Jim Hauser, an executive compensation attorney with Brown Rudnick, agrees that new policies of this type have become rare.
The 2006 law stipulated that companies could not deduct certain expenses of acquiring and holding such a policy from their taxable corporate income unless the covered employee worked at the company during the 12 months prior to his or her death. Before that, employers were able to buy policies under which they could collect death benefits decades after a person’s employment terminated.
In fact, many policies for which employers did not obtain consent are still in effect, because those purchased before the law became effective in 2006 were grandfathered from its provisions. And they are still generating litigation, typically filed against companies by relatives of recently deceased ex-employees.
In an earlier wave of litigation in the late 1990s and early 2000s, the IRS sued and prevailed over (or settled with) a number of large companies, mostly on the grounds that they did not have an “insurable interest” in the lives of rank-and-file employees. The IRS viewed the practice as primarily an effort to avoid income tax, says Hauser.
Such companies included Wal-Mart Stores, Dow Chemical, American Electric Power, Winn-Dixie Stores and Camelot Music. At the time the Wal-Mart litigation began in 2002, the company had COLI policies totaling $780 million in premiums.
COLI can boost the bottom lines of both the companies that buy it and the insurers that sell it. Under a typical arrangement, buyers of the insurance pay a fraction of the premium up front and borrow the rest from the insurer. The insurer profits because the interest rate on the loan is higher than the rate of return credited to the buyer on the policy’s cash value. The buying company profits by deducting the interest payments from its taxable income (if eligible to do so under the 2006 law) and because life insurance proceeds are not taxable. Left holding the bag for those profits is Uncle Sam.
It is virtually impossible to know just how much money is sitting in rank-and-file COLI policies today, because companies (other than financial institutions) aren’t required to report it in any public filing. Law firm McClanahan Myers Espy has on its website a list of about 200 companies that it says “are believed” to be the beneficiaries of COLI policies. The firm routinely sues companies on behalf of the relatives of deceased employees or ex-employees.
According to Mike Myers, co-founder of the firm, the purchase of COLI for rank-and-file employees is not as rare today as corporate attorneys say. Legal grounds for the lawsuits he pursues vary by jurisdiction, he says. Most often they claim, as the IRS suits did, that companies have no insurable interest in employees’ lives, so the person’s estate is entitled to at least some of the death benefit.