Corporate Owned Life Insurance, COLI
1. Definition of Corporate Owned Life Insurance (COLI)
Corporate Owned Life Insurance, often referred to as COLI, is the purchase of life insurance by a corporation on the lives of its owners, key executives or employees where the company is named as the owner and beneficiary under the insurance contract. The corporation pays the life insurance premiums and any values accumulated or death benefits paid under the contract are assets of the corporation.
2. The Current Marketplace
Large Corporate America has known for decades that Corporate Owned Life Insurance, COLI, is an excellent method to informally fund Employee Benefit Plans. Hundreds of millions of dollars are paid annually for insurance premiums building huge, tax-advantaged pools of money. This money can be used to fund the future benefits paid to employees and to ultimately provide cost recovery to the company.
3. Our Niche Market & Unique Approach
Closely Held Businesses
For reasons identical to Large Corporate America, the smaller, profitable small to mid-sized closely held business should purchase Corporate Owned Life Insurance, COLI. Their financial and business concerns regarding key employees are just as real. Usually, the financial effect on the family of a deceased shareholder is extremely severe due to the lack of marketability of the business coupled with poor business continuity planning. The desire for these business owners and key executives to build maximum wealth to secure the financial future for themselves and their families is also just as real.
Coordination to Personal Wealth Building Strategies
Typically, Corporate Owned Life Insurance, COLI programs focus on a methodology to provide the most efficient way to fund employee benefits programs for the corporation, an entity with a continuous life. Our strategies are designed to effectively transfer the tremendous wealth creation power of a mature life insurance contract to the owner or key executive during their lifetime. This transfer can be coordinated with a stock transfer, an employee bonus program or the purchase of the insurance contract from the company.
4. Benefit Programs Associated with COLI
Key Person Insurance:
The untimely death of a key employee or a business owner can have a disastrous effect on a business. Corporate Owned Life Insurance, COLI, can be purchased life insurance to guard against this risk. Some of the costs to a business that can result from the death of a Key Person include the following:
A weakening of the company’s credit rating
The financial cost to find, hire and train a replacement
The inability to find a replacement with the same ability
A loss of confidence among both suppliers and customers
A loss in productivity due to the distraction of other employees
A need for cash to fulfill promises made to the deceased employees family
A need for cash to fund a corporate stock redemption
Employee Benefit Plans:
It is common for a corporation to elect to reward a select group of executives or any employee whose benefits under a qualified plan have reached the limits set under Section 415. These plans are typically called Top Hat Plans or Excess Benefit Plans, respectively. More often than not, Corporate America chooses to informally fund the future liabilities of these plans to the corporation through Corporate Owned Life Insurance, COLI.
Under these types of programs, an employee may be entitled to a cash distribution at some point in the future. The employee’s beneficiary may also be entitled to a death benefit under the program. These programs are usually not taxable to the employee during the accumulation phase and if structured properly, only become taxable as benefits are paid to the employee.
These plans must be “unfunded” for the employee to achieve tax deferral on plan contributions. A plan is considered “unfunded” if all plan assets are paid from the general assets of the employer, which remain subject to the claims of the creditors of the employer. In essence, the employer’s obligation to make benefit payments to an employee may not extend beyond a simple, unsecured promise to pay money at some point in the future. It is an accepted practice in Corporate America to informally fund these future liabilities to the corporation through the use of Corporate Owned Life Insurance, COLI.
5. COLI as a Funding Arrangement
The liabilities to a corporation as a result of Employee Benefit Plans (promises to pay) are reflected on the balance sheet and can be significant. Corporate Owned Life Insurance, COLI, is often a cost effective method to provide funds to meet future plan obligations. Some of the unique qualities attributed to Life Insurance as an informal funding arrangement for Employee Benefit Plans include the following:
- The cash value of life insurance is accumulated on a tax-deferred basis.
Life Insurance death benefits may be received income tax-free to the corporation.
Tax-free payments may be made to the company to provide for plan benefits.
Life Insurance may allow for full benefit payments even if the employee is disabled prior to retirement.
Life Insurance may allow for full benefit payments even if the employee dies prior to retirement.
Life Insurance can provide a recovery of the entire cost of the program to the employer.
Life Insurance provides contractual guarantees that give the program added security.
6. Tax Accounting of COLI
The impact on corporate financial statements is a key consideration in the purchase of Corporate Owned Life Insurance, COLI. It is also necessary to understand how the earnings of the corporation are affected to evaluate the costs associated with the plan. The primary reason that life insurance is an attractive funding vehicle is the inherent recovery of costs associated with the plan. There will be a charge against earnings that cannot be recovered when the corporation elects to fund plan benefits out of current earnings and surplus.
The conventional method measures the cost of insurance from the standpoint of cash premium paid and surrender value received, if any. The accounting treatment of premium payments requires the recognition of the separate expense and savings element. If the policy is participating, the annual dividend may be used to reduce the cash premium payment. The net premium paid is treated as an expenditure that reduces Cash by the net amount paid. An increase in the cash surrender value of the policy increases the asset value of the business.
Any excess premium paid over the cash surrender value is treated as “insurance expense” and any excess of cash surrender value increase over premium paid is “other income (insurance)”. The journal entry to record a premium payment would appear as follows:
Life Insurance Expense
|Cash Surrender Value Increase
No expense is recognized when the cash surrender value is greater than the net premium paid. In fact, the retained earnings of the corporation will be increased as the asset value grows. The journal entry to record such a premium payment would appear as follows:
|Cash Surrender Value Increase
|Other Income (Insurance)
Effect on the Balance Sheet
The cash surrender value should not be reported as a “Current Asset”, but should be placed under the “Other Assets” category of the balance sheet.
When a policy matures by reason of the death of the insured, the corporation receives a substantial non-taxable increase in earnings. The gain is measured by the difference between the death benefit and the cash surrender value at the time of death. The journal entry as a result of the death of an executive would appear as follows:
|Cash Value of Insurance
Accountants may utilize various methods to transfer these journal entries to the financial statements. Some may wish to by-pass the income statement entirely and reflect the insurance expense (or income) on the balance sheet as a direct charge (or credit) to earnings. In this case, the credit entry would be to retained earnings instead of income. The more common practice would be to treat the insurance cost as an expense or income on the income statement.
7. New York State Insurable Interest Requirement
Corporate Owned Life Insurance, COLI, is subject to all the provisions of the New York State Insurance Law. It is the insurer’s responsibility to determine whether the policyholder (corporation) has an insurable interest in the person under the policy at the time of issue. A corporation can use COLI to fund an employee benefit plan or provide key person insurance in New York.
For an Employee Benefit Plan, the cash value reserves and/or death benefits received can be used to fund benefits payable under the plan. An insurable interest is deemed to exist if an employee is entitled to benefits under the plan. The insurer must ensure that the insurable interest requirement is (and continues to be) satisfied.
For Key Person COLI, the insurer must have procedures in place to ensure that the corporation has a lawful and substantial economic interest in the continued life, health or bodily safety of the insured person. This must be distinguished from an interest where the economic interest to the corporation is enhanced only by the death, disability or injury of the insured.