a shared policy in a written contract. It includes the agreement's term length, how the agreement ends, and the employee's responsibilities for maintaining coverage. It can also detail how coverage can change if the employee leaves the company or fails to hit agreed-upon targets.

Who Owns the Policy?

The employer or employee can each own the life insurance policy. The policy is never jointly owned. Each arrangement has a unique name and differs in features and operation. There are two types of split-dollar life insurance plans: an economic benefit arrangement and a loan arrangement.

Economic Benefit Arrangement

In an economic benefit arrangement, the employer owns the policy. They pay the policy premiums and decide on the employee's rights and benefits regarding the policy, including the death benefit portion and access to cash value. Meanwhile, the employee in the agreement designates beneficiaries to receive some of the death benefit payout if the employee passes away while the policy is active. Employees may be taxed on the economic value of this policy, which is calculated each year by the IRS.

Loan Arrangement

Under a loan arrangement, the employee owns the life insurance policy, but the employer pays the policy premiums. For tax purposes, premium payments are treated as loans to the employee each year. The employer must charge a sufficient interest rate based on the Applicable Federal Rate (AFR). However, this allows for flexibility in loan structure. The employer can structure this as a term or demand loan.

Benefits of Split-Dollar Life Insurance

Terminating a Split-Dollar Life Insurance Agreement

Several circumstances can result in the termination of a split-dollar life insurance arrangement, including the employee's death, the end of the agreement term, or the employee's retirement or employment termination.

Ethical considerations

Firstly, it is crucial to be honest and transparent with corporate clients. Provide accurate information about the policy, including its benefits and limitations, to ensure they fully understand the scope of their purchase. Misrepresentation can have severe repercussions and erode trust. Confidentiality is also key; protect client data and ensure strict confidentiality, employing stringent data protection measures.

Another important consideration is to always act in the best interests of the client, even if this means lower profits for your agency. Offer them the best coverage that suits their requirements and budget. Stay up to date with the latest laws, policies, and industry practices to ensure you are serving your clients effectively.

Avoid conflicts of interest and be transparent if any arise. Take responsibility for any mistakes and rectify them promptly. Ensure a fair and swift claims process, as delays and undue denials can harm your agency's credibility.

It is also important to promote ethical practices throughout your organisation, with regular training to instil these values in your team. Be open about any fees, commissions, or charges associated with a policy to avoid souring relationships.

With the use of digital tools, ethical considerations also extend to the online sphere. Protect client data with robust encryption methods and regular security audits. Ensure ethical AI and automation tools by keeping them free from bias and always having human oversight. Avoid digital discrimination, and ensure equal access to digital tools and resources for all clients.

In summary, ethical considerations are vital when providing life insurance for large corporations. By prioritising ethics, you build trust, solidify your reputation, and foster long-lasting relationships with clients.

Frequently asked questions