How would you feel if your employer wanted to insure your life — with the company as sole beneficiary? What if this has already been done, without your knowledge or consent?
Such practices are not only legal, they’re commonplace, despite attempts in recent years to curb the more flagrant abuses of what’s formally known as corporate-owned life insurance, or COLI, and informally as “dead peasant” insurance.
“Typically, the range of emotions I almost always see when people learn about this is disbelief to extreme anger,” says Mike Myers, an attorney with the McClanahan Myers Espey law firm in Houston, who has tried 18 COLI class-action lawsuits that resulted in settlements. “They usually don’t take the attitude of, ‘What’s the harm?'”
What exactly is the harm?
A ‘moral hazard’
“It creates a moral hazard,” says J. Robert Hunter, director of insurance for the Consumer Federation of America. “The employer might think, ‘Hmm, I’m starting to lose money; maybe I should knock off a few insured employees.’
“Obviously, Wal-Mart wouldn’t do that,” he adds. “But not everybody is Wal-Mart.”
In 2011, police in Ohio arrested the owner of an oil-change business and charged him with trying to hire a hit man to kill a former employee to collect on a $250,000 COLI policy, according to The Columbus Dispatch.
While such cases are rare, it’s little wonder that the insurance earned the pejorative “dead peasant” nickname.
Over the years, hundreds of companies are believed to have been named as beneficiaries in the deaths of current or former employees. Myers’ firm lists more than 200, including many familiar brand names.
The Wall Street Journal has reported that even major life insurance companies have held dead peasant policies on hundreds of their workers.
How did dead peasant insurance come about? Banks and large companies originally used corporate-owned life insurance as a tax-advantaged way to fund employee pension programs and hedge against their financial loss in the untimely death of a top executive, a practice known as “key man” insurance.
When corporations began pumping up those key-person policies beyond reason, then borrowing against them to enjoy huge interest write-offs, the IRS cracked down in 1986 by capping the amount of deductible interest at $50,000 per policy.
“That’s where it got out of control,” says Myers. “Because then the insurance entrepreneurs said, ‘Well, if the limit is now $50,000, instead of having two or three large policies, let’s have 10,000 or 20,000 smaller ones and cover the whole company.”
In the Pension Protection Act of 2006, Congress further restricted dead peasant programs by adopting best practices for new corporate-owned life insurance policies. These require companies to:
- Notify and obtain the consent of employees.
- Restrict COLI to the highest-paid 35 percent of the company’s workforce and anyone with at least a 5 percent ownership stake in the business.
- Provide detailed COLI reports annually to the IRS.
While companies can ignore the best practices, Hunter says they’ll likely forfeit some of the COLI tax advantages, including tax-free death benefits, if they do.
“I think it’s still going on,” he says. “I would have opted for tougher criteria.”
Failing the ‘insurable interest’ test?
Myers says dead peasant policies violate one of the tenets of insurance: the concept that a life insurance policyholder or beneficiary should have an “insurable interest” in the insured. Simply put, individuals or companies have an insurable interest in you if they benefit financially from your living and would suffer from your death.
“Throughout history, until relatively recently, insurable interest has been defined as close blood relatives, key employees and debtors up to the amount of debt, and that’s it,” he says.
Hunter agrees that dead peasant policies fail the insurable interest test. “If a very low-level worker dies, there is usually someone to replace them and it doesn’t really impact the entire corporate structure,” he says. “It puts no financial strain on the organization.”
Employees might not mind
But Peter Kochenburger, an insurance law professor at the University of Connecticut School of Law, says even that tenet has been open to interpretation.
“Insurable interest has been forever modified by state law,” he says. “Some states have allowed that an employer has an insurable interest in any employee, regardless of whether they’re a key man or not.”
Kochenburger says some employees may have no objection to being an insured commodity.
“The average guy may think, ‘So what? My employer is probably doing it because it’s a cheaper way to fund employee benefits, so I sort of benefit from that,'” he says.
But Myers says that’s a faulty assumption at best.
Does it really help pensions?
“Companies claim they’re not the beneficiaries, it’s the employee pension fund,” Myers says. “But I’ve never seen a company have a dedicated account for the receipt of these policy benefits that is held exclusively for the benefit plan.”
He adds that the benefit funds are typically in the soup of the company’s general treasury. “Once that happens, how do you distinguish between what you got from dead employees from what you got from selling inventory or tax refunds or whatever?” he asks.
What’s his solution to potential dead peasant insurance excesses?
“Strip away the tax advantage on policies insuring the lives of anyone on whom there is no insurable interest,” Myers says. “If we can go back to traditional insurable interests — key man, close relatives and debtors to the amount of debt — I think we’d be fine.”