A January 28 article in the Los Angeles Times triggered two effects: a hissy spat with the Times’s rival Southern California news organization, the Orange County Register; and a new spotlight on a once-common but highly controversial corporate practice that had declined in usage the past several years.
The Times got word that its competitor’s parent, Freedom Communications, had notified some employees that it wanted to take out insurance policies on their lives in a bid to generate new funding for its pension plan. Under a 2006 federal law, companies must get employees’ consent to buy life insurance on them in order to get tax-preferred treatment of the policy.
The newspaper’s article called the insurance plan “a supremely ghoulish financial strategy.” It also contained several derogatory comments about things seemingly unrelated to the matter, like recent layoffs at the Register and the publication’s allegedly failed content strategy.
Register publisher Aaron Kushner fired back in a memo to employees, encouraging them to print the article and “put it somewhere as a reminder of the kind of newspaper and journalism of which we want no part.” Life insurance is not ghoulish, he wrote; its purpose is to benefit “the people we love and care about most.” This particular initiative’s purpose was solely to benefit Register employees, he cried.
Times writer Michael Hiltzik, who had penned the original article, then issued a follow-up in which he wrote, “We didn’t say life insurance was ghoulish. We suggested that the practice of insuring the lives of rank-and-file employees for corporate purposes was ghoulish…. Kushner must know that the practice is controversial and has often been abused.”
He further branded Kushner’s suggestion that the insurance program solely benefited employees’ pension fund as disingenuous. To the extent that proceeds from the life insurance policies fund the pension plan, he pointed out, Freedom won’t have to use other resources to meet its legal obligations to fund the plan.
The back-and-forth sniping touched on many of the issues that led Congress to place significant restrictions on company-owned life insurance, or COLI, in the 2006 law. Since then, new COLI policies have mostly been taken out on key, highly compensated corporate executives (called key-man or key-person life insurance), a still-common practice that is exempt from provisions of that law.
Increasingly fewer new policies on the lives of rank-and-file employees — sometimes called “dead peasant” or “janitor’s” policies — have been written since the law’s enactment, and the values of those policies that are written are less, says Neel Lane, an attorney with Akin, Gump, Strauss, Hauer & Feld. The practice is not, however, illegal in most states.
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.
But there may be other grounds, says Myers. For example, to get a policy a company has to provide the employee’s Social Security number and other personal information to the insurer. That may entitle the person’s estate to compensation, a situation similar to that of a celebrity or athlete whose likeness is used on a billboard without his or her permission.
Even where companies did get employees’ permission for the policies, depending on the state there may be grounds for legal action, according to Myers: the consent could have been given under duress, or it could have been a “contract of adhesion,” where you had to give the consent to get or keep a job.
And in some cases, Myers says, a company might not provide enough detail to enable the employee to make an informed decision. “If the employer says, ‘hey, we’d like you to consent to this so we can defray our employee benefit obligations a little bit,’ you might be OK with that,” he says. “But if you’re the safety inspector at a chemical plant and knew you’d be worth half a million dead, you might not have given consent.”
In fact, argues Myers, lawsuits against companies over dead-peasant insurance aren’t all about damages. They’re also about about public policy. “You just don’t want anybody to have an incentive in the early demise of people they’re not really interested in. You can’t take out life insurance on a NASCAR driver in hope that he smashes into the brick wall and dies,” he says.
He continues, “It’s not a matter of thinking that employers are going to hire snipers and murder employees. But they could skimp on safety measures. Think about convenience-store clerks working the graveyard shift in a dangerous area. Maybe you skip the bullet-proof glass or the drop safe. Maybe you don’t have two employees work the shift for safety.”
In one case, the widow of a former employee at Amegy Bank in Houston alleged that the bank had purchased two life insurance policies worth a combined $4.75 million on her husband after learning he had a brain tumor. It later fired him but still collected on the policies when he died. The bank settled the case.
In another case, a widow sued Wal-Mart after a store manager allegedly forced her husband, a salaried employee not eligible for overtime, to work 16-hour shifts several days in a row, at the end of which he died of a heart attack while carrying a television to a customer’s car.
Lane points out that companies buying such insurance, and the lawsuits the practice spawns, should only be judged case by case. “Obviously if there are individual circumstances that are wrongful, that’s not a good thing,” he says. “But the employee never pays any premium. And it’s not unlawful to require giving consent to a COLI policy as a condition of employment. I don’t see why, as a general matter, it’s a public-policy problem.”
Adds Lane, “The guy at the L.A. Times calls it ghoulish because people die. But he’s actually talking about some very fortunate people who have a pension plan. It’s a planning mechanism for the pension plan sponsor to meet its funding obligation.” You can say COLI policies are ghoulish because they’re based on mortality tables, but so is all life insurance, as well as pension-plan funding, Lane notes.