Dead Peasant Life Insurance Caroline Murray was mourning the death of her husband, Mike, when she…

Dead Peasant Life Insurance Caroline Murray was mourning the death of her husband, Mike, when she…

Dead Peasant Life Insurance
Caroline Murray was mourning the death of her husband, Mike, when she received a call from the employee benefits division of his company requesting a copy of the death certificate.1 After asking why they needed the certificate, Caroline was surprised to learn that her husband’s company had purchased a life insurance policy on her husband. Especially surprising was the fact that Caroline had no record of the policy, and apparently, neither did her husband. This particular policy listed only the company as beneficiary and allowed the company to borrow against Mike’s policy, write off the loan’s interest on its taxes, and receive a tax-free payout upon Mike’s death. Mike’s position at the company was not an executive one; he was the security guard at a local manufacturing company, and his company received $80,000, tax free, upon his death. His family received nothing. How did this happen? Through the company’s purchase of a life insurance policy nicknamed “dead peasant” life insurance.
CORPORATE-OWNED LIFE INSURANCE POLICIES
The Prevalence of COLIs. Corporateowned life insurance policies (COLI) have been around for years. They are used as funding mechanisms for protecting businesses against the loss of its “human capital.” Additionally, until the 1990s, these policies provided financial gains for companies as a form of “tax arbitrage” where they could deduct the interest on leveraged insurance transactions while simultaneously avoiding tax payments on the interest credited to the policies’ cash values. In the mid-1990s, the federal government closed most of the tax loopholes and opportunity for arbitrage; however, the tax-free benefits and tax deferrals on the policies still exist as financial incentives for many companies. It is estimated that about a quarter of the Fortune 500 either have or had “broad-based” COLI policies covering about 5 million employees.2 The pseudonym “broad-based” refers to the policies’ coverage of both executive and lower-level employees. Until the mid-1980s, most states required that an employer have an “insurable interest” in the lives of the employees that they insured, so these plans were limited to executives. As a result of federal tax law changes that limited the amount that companies might deduct per insured employee, many states relaxed the “insurable interest” requirement, and businesses began taking life insurance policies out on rank-and-file workers to retain profitability on their policies. Articles in the Wall Street Journal in early 2002 drew newfound attention to the large corporations who purchased a considerable number of these policies, including AT&T, Dow Chemical, Nestlé, Pitney Bowes, Procter & Gamble, Enron, and others.3 A 2002 San Francisco Chronicle article cited the fact that Wal-Mart took out COLI policies on more than three hundred and fifty thousand of its workers in the 1990s.4The Laws Regarding COLIs. How is it that companies are able to take out life insurance on employees without their knowledge? Part of the confusion lies with the different state laws. Some state laws, like those in Texas, require that employees “consent” to having their lives insured while other states, like Georgia, do not require consent. Additionally, some employees “consent” without knowing it. In one Texas lawsuit, Wal-Mart employees alleged that they consented without knowing it when they were offered a special $5,000 death benefit when Wal-Mart launched the program from 1994–1996. Wal-Mart disputed the claim by stating that the policies were signed in Georgia with an insurance management company located in Georgia, and therefore the more lenient Georgia law applied, regardless of the consent issue.5
Wal-Mart ended up settling the suit after the Fifth U.S. Circuit Court of Appeals upheld a ruling that Wal-Mart lacked sufficient financial interest in the lives of its rank-and-file employees.6 While only five states required employee consent for COLI in 2003, many states have recently prohibited the sale and/or purchase of such policies without consent, and to anybody other than executives. However, the term “consent” is nebulous when some states consider consent granted if an employee does not object to a notice of the employer’s intent to purchase a policy.7
Perhaps as a result of contradictory state laws and litigation, the federal government has recently initiated “best practices” for COLI insurers, albeit under tax law. In August 2006, President Bush signed the Pension Protection Act, which among other things, amended the Internal Revenue Code 101(j) to institute a “COLI Best Practices Act” promoting consent of each insured employee and reinforcing that the policies should be sold and purchased for “highly compensated” employees. If an employer does not comply with section 101(j), all policy proceeds in excess of total premiums paid by the employer would be included in the employer’s taxable income, thereby limiting the financial benefit of the policy.
CRITICS The COLI Debate. Critics of dead peasant insurance policies point to the disincentives for employee safety; after all, if a company is going to collect money on an employee’s death, what incentives does it really have to protect that employee? Additionally, critics point to the comparison to slaveholders’ policies, the loss of tax revenues, and the use of these policies to fund exorbitant executive compensation programs. Supporters of these insurance policies cite the fact that it is no different than insuring a business asset and it is perfectly legal. For years, companies have protected their interests with life insurance policies on their CEOs, top management team members, and executives whose deaths could seriously impact a company’s bottom line. Finally, many supporters point out that these insurance policies provide a nice vehicle for funding the growing costs of retiree benefits, so there is financial soundness to these policies that offer benefit to all employees of the companies. The Current Situation. While different states continue to set the parameters for the legalities of these policies, some companies have decided to cancel these COLI policies to avoid the risk of lawsuits from family members of the deceased who say that they are the rightful owners of the policies. In January 2002, Wal-Mart canceled most of these policies after several lawsuits with similar companies resulted in stiff penalties and settlements. Wal-Mart continues to settle claims from the estates of deceased Wal-Mart employees. In December 2006, Wal-Mart agreed to pay nearly $5.1 million to settle a class-action lawsuit on COLI policies it took out on former employees in Oklahoma. In 2005, Camelot Music, Inc., lost its case to retain COLI policy proceeds when the Tenth Circuit Court of Appeals in Denver held that employers cannot collect the proceeds of COLI policies they write on rank-and-file employees. However, despite the risk, COLI policies still exist as an investment tool for businesses. By the beginning of 2007, COLI policies still accounted for at least 30 percent of the life insurance market, with many falling under old guidelines.8
In 2007, a new effort began to limit the dead peasant life insurance practice. Rep. Gene Green (D-TX) introduced HR 150 “to prevent the nondisclosure of employer-owned life insurance coverage of employees as an unfair trade practice under the Federal Trade Commission Act, and for other purposes.” It is too early to know what will happen to this proposed legislation. At this writing, it has been referred to the House Subcommittee on Health, Employment, Labor, and Pensions. Although this legislation would not outlaw the practice, it would require that employees be informed when insurance is taken out in their names. The goal is for widows and widowers of the employees to be able to mourn the death of their loved ones without surprise calls from benefits divisions.
Questions for Discussion
1. What are the major ethical issues involved in this case? Is it ethical for an employer to benefit from the death of an employee if they took out and paid for the policy?
2. How does the idea that these policies fund executive compensation and/or retiree benefits affect your answer to #1?
3. Should Congress create more stringent guidelines beyond “best practices” for the administration and use of these types of COLI policies? Should states be pressured to conform to a “consent” policy? Should the proposed legislation be passed?