‘Dead Peasant’ insurance policies stir controversy

The Bakersfield Californian
February 19, 2014

A retired client stormed into my office a few weeks ago. You could almost see the steam pouring out of his ears. After reading recent news stories, he came to suspect he may be a “dead peasant.”

The dead peasant my client was referring to is the pawn in a controversial financial strategy that some companies use to get tax-free money to shore up their bottom lines. In many cases, the companies claim the strategy is being used to pay employee benefits, such as pensions. But, in reality, there are no strings attached, and the money can be used for anything, including executive bonuses.

The strategy involves the use of corporate-owned life insurance (COLI) policies, also known as “dead peasant” policies. These policies made headlines in late January when the owner of a Southern California newspaper emailed his employees informing them he wished to buy life insurance on them.

In a nutshell, here’s how a typical COLI arrangement works: The buyer of the insurance (the company) pays a fraction of the premium up front and borrows the rest from the insurer (an insurance company.) The insurer profits because the loan’s interest rate is relatively high. The buying company profits by deducting the interest payments on the loan from its taxable income. And when the “peasant” dies, the company receives a tax-free windfall.

Often the deceased has long left the workplace – moving to a different job, or retiring. Many a clerk, janitor or other line employee would likely be surprised to learn that his present or former employer will receive $100,000, $200,000 or more when he dies.

In 2006, Congress closed some of the tax loopholes involving COLI, partially eliminating interest deductions and requiring companies to obtain workers’ permission before buying policies. But the millions of policies sold before 2006 do not have these restrictions.

What’s the big deal? Some believe from a public policy standpoint it is wrong for workers to be worth more dead than alive to their employers. This may be especially true if the equation could affect workplace safety decisions. And it is generally believed that those who benefit from insurance payoffs should have an “insurable interest.”

The policies originally were intended to insure owners and key executives, whose deaths would be a major financial loss to a company. But in the 1980s, insurers convinced most states’ regulators to allow policies to be taken out on rank-and-file employees. Policy sales boomed.

Today’s newly enrolled “peasants” should know about the policies. But those covered with pre-2006 policies and their survivors are clueless. They learn about policies incidentally – through SEC filings or court actions – or accidentally.

Consider the case of the Texas widow who mistakenly received a letter with a $1.6 million check made out to her late husband’s employer, a bank. The bank had taken out insurance policies on the man after he had been diagnosed with brain cancer, had two surgeries and was undergoing chemotherapy. Shortly after buying the policies, the bank fired the man, alleging poor performance. He died a few months later. Learning about the bank’s insurance windfall, the widow sued in 2009, claiming the company had no “insurable interest” in her husband. The widow settled in return for an undisclosed payout.

Business and trade publications, including The Wall Street Journal and Forbes, have widely reported similar cases and six-figure awards to settle heirs’ claims.

Long viewed as a questionable tax shelter, COLI is reportedly being targeted for additional curtailment by the Obama administration. If future regulations extended disclosure requirements to policies purchased before 2006, people, including my client, would know for sure if they are peasants and their heirs may be able to assert their rights to share the insurance proceeds.