Ethical Reflections on Company-Owned Life Insurance

Ethical Reflections on Company-Owned

Life InsuranceHugo Nurnberg

Douglas P. Lackey

ABSTRACT. COLI – company owned life insurance –

is often purchased by firms on employees in whom the

firm has no demonstrable insurable interest. Though no

immediate harm comes to individuals insured in this way,

purchasing such policies raises moral questions. From a

Kantian framework, questions arise about reciprocity and

fairness, the deception of employees, the generation of

mistrust, and the use of the employee’s life as a means to

profit. No compensating social good is served by the sale

of these policies.

KEY WORDS: COLI, ethical reflections, insurance

ethics, Kantian framework

Introduction

For hundreds of public companies, an important

source of income has been from life insurance on

nonessential employees, such as low-level manag-

ers, clerks, and janitors (see Schultz and Francis,

2002a, b, c, d, e). Individual companies bought life

insurance on thousands of present employees,

former employees, and retirees, often without the

employees’ knowledge or consent. The companies

paid the premiums and received interest revenue

and death benefits. The companies were the pol-

icyholders and beneficiaries, owned the cash sur-

render value (CSV), hence the policies were

company-owned life insurance (COLI). Often the

death benefits were not received by the compa-

nies, but merely reduced subsequent premium

payments. When such policies covered janitorial

employees, they were referred to as janitors’ insur-

ance. At least one company referred to COLI as

dead peasants’ insurance.

Several articles discuss certain legal (Martin, 2004;

Rush, 2004; Swan, 2003) and financial reporting

(Nurnberg, 2004, 2005) issues relating to COLI. This

article critically evaluates the ethics of COLI.

Succeeding sections discuss the following subjects:

initial ethical reactions; concept of insurable interest;

employee notification and consent; tax treatment of

COLI; and the ethical evaluation of COLI.

Initial ethical reactions

Many ethical issues arise about COLI on unskilled

and easily replaceable employees, former employees,

and retirees. Notwithstanding changes in state

insurance laws, do companies really have an insur-

able interest in these employees? Is it ethical for

companies to purchase COLI on these employees

without their notification and consent? Is it ethical

for companies to continue to hold COLI on former

employees and retirees?

Schultz and Francis (2002e) note that COLI is

controversial, even within the insurance industry.

They quote TIAA-CREF chairman and chief

executive officer John H. Biggs to the effect that

COLI is ‘‘… a form of insurance that’s always

seemed revolting to me.’’ According to Biggs, it just

does not seem right for companies to profit from the

death of nonessential employees, former employees,

and retirees. Another COLI critic (Martin, 2004)

argues that employees should not be worth more

dead than alive to their employers, that employee

consent should be required for COLI, and that

consent has to be meaningful so that employees can

fully comprehend the amount of death benefits

accruing to the employer.

Martin (2004, p. 675) writes, ‘‘It is unseemly for

businesses to benefit from the deaths of their

Journal of Business Ethics (2008) 80:845–854 � Springer 2007DOI 10.1007/s10551-007-9472-7

employees.’’ We concur with the conclusion, but

Martin does not supply an argument to justify her

judgment of ‘‘unseemliness’’ – she does not show

how benefiting from the deaths of employees

transgresses moral rules or violates moral concepts.

In what follows, we attempt to locate the relevant

moral factors that support the intuitive negative

judgments of Martin and other students of COLI.

Concept of insurable interest

According to Martin (2004), at one time it was not

unusual for people to purchase life insurance on fa-

mous people they did not know, betting on the

celebrities’ early demise. The concept of insurable

interest developed in the insurance laws of the various

American states to discourage people without a gen-

uine interest in the continued life of another person

from betting on and possibly creating circumstances

to accelerate the timing of that person’s death. She

(ibid.) cites an 1881 U.S. Supreme Court decision

holding that life insurance purchased by one without

an insurable interest in the insured is against public

policy because it constitutes ‘‘... a mere wager, by

which the party taking the policy is directly interested

in the early death of the insured. Such policies have a

tendency to create a desire for the event.’’1 Obviously

this interest in the early death of the insured may easily

carry over to employees who have only a pecuniary

relationship with their employers.

