By Lee Sherman
What was once a way to profit from the deaths of important executives has become a means of sharing corporate wealth.
A company will usually take out Corporate Owned Life Insurance (COLI) on its most important executives as a hedge against the financial cost associated with losing that employee due to unexpected death. To understand why this is so important, imagine Apple without Tim Cook or Tesla without Elon Musk. Today’s chief executives aren’t just faceless automatons, they are the heart and soul of the company, as much a celebrity as any rapper or athlete. And every breath they take moves the stock price.
What is COLI?
Corporate-owned life insurance, is a life insurance policy that a company has taken out on an employee. It is owned by the employer, and, in most cases, the employer is also the primary beneficiary. You might also find it referred to by the rather prosaic names, janitor’s or dead peasants insurance, because of the somewhat secretive way it has been used in the past.
COLI is somewhat reminiscent of another lesser known corporate practice called a key man clause, found in some merger and acquisition agreements. A key man clause usually involves an agreement that a certain executive will stay with the new company for some pre-determined amount of time and some kind of financial renumeration held back should they leave earlier.
Similarly, key person insurance insures key executives whose death would cause a financial loss to the company. Key person policies may be either term life insurance or permanent life insurance. The premiums are paid by the company and if the employee dies, the payout is used toward the cost of hiring their replacement.
Replacing a key executive is extremely costly today, involving huge payouts to executive recruiting firms, along with the huge compensation packages offered to top executives. COLI is also used to offset the costs associated with having to redeem stock upon the executive or owner’s death. Companies are even allowed to deduct their life insurance premiums from corporate profits and earnings except in cases where the company paying the premium is also the beneficiary. While COLI originated as “key person” insurance, today it is a common hiring practice that has been extended to a much broader range of employees.
Another type of COLI is split-dollar life insurance. In this scenario, an employer and an employee share the cost and or proceeds from a policy that also has a cash value. With split-dollar life insurance, the script is flipped and COLI is used as part of an employee’s overall compensation package as a benefit. While the exact split can vary, this is more similar to a personal life insurance policy because if the employee dies, their family will receive at least a portion of the benefits.
It used to be that you could work many years for a company without even knowing that it had taken out a life insurance policy on you. But new regulations require corporations to get the consent of the individual before they take out a policy on them. In most cases this comes at the time the employee is hired or when a company is founded.
As COLI has evolved, it has changed from being purely a way for companies to recoup their losses to an important part of an executive’s compensation. Your financial advisor can help you understand the role of COLI in your financial and retirement planning.
Lee Sherman is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Lee is an experienced journalist and editor with over 30 years of expertise with a significant history of writing in the personal finance and technology arenas.