In view of expanded Internal Revenue Service restrictions on executive compensation plans, and still more action pending in Congress, advisors have good reason to question whether the current vehicle of choice for funding these plans–corporate-owned life insurance–will remain so. The consensus opinion among insurance professionals contacted by National Underwriter is 'yes' and for a familiar reason–unmatched tax benefits.
"When businesses create an unfunded liability to provide for executive retirement benefits, that's when COLI comes into play," says Albert "Bud" Schiff, CEO of Nylex Benefits, a wholly owned subsidiary of New York Life based in Stamford, Conn. "For many firms, COLI is a superior solution to the alternatives: funding an executive benefits package with taxable investments, such as mutual funds, or deferring the issue to the next generation of managers."
Cameron Sutton, an executive vice president at Aon Consulting, Atlanta, Ga., agrees, adding: "COLI is like a mutual fund with an insurance wrapper around it. As such, businesses enjoy tax-deferred growth of the inside buildup of the policy's cash value, tax-free withdrawals and loans, and income tax-free death benefits to beneficiaries."
The tax advantages offered through corporate-owned life insurance are no small consideration for small business owners who are looking to attract and retain qualified executive talent. Sources contacted by National Underwriter say the impact of executive compensation planning on company financial measures–cash flow, P&L and the balance sheet–increasingly guides decision-making among corporate CFOs and boards.
Observers say the current regulatory environment also is fueling interest in COLI. They point, for example, to new Financial Accounting and Standards Board (FASB) rules, which have taken the luster off stock options by requiring companies to expense them on their financial statements. Also to consider is the Sarbanes-Oxley Act of 2002, which has heightened publicly held companies' fiduciary responsibilities with respect to executive comp planning. That, observers say, has forced corporate management to take a more active role in the comp planning and to stick to packages that are sure to pass muster with government regulators.
Among these are COLI-funded nonqualified deferred compensation plans and supplemental executive retirement plans or SERPs. Sources say new rules of IRC Section 409A, an outgrowth of the American Jobs Creation Act of 2004, have increased acceptance of these vehicles by clarifying how such plans may be structured.
The IRC provisions, which took effect in January 2005, specify events when execs can take distributions on deferred comp (e.g., no sooner than six months after separation of service, death, disability or an unforeseeable financial emergency). And, certain exceptions notwithstanding, the code also prohibits an acceleration of the specified time or fixed schedule for paying benefits, as when employing "haircut distributions."
Businesses that now legitimately operate beyond 409A's scope would either have to amend compensation packages by year-end 2006 to bring them into compliance or terminate them. These may include, for example, plans that reimburse executives for post-retirement medical expenses.
"With codification of 409A, there's a higher comfort level with nonqualified plans among business owners," says Michele Van Leer, a vice president and general manager at Sun Life Financial, Wellesley Hills, Mass. "COLI-funded packages have gained a greater degree of legitimacy."
Legislation pending in Congress, he adds, should ease concerns among large enterprises about COLI–a not insignificant point in the wake of much-publicized cases involving Wal-Mart, among other firms, that purchased insurance on employees' lives without their knowledge.
A pension reform bill now before the House-Senate Conference Committee contains a provision codifying into federal law current "best practices" on corporate-owned life insurance. The COLI provision would limit coverage to directors and "highly compensated employees" (i.e., individuals earning at least $90,000 annually or in the top 35% by compensation); require employers to obtain employees' informed consent before enrolling them in a COLI plan; and require employers to report information about their COLI plans to the IRS.
Yet another legal component underpinning COLI-funded plans, says John Gephart, a second vice president of advanced sales at Cincinnati, Ohio-based Union Central Life, is the "top hat" exception to the Employee Retirement Income Security Act. The ERISA exception grants employers the flexibility to develop executive compensation programs for key employees and executives.