The concept of insurable interest was initially

codified in the insurance laws of most states during

the second half of the nineteenth century and the

first half of the twentieth century. Typically, a

beneficiary had an insurable interest in the life of

another if the beneficiary is so closely related by

blood or affinity that she/he wants the insured to

continue to live, irrespective of monetary consider-

ations; or if the beneficiary is a creditor of the in-

sured; or if the beneficiary has a reasonable

expectation of pecuniary benefit or advantage from

the continued life of the insured.

For example, within the context of insurance law

in the state of Texas, Rush (2004) notes that whether

one has a reasonable expectation of pecuniary benefit

or advantage was determined by monetary consid-

erations, viewed from the standpoint of the benefi-

ciary: Would the beneficiary regard himself as better

off from the standpoint of money, would he enjoy

more substantial economic returns should the insured

continue to live, or would he have more, in the form

of the insurance proceeds, should the insured die?

Individually owned life insurance

Usually, the insured is the policyholder and his/her

dependents are the beneficiaries of an individually

owned life insurance policy; death benefits replace

the insured’s economic support. Such insurance

makes the beneficiaries ‘‘whole’’ upon the death of

the insured, not profit from his/her death. Those

insured share the risks among themselves that some

will live to a full term and some will not. As such,

most view most individually owned life insurance as

prudent personal financial planning involving few

ethical issues, not as wagering or speculation.

COLI on essential employees

For many decades, insurance laws of most American

states recognize that companies have an insurable

interest in highly skilled and extensively trained

essential employees who are difficult to replace –

so-called key person employees.2 The loss of their

services due to death is disruptive; their replacement

and training are costly. Accordingly, companies have

a pecuniary interest in the continued life of these

employees. Such key person life insurance provides the

funds to compensate companies for the loss of

services and/or buy back shares held by these

employees. It makes the company beneficiary

‘‘whole’’ due to the death of the insured, not profit

from the death. As Rush (2004) notes, moreover, it

is not unreasonable to assume that most key persons

are aware that they are insured. Often they are in-

volved in the decision to be insured, hence not only

are aware of but consent to being insured. Accord-

ingly, few ethical issues arise with respect to COLI

on essential employees.3

COLI on nonessential employees

Insuring the lives of hundreds or thousands of readily

replaceable unskilled employees does not have the

846 Hugo Nurnberg and Douglas P. Lackey

same objectives or involve the same ethical issues, as

insuring the lives of essential employees. Rush

(2004) notes that under Texas insurance law, a

company does not have an insurable interest in all

of its employees solely because of the existence of

an employer–employee relationship; a company has

an insurable interest only in those employees with

extensive skills and experience on whom the

company depends for its continued success. For

example, neither a janitor nor a convenience store

clerk would be considered someone from whom an

employer would have a ‘‘reasonable expectation of

pecuniary benefit’’ from his/her continued life

under Texas law.

However, when it comes to defining insurable

interest, Texas insurance law was an exception to the

laws of most states. As a result of extensive political

lobbying by the insurance industry in the 1980s and

1990s, most states expanded the concept of insurable

interest to include low level, low skilled, nonessen-

tial employees (see Schultz and Francis, 2002e).4 The

insurance industry argued that employers have a

pecuniary interest in employees, because it is costly

to hire and train replacement workers and provide

employee benefits, even when employees are non-

essential and easily replaceable. However, Martin

(2004) notes that the Internal Revenue Service ex-

pressed public concern when a 29-year-old em-

ployee who is earning $30 thousand a year is insured

under a COLI policy for $4 million. She (ibid.) notes

that even the American Bankers Association cau-

tioned banks to pay particular attention to insurable

interest and economic substance in their COLI plans

when subject to certain audits by the Internal

Revenue Service.

Additionally, in most states, COLI remained in

force after employee termination or retirement.

Companies used the database of deaths maintained

by the Social Security Administration to track

employees by social security number after termi-

nation or retirement, and received COLI death

benefits upon their demise (see Schultz and Fran-

cis, 2002e). Nonessential employees rarely provide

service to their employers after termination or

retirement. Accordingly, it is difficult to rationalize

how companies continue to have an insurable

interest in employees after termination or retire-

ment – but they did under the insurance laws of

most states.

Employee notification and consent

In some states, COLI policies were purchased on

nonessential employees without employee notifica-

tion or consent. That is, some states required em-

ployee notification before purchasing COLI; other

states required employee notification and consent. In

some states, employees were insured unless they

acted to avoid it, so-called ‘‘negative consent’’

arrangements; if employees did not explicitly reject

coverage in writing within a short time of initial

employment, they were covered, typically beyond

termination and retirement until death.

