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You may not hear the outdated term “dead peasant” insurance very often, but it describes a type of life insurance practice that is still used by corporations. Corporate-owned life insurance (COLI) is actually a strategy used by large businesses to create a financial safety net in the event it would lose one of its top employees. For instance, if a CEO’s or executive’s death would greatly impact the company, a COLI policy could provide a payout that gives the company a chance to recover and rehire for the position. Bankrate’s insurance experts unpack this unusual term and answer your questions.
What is corporate-owned life insurance?
Corporate-owned life insurance is a type of life insurance that businesses purchase on their employees, with the company itself named as the beneficiary. This type of insurance is typically used to safeguard the company’s financial interests in various situations where the loss of key personnel would have significant effects. COLI is commonly purchased for specific purposes such as:
- Key person life insurance: Protects the company financially if a crucial executive or high-ranking employee dies, allowing funds to cover costs like recruiting and training a replacement.
- Buy-sell agreements: An entity buy-sell agreement is when a business owns life insurance on each co-owner of the company. If a death occurs, the company uses the life insurance proceeds to purchase the deceased’s interest from his or her estate.
- Split-dollar life insurance: This arrangement allows both the company and the employee to share in the benefits of the policy. While the employer pays some or all of the premiums, both parties may split the death benefit or cash value.
- Funding retirement and compensation plans: COLI is also used to fund nonqualified deferred compensation and retirement plans, offering tax advantages for the company as the policy’s cash value grows.
It’s important to note that while COLI can be written on multiple employees, it’s not commonly purchased for an entire workforce but rather key individuals critical to the company’s success. Additionally, corporate-owned life insurance is not the same as group life insurance, which may be offered to employees as part of their employment benefits. With most basic group life insurance policies, the employer typically pays the premiums but the employee’s beneficiaries receive the full death benefit.
Why is it called dead peasant life insurance?
Company-owned life insurance is commonly referred to as dead peasant life insurance or even “janitor insurance” because of its historical use. In the 1980s, many major corporations began purchasing corporate-owned life insurance on low-wage workers without telling them.
Their intention was not solely to profit from the employees’ deaths, but the move was viewed as controversial because companies could secretly make millions off employee death benefits and the growth of the policies’ cash value.
As a result, the name “dead peasant insurance” was given to corporate-owned life insurance in reference to a novel called Dead Souls by Nikolai Gogol. The lead character buys dead serfs from a landowner in the book and uses them to secure a high-value loan.
Why do companies buy dead peasant life insurance?
When someone passes away, life insurance typically helps provide financial security to their loved ones. But what happens when a business loses someone crucial to its success, like a CEO or a top executive? Companies can face major financial setbacks, too. That’s where corporate-owned life insurance comes into play.
COLI policies are designed to protect businesses from the financial impact of losing a key employee. Imagine a company losing its founder or an executive who plays a vital role in its operations. The cost of finding, hiring and training someone to fill that void can be enormous. COLI offers companies a financial cushion, helping them cover those costs or stabilize the business during difficult transitions.
But the benefits don’t stop there. These policies often come with tax advantages that can help the business financially, similar to the way individuals benefit from tax-free life insurance payouts. For companies to enjoy these tax perks, however, they need to meet specific IRS requirements.
Notice and consent:
Before the policy is issued, the employee must:
- Be informed in writing that the employer intends to insure them, including the maximum coverage amount.
- Provide written consent to be insured during and after their employment.
- Be made aware that the employer will be a sole or partial beneficiary of the death benefit.
Exceptions:
- If the insured was employed within 12 months before their death.
- If the employee was a director, highly compensated or a major stakeholder (owning 5 percent or more) at the time the policy was issued.
These policies can serve various purposes, from protecting against financial losses to funding employee benefit plans. For businesses, having a policy like this in place ensures that they have a financial safety net if the unexpected happens, keeping the company steady even in uncertain times.
Is dead peasant insurance legal?
Despite the controversy, dead peasant life insurance is legal but highly regulated. In 2006, the Internal Revenue Service (IRS) instituted the Pension Protection Act, which created a strict set of guidelines that made it more difficult for companies to exploit their employees with a corporate-owned life insurance policy.
In the past, specifically during the 1980s and 1990s, companies misused these policies by secretly purchasing insurance on employees without their knowledge and sometimes collecting benefits long after those employees had left the company. However, Congress and the IRS stepped in to address these abuses.
Today, most states require employers to have an “insurable interest” in the employee’s life to justify a COLI policy. This means the company must show it would face financial loss if the employee passed away. Typically, this applies to key individuals, but in some states, the insurable interest can also relate to employees benefiting from the company’s plans.
Additionally, at least 48 states now require that companies notify the employee and obtain their consent before issuing a COLI policy. Employees must be informed in writing about the policy and provide written consent, and they have the right to refuse participation without any form of retaliation from the employer.
Frequently asked questions
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Key person life insurance, also called key man insurance or key employee insurance, is a policy that a company takes out on an essential employee whose loss could significantly impact the business financially. This might include executives, founders or anyone with a unique skill set critical to the company’s success. The insurance helps protect the company by providing a death benefit to cover losses related to the employee’s death, such as the cost of hiring and training a replacement or covering lost revenue. Key person policies can be term or permanent, and the company is typically the beneficiary.
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In most cases, the company is the beneficiary of a corporate-owned life insurance policy. However, in certain arrangements, such as a buy-sell agreement, the employee’s heirs may receive a portion of the death benefit. For example, in a buy-sell agreement, the proceeds from the policy are often used to purchase the deceased’s share of the business from their heirs. This allows the company or remaining owners to continue operating without disruption while the employee’s family receives compensation for their share.
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No, the employees covered insured through corporate-owned life insurance policies do not pay the premiums. Instead, the employer pays and owns the policy. However, in 2006, Congress passed the Pension Protection Act which gave employees the option to opt out of COLI policies. If an employee does so, their employer cannot legally go after the employee or force them into a policy.
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Several companies have policies that were taken out before the 2006 legislation that required transparency around opening corporate-owned life insurance accounts. Companies that have dead peasant insurance include Walmart, Dow Chemical, American Electric Power, Winn-Dixies and more.
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