Many of us may not know it, but we may be worth more to our employers dead than alive. The so-called dead peasant, or dead janitor insurance is insurance purchased by companies on low-level employees. This practice is generally done without the knowledge of the employee. When the employee dies, the family receives no benefit. Instead the face value of the policy goes to the company, tax-free[1]. This insurance is also known as corporate-owned Life Insurance or COLI[2].
Prior to the 1980s, insuring lower level employees by corporations was not allowed; [3] there was no “insurable interest”[4] in the employees’ survival. Companies could not argue there would be financial hardship if file clerks, janitors or nonessential managerial personnel perished. The rules for insurability[5] were designed to prevent life insurance from providing an incentive or avenue to profit from ones death. Insurance companies aggressively lobbied state insurance departments to modify the rules. The net effect allowed insurance companies to sell janitor insurance; without regulations or guidelines.
The rules in most states are unclear whether employers are obligated to inform workers if they are covered by COLI. Insurance codes in most states provide little help, if any, to an employee in discovering out whether a company has insured them, or the amount of the death benefit. Nor can family members ascertain if a current or past employer collected, or if they will collect. “ In Georgia, in fact, employers can even collect death benefit on the children and spouses of their employees. When asked about the law, the state’s insurance regulators said employers and insurers don’t report the details of COLI transactions to the state; (Schultz, Francis WSJ, April 24, 2002).”
Why do corporations buy janitor insurance? These policies yield tax-free income as their cash value increases. Corporations can borrow against these policies to raise cash. Money from these policies may be used for any purpose. Until 1996 the biggest advantage was the tax deduction received on the interest they were paying.[6] These loans were often at lower interest rates than money that could be borrowed from banks. Even without these deductions, corporations would benefit from tax-free gains and the death benefit collected.[7]
The IRS has the ability to find out about the COLI policies. The rules for disclosure are vague, thus making it hard to determine the amount of money spent on insurance. Corporations also use other types of COLI insurance to pay for executive benefits. The rules for disclosure don’t require companies to distinguish if the insurance is ‘COLI Executive’ or ‘Janitor COLI’; thereby, companies report their life insurance in aggregate. Accounting standards only require companies to report cash value as an aggregate number and only if the increase is significant.
If Congress asked their economists to determine the cost to tax payers, they would have a hard time determining a dollar value. Companies borrow against the cash value on the policies and do not report it as income; therefore, it is not taxable.
Even though tax breaks on the interest are being phased out, companies are still investing in COLI life insurance. They still enjoy the tax-free buildup of cash value in the policies, which add to net income. This income is often referred to under a generic heading like other ‘income” or “other assets”. The death benefit is tax-free to the company. Future death benefits are attractive off-balance sheet assets for corporations, who understand the significance of future downstream earning from the death benefit.
Corporations closely monitor the demise of current and former employees insured by the company. One way of confirming employees’ deaths is checking with the Social Security Administration database on deaths. The exhibit below shows some examples of the amount of money companies have collected on employees.
How companies profited from the deaths of their employees
|
|
Felipe
Tillman |
William
Smith |
Doug Sims |
Peggy
Stillwagoner |
|
Employment |
Music-store worker |
Convenience-store clerk |
Distribution-center worker |
Home-health nurse |
|
Died |
Jan. 1992 |
Dec. 1991 |
Dec. 1998 |
Oct. 1994 |
|
Age
|
29 |
20 |
47 |
51 |
|
Cause |
AIDS |
Murdered at work |
Heart attack |
Car accident |
|
Death Benefit |
$339,302 |
$250,000 |
$64,504 |
$200,000 |
|
Paid to |
Camelot Music/CM Holdings |
National Convenience Stores |
Wal-Mart Stores |
Advantage Medical Services |
Source: WSJ research
Not only do non-financial corporations engage in this practice, so do some of America’s biggest banks. Bank One, Morgan Chase & Co, and Bank of America Corp own billions of dollars in life insurance face value. This insurance is called Bank-Owned Life Insurance or BOLI. In 1996, the IRS disallowed interest write-offs companies and banks were taking against loans on life insurance policies. In 1997, thanks to effective lobbying by the banking industry, regulators changed the rules. Banks often borrow money from the government at reduced rates. The ability to borrow at such low interest rate helps to boost bank profits. Using life insurance to borrow against the cash value is no exception. Because gains are tax-free this will contribute to the banks’ and companies’ bottom line. One bank reported that 12.4% of net profits came from policies (Francis and Schultz, WSJ, April 26, 2002).
Corporations and banks benefit from these insurance policies in many ways:
1) The money collected from death benefits is tax-free.
2) They are not required to tell how the money is used once the death benefit is collected.
3) Polices yield a tax-free investment as the value rises.
4) Before 1996, companies could barrow against these policies and the interest was tax deductible.
5) The future death benefit is an attractive off-balance sheet asset.
6)
Is it ethical for corporations to have COLI or BOLI on their employees? The ethics in this issue are very clear. Only companies possessing these policies benefit from this practice. Companies are not required to disclose any information about this type of insurance. COLI and BOLI insurance has been in a shroud of secrecy until recent articles appeared on this practice. A recent non-scientific survey in the Wall Street Journal asked if employers should be allowed to buy insurance with out the employee’s knowledge? Answer 202-Yes, 600-No. This clearly shows that the differences in opinions will remain until new federal and state guidelines are adopted.
Works Cited
1. U.S. News & World Report, 5/6/2002, Vol. 132 Issue 15, p32, 2/3p, 1c
2. April 27, 2002 <http://discusions.wsj.com/n/mb/message.asp?
3. Francis, Theo, and Ellen E. Schultz. “Case Shows How ‘Janitors Insurance’ Boost
Employers’ Earning”. The Wall Street Journal, April 25, 2002.
4. Francis, Theo, and Ellen E. Schultz. “Banks Use ‘Janitor’ Insurance To Get Boost
In Their Profits”, The Wall Street Journal, April 26, 2002.
5. Francis, Theo, and Ellen E. Schultz. “Large Banks Quietly Pile Up ‘Janitors’
Insurance Policies”, The Wall Street Journal, May 2, 2002.
6. Schultz, Ellen E., and Theo Francis. “ ‘Companies Profit on Workers Deaths Through
‘Dead Peasants’ Insurance”’, The Wall Street Journal, April 19, 2002.
7. Schultz, Ellen E., and Theo Francis. “ ‘Janitors Insurance’ Issue Leaves Workers in
the Dark on Coverage”, The Wall Street Journal, April 24, 2002.
8. Schultz, Ellen E., and Theo Francis. “Senator to Target Tax Boon To Firms Workers”,
The Wall Street Journal, May 3, 2002.
Life insurance proceeds are almost always tax-free to the beneficiary. In this paper company is the beneficiary.
Company owned life insurance is not the same as employer paid life insurance where the employee designates the beneficiary.
Companies take out insurance policies are taken out on key employees or group of employees. These policies referred to as “Key Man Policies” help protect the company from financial loss.
Insurable interest, which holds that an insured must demonstrate a personal loss or else be unable to collect amounts due when a loss caused by an injured person occurs, (Trieschmann, J. S., Gustavson, S. G., & Hoyt, R, E., (2001). Risk Management Insurance, (11th ed.) South-Western College Publishing.
Rules for insurability, are the standards, guidelines and regulations by which the insurance industry operates in.
In 1996 the IRS began disallowing deductions companies were taking on interest on loans against life-insurance policies.
[7] Tax-free gains are the increase in cash value of the policies. This profit falls to the bottom line.