What Is Corporate Owned Life Insurance (COLI) & How Does It Work?

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Corporate-Owned Life Insurance (COLI), also known as Company-Owned Life Insurance, is a type of policy that corporations use as a way to insure their employees. The company is both the policy owner and beneficiary, meaning it pays the premiums and receives the death benefits upon the death of the insured employee. The employees insured are often key executives, but they can also include a broader range of the company’s workforce.

Here’s a basic breakdown of how COLI works:

Policy Purchase: The corporation purchases life insurance policies on the lives of certain employees. These employees are typically key personnel whose death would result in a financial loss for the company.

Policy Ownership and Beneficiary Status: The corporation is both the owner and the beneficiary of the policies, meaning it pays the premiums and collects the death benefits.

Employee Consent: Employees must be notified about and consent to these policies. They must be informed of the amount of coverage and that the coverage may continue even after they leave their job.

Premium Payments: The corporation pays the insurance premiums. These payments are not tax-deductible.

Cash Value Growth: Just like a whole life insurance policy, a COLI policy can accumulate cash value over time. This growth is tax-deferred. The company can borrow against this cash value, if necessary.

Death Benefit: Upon the death of the insured employee, the company receives the death benefit, which is generally tax-free. The funds can be used to cover the costs associated with losing an employee, such as hiring and training a replacement.

Tax and Accounting Benefits: COLI policies can provide tax advantages for the company. The cash value growth is tax-deferred, and the death benefits are typically tax-free. Additionally, depending on the accounting methods used, the increases in cash value and death benefits can help offset liabilities for post-retirement benefits.

Risk Management: Companies use COLI policies as a form of risk management to protect against the financial impact of losing key employees.

Just like with BOLI, companies must be cautious about the associated risks with COLI such as credit risk, interest rate risk, and regulatory changes. As such, the decision to purchase COLI policies should involve multiple internal units like risk management, finance, and legal, and the companies may also seek external professional advice.

Here is a COLI example:

Company X is a technology company specializing in cybersecurity. It has grown significantly in recent years, thanks to the expertise of its Chief Technology Officer (CTO), John. John’s knowledge of the industry and leadership in product development has been critical to the company’s success.

The board of Company X recognizes that if John were to unexpectedly pass away, the company would face significant challenges. It would need to find a replacement with similar skills and experience, which could be difficult and costly. The company’s operations and projects could also be disrupted during the transition period, which could affect the company’s financial performance.

To mitigate this risk, Company X decides to take out a COLI policy on John. After informing John and obtaining his consent, the company purchases a life insurance policy on him with a death benefit of $5 million. Company X is the owner and the beneficiary of the policy, and it is responsible for paying the annual premiums.

The COLI policy accumulates cash value over time. The cash value growth is tax-deferred, meaning Company X does not have to pay taxes on the growth unless it withdraws funds from the cash value. If needed, Company X can borrow against the cash value of the policy, although doing so could reduce the death benefit.

Several years later, John unexpectedly passes away. The company is able to claim the death benefit from the COLI policy. The $5 million death benefit is generally received tax-free.

The company uses these funds to cover the costs associated with finding a replacement for John. This includes costs like hiring a recruitment agency, paying for interim leadership, and providing a competitive salary and benefits package to attract a high-quality candidate. The funds also help to sustain the company during the transition period, offsetting any short-term disruptions to the company’s operations and financial performance.

This is a simplified example, and in practice, implementing a COLI strategy involves complex decisions about the type of policy, the amount of coverage, the employees to be insured, and how to manage the policy over time. Companies also need to consider the potential risks and costs associated with COLI, including premium payments and the risk that the insurer could change the terms of the policy or that regulatory changes could affect the tax benefits of the policy.

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