However, employee notification was often per-

functory, frequently incidental to familiarizing the

employee with company policies and employee

benefit plans upon initial employment. Schultz and

Francis (2002a) report that employers often ex-

plained COLI to new employees as part of a com-

pany’s employee benefit plan, often in a perfunctory

manner. Similarly, employee consent was often

perfunctory, not informed consent. Consenting

employees were rarely told how much a company

would receive in death benefits, or that coverage

would continue after they left the company or re-

tired. For example, Schultz and Francis (2002a, b)

report that some companies offered as little as $1,000

or $5,000 of death benefits to employees to induce

them to consent to COLI coverage, without

informing them that death benefits to the company

might be anywhere from $200,000 to $500,000.

The National Association of Insurance Commis-

sioners (NAIC) proposed to require employee

notification and consent for all COLI policies (see

Connolly, 2002). It also proposed to prohibit retal-

iation against employees who do not consent. Re-

cently, these proposals were incorporated in the

insurance laws of several states; see Addendum.

Tax treatment of COLI

For regular federal taxable income purposes, pre-

miums on COLI policies are not deductible, and

death benefit proceeds were not taxable until

recently. Additionally, interest income on cash sur-

render value (CSV) is not taxable, and companies

may borrow against CSV.5 Unlike interest cost

incurred to finance tax-exempt securities, however,

Ethical Reflections on Company-Owned Life Insurance 847

interest is still deductible on non-COLI loans used to

finance COLI indirectly. The favorable tax treat-

ment of interest income on CSV and death benefit

proceeds provided the primary motivation for most

companies to invest in COLI: the after-tax yield on

COLI was higher than the yield on alternative

investments.6

Although somewhat ambiguous, the Income Tax

Act of 1913 exempted COLI interest revenue on

CSV and death benefit proceeds from federal income

tax (see U.S. Congress, 1913, pp. 14–15, 506–508,

1239; and Gazur (1991, section B(2)). Gazur (ibid.)

notes that the Revenue Act of 1921 explicitly reflects

Congress’ view that COLI insurance ‘‘... constitutes a

reasonable and proper...provision against actual losses

which business enterprises sustain in the death of

responsible officers and employees.’’7 That is, the

1921 Act presupposed then existing state insurance

laws that limited insurable interest under COLI to

essential employees; that the demise of essential

employees resulted in substantial economic loss to

their employers; and that this loss should not be

compounded by imposing income tax on COLI

death benefit proceeds or interest income on CSV

accruing to offset premium expense.8 There is no

evidence that Congress contemplated exempting

interest income or death benefit proceeds of COLI

on nonessential employees in its deliberations from

1913 through 1921.

Since more states defined insurable interest to

include nonessential employees, more companies

had COLI until recently than heretofore. But COLI

interest income and death benefit proceeds were still

nontaxable, and interest expense on non-COLI

loans was still deductible. The result was a substantial

loss of corporate tax revenues to the government due

to COLI. Indeed, Francis (2003) reports that the

U.S. Department of Treasury estimated that the

COLI exemption will cost $9.3 billion a year in

forgone tax revenue over the next 5 years under

then existing tax laws. Presumably, this loss would

be offset by higher tax revenues from other com-

panies and individuals.

Welfare and wrongs

Consider the typical case: a non-essential worker

insured under COLI who does not know that this

insurance exists. Certainly the policy does not injure

the employee: his/her life goes as well as it would go

if the policy had not been purchased by the firm.

There is no decline of individual welfare. But in a

Kantian ethical framework, not every breach of

ethics has an injured victim, and there are moral

wrongs that must be assessed apart from consider-

ations of individual welfare. For example, one could

wrong a person through deception, even though the

deception produces no injury to the deceived. What

is wrong about deception, in a Kantian framework,

is the lack of respect shown to the target of decep-

tion. Likewise, we argue that the attitude expressed

by the firm towards the non-essential employees

through the purchase of life insurance shows a

similar lack of respect, treating the very lives of the

employees and retirees as numbers in a ledger. The

moral attitude expressed by such treatment falls short

of developing standards in business ethics.

Breaking the bonds within the firm

We take it as established in business ethics that the

employer–employee relationship should be based on

mutual trust and respect (see Velasquez, 1982, pp.

301–349; Snoeyenbos et al., 1983, pp. 259–345).

