B—Corporate Owned Life Insurance (COLI)

The term “company owned life insurance” (COLI), also referred to as corporate owned life insurance, or employer-owned life insurance (EOLI), is used to describe a wide variety of life insurance products that are purchased to fund both employee benefit plans and business insur-ance needs. These products include virtually all forms of permanent life insurance, including participating whole life, interest sensitive whole life, indexed universal life, universal life, and variable life.

Employee benefit plans. COLI products are purchased on the lives of key employees to fund survivor income plans, post-retirement medical benefits, and supple-mental executive retirement plans (SERPs) (see section 4.9[L], Supplemental Executive Retirement Plan (SERP)). When used for funding employee benefit plans, key features of COLI products include:

1. high early cash values ordinarily exceeding 90 percent of first-year premiums (and some-times equal to or higher than first-year premiums);


2. underwriting considerations providing either guaranteed issue or simplified issue;


3. flexibility in funding variable benefits from both cash values and death proceeds;


4. change of insured provisions;


5.  levelized commissions;


6.  limited pay features; and


7.  contract guarantees relating to mortality charges, expense charges, credited interest rates, and interest rates charged on borrowed funds.

Tax and investment considerations often weigh heavily in the design and implementation of these plans. You will sometimes find products with lower cash value to premiums that focus more on returns at death, but the underwriting concessions on those products are often not as significant as the simplified issue and guaranteed issue programs offered on high cash value products.

Business insurance needs. COLI products are also purchased on the lives of business owners and key employees to fund a wide variety of needs related to risk planning, business continuation, and succession planning. These include entity purchase agreements.

In response to the regrettable practice of insuring rank-and-file workers without their knowl-edge and consent, Congress included in the Pension Protection Act of 2006 major provisions affecting the income tax treatment of employer owned life insurance policy death benefits. Employer-owned life insurance contracts, entered into after August 17, 2006, must meet certain requirements in order for the death proceeds to be excluded from taxable income. The general rule is that death proceeds from these contracts are taxed as ordinary income, except to the extent of any premiums paid for the policy. Exceptions to this general rule are based upon the insured’s status, or how death proceeds are paid or used. The requirements and meeting the exceptions to the general rule are now generally referred to as employer owned life insurance (EOLI). 

The above concepts are obvious examples of “employer-owned” life insurance. Not so obvious is the application of the “related persons” provision, which treats individuals as “related” if they own more than 50 percent of a corporation (i.e., life insurance contracts owned by a majority stockholder are treated as “employer-owned”). For example, in the cross purchase agreement in section 3.4[C], Cross Purchase Agreement, assume that Owner A is a 60 percent stockholder, and Owner B is both a stockholder and an employee of the business. Insurance purchased by Owner A on Owner B’s life to fund their cross purchase agreement is treated as employer-owned, and the death benefit is subject to income taxation. Payment of the proceeds to B’s heirs would provide relief from taxation, but only if there had been the required notice and consent (see below).

The “related persons” provision is further complicated by application of the attribution rules. For example, assume Owner A is a 40 percent owner, Owner B (A’s brother) is a 35 percent owner, and Owner C is a 25 percent owner. By family attribution B’s stock is attributed to A, making A a majority stockholder (A’s 40 percent + B’s 35 percent = 75 percent). Insurance A owns on C is treated as employer-owned, and the death benefit is subject to income taxation. These attribution rules may even cause life insurance contracts owned by individuals, who themselves are not business owners, to be treated as employer-owned (e.g., insurance on A owned by A’s spouse treated as employer-owned). Hopefully, the IRS will clarify and limit the scope of these rules. Ustil then, it is essential to fall within the exceptions by first meeting the following notice and consent requirements. As a practical matter, because the rules governing what is and what isn’t covered by the notice and consent requirements are not as clear as they could be, it is prudent to give notice and consent before the policy is issued in any situation that could conceivably be covered. The requirements are not onerous and the consequences for non-compliance are draconian.

Notice and consent requirements. To qualify for an exception, it is essential to first meet strict notice and consent requirements. Under these requirements, the employee must:

1. be notified in writing that the employer intends to insure the employee’s life and the maximum face amount to be issued;


2. be informed that the employer will be the policy beneficiary; and


3. give written consent, before the policy is issued, to being insured and consent to the coverage continuing after the insured employee terminates employment.

It is strongly recommended that notice be given, and consent be obtained, at the time an application is taken for virtually any life insurance contract that might conceivably fall within the scope of this law. The statute provides no means of obtaining relief from these requirements. The potential cost of noncompliance is income taxation of the death proceeds in excess of premiums paid.

Reporting requirements. Every employer (technically referred to as the “applicable policy-holder”), owning one or more employer-owned life insurance contracts issued after August 17, 2006, must file a return showing for each year:

1. the number of employees at the end of the year;


2. the number of employees insured under such contracts at the end of the year;


3. the total amount of insurance in force at the end of the year under such contracts;


4. the employer’s name, address, and taxpayer identification number, and the employer’s type of business; and


5. that the employer has a valid consent for each insured employee (if any consents were not obtained, the number of insured employees for whom such consent was not obtained).