Numerous invocations of the metaphor that the firm

is a ‘‘family’’ show that this view is accepted, at least

in theory, by employers as well as ethicists.

The purchase of COLI insurance on non-essential

employees intrudes on these moral features. Given

COLI, when tax advantages are considered, the firm

profits from the death of the employee. In such

circumstances, how can the employee trust the firm

to do all it should to make the workplace a safe

place? How can the employee trust the firm to do all

that it should in the way of health insurance? If you

were living with someone and discovered that this

person had taken out, perhaps without your

knowledge, a life insurance policy with a maturity

value conspicuously greater that the capitalized value

of your income contribution, should you continue

to trust that person? A dozen episodes of ‘‘Law and

Order,’’ ripped from today’s headlines, suggest that

you should not. Similarly, Martin (2004) suggests

a priori that most of us would be uncomfortable to be

employees that are worth more dead than alive to

our employers.9


The trust-eroding character of COLI can be

exhibited in a thought experiment in which the

tables are turned. Suppose insurance companies

provide policies, available to labor unions, that

award unions substantial sums if the CEOs of

unionized firms are sacked by their Boards of

Directors. Could a CEO trust the firm’s unionized

workers not to take actions – strikes, slow downs,

work to rule, etc. – to produce the demise of the

CEO? Certainly the CEO would have considerable

ongoing difficulties interpreting workers’ actions.

Anxiety would replace trust. The presence of such

policies would make any CEO nervous. Likewise,

workers should be made nervous by COLI plans,

once they become aware of them.

Consider now the problem of respect. People

often have life insurance policies on their spouses,

but in the normal case the presence of the policy

does not devalue the spouse. The policy is a

prudent measure to supplement lost income should

the spouse die – a project to which the spouse is as

committed as the beneficiary. If the spouse dies,

the grief is real, policy or no policy, because in the

case of love one accepts no substitutes. But in the

case of COLI for non-essential workers, there is

no love and the worker is therefore a replaceable

item. The worker earns respect by doing a good

job, but doing a good job is defined as doing that

which, one way or another, produces profit for the

firm. It follows from the profit principle that if the

worker is worth more to the company dead than

alive, she/he will be respected more if she/he dies

than if she/he lives. This means that while she/he

lives, she/he does not get the respect she/he de-

serves.

Fairness and reciprocity

The fact that union-owned CEO insurance would not

be welcomed by CEO’s shows a lack of reciprocity in

firm-employees relations. The firm insures the

employees, but the employeedoes not insure the CEO.

Does lack of reciprocity imply lack of fairness? Is

this a violation of the Golden Rule?

Not every failure of reciprocity is a failure to be

fair. Managers can give orders to employees under

them. Employees cannot give orders to managers

over them. In this, there is a lack of reciprocity, but

hardly a lack of fairness. In a complex organization,

there are different roles, and different sets of

acceptable behavior deriving from those roles. How

do you draw the line between fair and unfair failures

of reciprocity?

Consider the case of managers and those that

answer to them. In this case, the unidirectional

character of authority is essential to the functioning

of the organization, something to which everyone in

the organization is committed. We may infer from

this that a failure of reciprocity is a problem when

the lack of reciprocity is not essential to the success

of the firm. Another way of putting this is that a lack

of reciprocity is morally problematic if not everyone

affected by the lack of reciprocity would consent to

it, all things considered.

It certainly appears that COLI on non-essential

employees is not necessary to the success of firms.

Firms did well before COLI and firms will do well

without COLI. The lack of reciprocity in COLI

does not result from the differentiation of roles

necessary in large-scale organizations. Absent such a

context, this lack of reciprocity is unfair.

The issue of consent

Is it honest to purchase COLI on nonessential

employees without employee notification and con-

sent? No. And to satisfy the ethical standards of

honesty and fair dealing, the purchase of COLI on

nonessential employees should involve informed

notification and informed consent, not perfunctory

notification and perfunctory consent. Employees

should be fully informed of the nature and extent of

COLI, especially the amount of death benefits to be

received by their employers, the ease with which

companies can rescind any earmarking of COLI

death benefits for employee benefit programs, the

fact that the insurance continues after employee

termination or retirement, and the tax-avoidance

motivations for acquiring COLI. As noted earlier,

until the recent changes in federal tax laws and state

insurance laws, employee notification and consent

was typically perfunctory. Without informed noti-

fication and consent, acquiring COLI on nones-

sential employees is misleading if not downright

deceptive, and clearly contrary to the notions of

honesty and fairness as commonly understood.


Many employees were unaware that their firms

carried insurance on their lives. If there were

nothing morally problematic about the practice,

there would be no pressing moral need to inform

employees. But the previous paragraph indicates that

there are morally questionable features of this prac-

tice, and the absence of consent rankles. Let us

suppose that firms were completely open about the

practice, and got signed consent statements from

employees before insuring them. Would that make

the moral problem go away? Not necessarily. Sup-

pose that a firm asked prospective employees to sign

statements before being hired, ‘‘I agree to lie for the

company if my supervisor asks me to do so.’’ It

would hardly follow, for an employee who signed

the form, that lying when requested would be

morally permissible. Likewise, the fact that pro-

spective employees agree to the firm’s purchase of

insurance on their lives does not, by itself, assure that

the practice is morally permissible.

The domestic analogy helps here. We think that

married people have a right to know when their

spouses have taken out insurance on their lives. But

informing the insured would not by itself make the

action right. Informed consent is a necessary but not

sufficient condition for moral permissibility.

Using people only as a means

The purchase of COLI on nonessential employees

entails using these employees as a means to realize

tax benefits and increase corporate profits. Thus,

employees are used as means to achieve ends, not as

ends in themselves. Accordingly, the purchase of

COLI on nonessential employees is unethical under

a Kantian framework (see Kant, 1785, pp. 51–52; see

also Guyer, 1998, 2004). Additionally, the COLI tax

benefits are offset by an increased tax burden on all

other companies and individuals.10 There is also a

potential moral hazard problem to COLI.11

Let us return to the core problem: the attitude

expressed by the purchase of COLI on non-essential

employees. Kant (1785, pp. 63–67) says, in our view

rightly, that persons should not be used only as

means, but should also be treated also as ends in

themselves. In the case of COLI, it is not the person,

but the person’s biological life, that is treated as a

means; the lack of respect shown towards the life

extends, we believe, to the person as well. Consider

the following example. Suppose that a parent has ten

children, in a society in which infant and childhood

mortality is high. The parent purchases very high-

maturity value life insurance policies on each of the

ten children, knowing that the expected value of the

decision to buy the policies is negative, but that, if

one child dies, the return will far outweigh the cost

of the policies and will be a bonanza. The parent,

like many gamblers, focuses on the probabilistic big

win rather than the certainty of small losses. This

parent views each child as an opportunity for spec-

tacular financial gain. That attitude is inconsistent

with the love that children should get from parents

and the respect that persons, even young persons,

should get from others.

The public interest

The previous sections have cited problems with

COLI as regards trust, respect, and fairness. We

present no comprehensive moral theory, and will

not argue that these three values in all circum-

stances trump all competing moral considerations. If

there were a compelling public interest in retaining

COLI, or if some great harm to the public good

would follow from its abolition, the problems of

trust, respect, and fairness might be set aside. But in

fact it seems that the public interest suffers from

COLI. COLI provides tax advantages to corpora-

tions that are not available to individuals, and thus

shifts the tax burden from the corporate income tax

to the individual income tax, assuming, as is the

usual case, that declines in revenue are not

immediately matched by declines in spending.

From a policy perspective, COLI appears no dif-

ferent from the familiar cases in which some group

obtains a benefit palpable to each member while a

much larger group shares a larger burden, a burden

divided up into such small pieces that each member

of the group barely discerns his/her losses. If any-

thing, utilitarian considerations count against

COLI, and there is no countervailing principle in

law or ethics that corporations have a general lib-

erty right to buy insurance when such purchases are

in fact contrary to the public good. The possibilities

of pooling losses, and the arrangements for doing

this, are not constitutionally protected, and the


regulation of insurance is and has been guided not

by thoughts of rights, but by considerations of

general welfare.

Summary and conclusion

This article critically evaluates the ethical issues of

company-owned life insurance (COLI) on nones-

sential employees, often purchased without em-

ployee notification and consent. The companies are

the policyholders and beneficiaries, and the

employees are unskilled and easily replaceable. Al-

though the company seems to lack an insurable

interest, insurance laws in many states permitted

COLI on nonessential employees.

Such employees suffer no immediate harm from

being insured in this way. But purchasing COLI

policies raises several ethical questions. From a

Kantian framework, questions arise about reciprocity

and fairness, the deception of employees, the gen-

eration of mistrust, and the use of the employee’s life

as a means to profit. No compensating social good is

served by the sale of these policies.

Addendum

Under the Pension Protection Act of 2006, the U.S.

Congress revised parts of the Internal Revenue

Code (IRC) relating to COLI. The new general rule

is that death benefit proceeds on COLI policies is-

sued after the 17 August 2006 enactment date are

nontaxable only to the extent of premiums paid by

the employer; remaining COLI death benefit pro-

ceeds are included as ordinary income and fully

taxable.

However, provided employee notice and consent

requirements are met,12 all COLI death benefit

proceeds remain nontaxable on an insured individual

who (1) was an employee at any time during a

12 month period before death, or (2) was, at the

time the COLI policy was issued, a director, a 5% or

greater owner of the business at any time during

the preceding year, or a highly compensated

employee.13 The revised IRC also contains detailed

recordkeeping and filing requirements.

Additionally, many states recently revised their

insurance laws to prohibit or significantly restrict

COLI. For example, effective 1 January 2004,

California Assembly Bill 226 (Section 10110.1)

prohibits insurers from issuing or delivering COLI

policies on the lives of current or former non-ex-

empt California employees. (An exempt employee

is an administrative, executive, or professional

employee who is exempt under Section 515 of the

California Labor Code from overtime rates of

compensation.) Bill 226 (Section 10110.4 (f)) per-

mits COLI policies purchased prior to the effective

date of Section 10110.4 to remain in effect, pro-

vided that no further premium payments are made

after the effective date and the employer discloses

to the insured non-exempt employee (1) the exis-

tence of the policy, (2) the identity of the insurer

under the policy, (3) the benefit amount (unless the

entire benefit amount is used for non-exempt

employee benefits), (4) how the benefits paid

would be used, and (5) the beneficiary.

Similarly, New York State insurance law (Sec-

tion 3205) was revised in 2006 to restrict COLI to

finance employee and/or retiree benefit plans.

COLI coverage is permitted up to the costs of

employee and/or retiree benefits already incurred

since the earliest date COLI coverage on an em-

ployee or retiree was issued, plus the projected

future cost of such benefits. However, prior to or

at the commencement of COLI coverage, the

employer must notify prospective employees in

writing that coverage is being obtained on their

lives, obtain employee consent in writing to such

coverage, and give each consenting employee the

right to have any coverage on his/her life discon-

tinued at any time.

Acknowledgements

The authors gratefully acknowledge the considerable

help of librarian Rita Ormsby (Baruch College) in find-

ing the relevant tax legislation references. They also

gratefully acknowledge the helpful comments of

Michael Levine (University of Western Australia). Any

errors, of course, are the responsibility of the authors

alone.


Notes

1 Warnock v. Davis, 104 U.S. 775, 779 (1881); see

also Grigsby v. Russell, 222 U.S. 149, 154 (1911).2 Indeed, Zelizer (1979, p. 108) notes that key-person

life insurance emerged in the 1870s. She cites Couch

(1960, p. 261) to the effect that ‘‘...each member of a

business partnership was declared to hold [an] insurable

interest in the life of his partners, and a corporation in

the lives of its officers, key employees, and principal stockhold-

ers.’’ She also cites Harnett (1957, p. 55, italics added) to

the effect that ‘‘[e]mployers have similar insurable inter-

est in executives and important employees, although

none in minor employees.’’3 This is not to say that there are no ethical issues on

COLI on essential employees. There are ethical issues

here as well as on COLI on nonessential employees,

especially if essential employees are not notified of, or

do not consent to being insured, but at least some of

the ethical issues are quite different from those on

COLI on nonessential employees.4 Some states legally restricted COLI to financing em-

ployee benefit programs. Other states make no such

restrictions, although some companies voluntarily

earmark COLI death proceeds for these purposes.

Voluntary earmarking is not legally binding, however,

and reversible at the companies’ discretion. Moreover,

because cash is fungible, it makes little economic

(though not legal) difference whether employment or

postretirement benefit programs are funded with cash

from COLI death proceeds or other corporate cash.5 For many years, interest on COLI loans was tax

deductible. Initially, policyholders and insurance com-

panies structured COLI with artificially high interest

rates on CSV offset by artificially high interest rates

on the COLI loans, both unrelated to market interest

rates. Since the mid-1990s, the Internal Revenue Ser-

vice has argued repeatedly that such COLI policies

are sham transactions, i.e., that they serve no valid

business purpose other than reducing income taxes,

and has disallowed deductions for interest on COLI

loans. In 1996, Congress began phasing out the

deductibility of interest on COLI loans. In 2006,

Congress further restricted the nontaxability of COLI

death benefits; see Addendum.6 Martin (2004) reports that some COLI plans adjust

or ‘‘true up’’ premiums so that premiums paid and

death benefits received are equalized after adjusting for

the interest factor. As a result, risk is eliminated, making

such plans meaningless as far as providing insurance to

employers. The only remaining benefits to the policy-

holder are the income tax benefits.

7 The quotation is from a report of the House Ways

and Means Committee leading up to the 1921 Act. See

U.S. Congress, 1921a, sec. 215(b)(1), p. 818.8 The U.S. Congress deliberated the treatment of

COLI over several years following the 1913 Act. For

example, in the deliberations leading up to the Revenue

Act of 1918, Congressman Kreider noted that ‘‘[t]here

are many firms in business that have perhaps one valuable

man or more than one who are essential to the business.

This firm is perhaps a heavy borrower of money, and in

order to negotiate their paper on the market and to

secure large loans from banks they find it advisable and

profitable to take out insurance policies upon these par-

ticular men, and they so notify the banks or their credi-

tors that in case the individual who is responsible for the

successful carrying on of the business should die the insurance

becomes due and payable, and there will be cash to

liquidate the debts...’’ See U.S. Congress, 1918, sec.

215(d), p. 920, italics added. Congressman Kreider was

unsuccessful in persuading Congress in 1918 to retain

the exemption of COLI death benefits. Under the

Revenue Act of 1918, the exemption of death benefits

was limited to those paid to beneficiaries or the estate

of the insured. The Revenue Act of 1921 reinstated the

exemption for corporations and partnerships that were

COLI owners or beneficiaries. See U.S. Congress,

1921a, sec. 215(b)(1), pp. 817–818.9 Additionally, Martin (2004) suggests that COLI

intrudes on the bonds of trust between public corporate

employers and their stockholders. Published financial

reports and regulatory filings were not transparent with

respect to COLI, and investors could not easily ascertain

the effect of COLI on corporate net income. As a

result, shareholders could be misled about corporate

profitability. Financial managers could easily offset poor

earnings from core operations with substantial earnings

from COLI.10 This analysis assumes that COLI tax benefits go

straight to the companies and their stockholders. It also

assumes a given level of taxation, whereby the govern-

ment assesses more taxes on other companies and indi-

viduals to offset lost tax revenues due to COLI. But

there may be secondary effects. Tax savings from COLI

might enable employers to pay higher wages and pro-

vide more fringe benefits to employees. Indeed, many

companies claim that they ‘‘finance’’ employee health

insurance benefits with COLI, but money is fungible.

Whether employees receive higher wages or fringe ben-

efits due to COLI is problematic. Most likely, employee

wage levels and fringe benefits are set by the demand

and supply of labor, not by whether employers use

COLI to ‘‘finance’’ them.


11 Since employers benefit from the premature death

of employees subject to COLI, there may be an

incentive however subtle to hasten their demise. For

large groups of employees, less safe working condi-

tions or less generous health benefits might hasten

their demise. Although this potential moral hazard

problem is speculative and far from a known or pro-

ven consequence, it is worth noting because COLI

was widely used in industries where insured employ-

ees worked in potentially dangerous surroundings.

Examples include night-time gas station attendees and

convenience food cashiers who receive few health

insurance benefits and who work alone in poorly

lighted parking facilities.12 According to Magner and Leimberg (2006), there

are three elements to the notice and consent require-

ments under the revised IRC. Before the issuance of a

COLI policy, (1) the employee must be notified in

writing that the employer intends to insure the employ-

ee’s life, including notification of the maximum death

benefit; (2) the employee must be notified in writing

that the employer will be a beneficiary of any death

benefits; and (3) the employee must provide the em-

ployer with written consent to being insured while an

employee and after employment terminates.13 According to Magner and Leimberg (2006), a

highly compensated employee is either (1) an individual

who received compensation in excess of $95,000 (ad-

justed in the future for inflation) in the preceding year,

(2) one of the five highest-paid officers, or (3) among

the highest-paid 35% of all employees.

References

Connolly, J.: 2002, ‘COLI Guidelines Move Ahead At

NAIC’, National Underwriter CXVI, No. 37 (16 Sep-

tember), p. 33.

Francis, T.: 2003, ‘‘Janitors Insurance’ May Cost Tax-

payers $1.9 Billion a Year’ The Wall Street Journal

(February 19).

Gazur, W. M.: 1991, ‘Death and Taxes: The Taxation of

Accelerated Death Benefits for the Terminally Ill’,

Virginia Tax Review (Fall).

Guyer, P. (ed.): 1998, Kant’s Groundwork of the Metaphysics

of Morals: Critical Essays (Rowman and Littlefield,

Lantham, MD).

Guyer, P.: 2004, ‘Kant, Immanuel’, In E. Craig (ed.),

Routledge Encyclopedia of Philosophy (Routledge, Lon-

don) At http://www.rep.routledge.com/article/

DB047SECT11.

Kant, I.: 1785, Groundwork of the Metaphysic of Morals.,

trans. [1948] by H. J. Paton. (Hutchinson & Co., Ltd.,

London).

Martin, S. L.: 2004, ‘Corporate-Owned Life Insurance:

Another Financial Scheme that Takes Advantage of

Employees and Shareholders’, University of Miami Law

Review (January).

Magner, J. and S. R. Leimberg: 2006, ‘Pension Protec-

tion Act Adopts Far-Reaching New Rules for COLI’,

Estate Planning, XXXIII, 10 (October), pp. 3–7.

Nurnberg, H.: 2005, ‘Company Owned Life Insurance in

Business Combinations and Goodwill Impairment

Testing’, The CPA Journal (March), pp. 26–29.

Nurnberg, H.: 2004, ‘Accounting for Company Owned

Life Insurance’, Accounting Horizons (June) XVIII(2),

pp. 109–126.

Rush, C.: 2004, ‘Corporate-Owned Life Insurance

(A/K/A ‘Dead Peasant’ or ‘Dead Janitor’ Policies): Has

Texas Buried the Insurable Interest Requirement?’,

Houston Law Review (Symposium: The Eighth Annual

Frankel Lecture).

Schultz, E. E. and T. Francis: 2002a, ‘Companies Profit

on Workers’ Deaths Through ‘Dead Peasant’ Insur-

ance’, The Wall Street Journal (April 19).

Schultz, E. E. and T. Francis: 2002b, ‘Janitors Insurance

Issue Leaves Workers in the Dark on Coverage’, The

Wall Street Journal (April 24).

Schultz, E. E. and T. Francis: 2002c, ‘Case Shows How

‘Janitors Insurance’ Works to Boost Employers’

Earnings’, The Wall Street Journal (April 25).

Schultz, E. E. and T. Francis: 2002d, ‘Large Banks

Quietly Pile Up ‘Janitors’ Insurance Policies’, The Wall

Street Journal (May 2).

Schultz, E. E. and T. Francis: 2002e, ‘Tax Benefits of Life

Insurance Help to Boost the Bottom Line’, The Wall

Street Journal (December 30).

Snoeyenbos, M., R. Almeder and J. Humber: 1983,

Business Ethics (Prometheus Books, Buffalo, NY).

Swan, G. S.: 2003, ‘The Law and Economics of

Company-Owned Life Insurance (COLI): Winn-

Dixie Stores, Inc. V. Commissioner of Internal

Revenue’, Southern Illinois University Law Journal

(Winter).

U. S. Congress, House: 1913, ‘Congressional Record:

Sixty-Third Congress’, First Session.

U. S. Congress, House: 1918, The Revenue Act of 1918.

U. S. Congress, House: 1921a, ‘Congressional Record:

Sixty-Seventh Congress, First Session’, Report–Ways

and Means Committee.

U. S. Congress, House: 1921b, The Revenue Act of 1921.

Velasquez, M.: 1982, Business Ethics (Prentice-Hall,

Englewood Cliffs, NJ).


Zelizer, V. and A. Rotman: 1979, Morals and Markets: The

Development of Life Insurance in the United States

(Columbia University Press, New York).

Hugo Nurnberg

Department of Accountancy,

Baruch College, CUNY,

New York, NY, 10010, U.S.A.

E-mail: [email protected]

Douglas P. Lackey

Department of Philosophy,

Baruch College, CUNY,

New York, NY, 10010, U.S.A.

E-mail: [email protected]


Documents

Ethical Reflections on Company-Owned Life Insurance