BOSTON (MainStreet) — You may be worth more to your employer dead than alive.
Since gaining popularity in the 1980s, companies have been taking out Corporate Owned Life Insurance policies on employees and listing themselves as the beneficiary. Many workers go about their workday with no clue that such policies exist and that their company has placed a bet on their timely (at least from an actuarial standpoint) death.
Unlike traditional "key man" policies that a company might have on an executive or invaluable employee, insurance referred to as "janitor's insurance" a "mortality dividend" or "dead peasant" policies are on rank-and-file workers. The term was coined by an insurance brokerage firm in memos made public during a tax-related lawsuit filed by the IRS against the supermarket chain Winn-Dixie (Stock Quote: WINN) (which bought life insurance policies on approximately 36,000 of its employees without their knowledge or consent).
"I think it's the rare situation that people have an incomplete understanding of the entire transaction or whether there is coverage at all," says Mike Myers, an attorney with the Texas firm McClanahan Myers Espey who specializes in COLI cases. "There are plenty of laws requiring notice and consent and whatnot that would let people know whether their lives are covered by these policies. Unfortunately, those laws very often get ignored and people do not know that their lives are covered. Even if there is some minute mention of it, they certainly do not know any meaningful level of detail about what the transaction really involves."
"I've seen insurance on people who do janitorial services, who are part-time clerks working at a mall, people who gather up shopping carts in the parking lot and convenience store clerks," he adds. "We are not talking about key executives who likely participate in the decision to have this insurance put on their lives. We are talking about down to the most basic level of manual labor ... It would not be unusual for a retail clerk to be covered for several hundred thousand dollars."
There are ways around the many state laws that require an employee to be made aware of such policies. In some cases, they are given a smaller amount of company-paid life insurance as an enticement. Consent can also be buried amid the fine print of human resources documents. Or everyone just looks the other way.
"Laws are pretty consistent and common about getting consent before you insure someone's life," Myers says. "Unfortunately, what happens is that they either get ignored by the insurers and the policyholders or they try to find a state where maybe the law doesn't have a lot of teeth. We have seen situations where executives get on airplanes, fly to an airport in a favorable state, sign the paperwork, fly back home to the corporate headquarters and then argue that the law of that favorable jurisdiction should apply because that's where they met at the airport to sign the papers."
Georgia, a state with no legal restrictions on the practice, is a popular pit stop for insurance paperwork.
"We would have companies headquartered in Ohio with insurance brokers in Florida saying that Georgia law should apply," Myers says. "Wal-Mart (Stock Quote: WMT) is an example. The insurance executives got on their airplanes in New York and the Wal-Mart folks got on their plane in Arkansas, they flew to Atlanta, went to the Wachovia Bank (Stock Quote: WB) next to the airport, signed all the papers, then got on their jet and flew home."
"Camelot Music argued in court that this should be governed by Georgia law and they didn't even go through the effort to get on the airplane," he adds. "They just said they intended for Georgia law to cover these policies, so it should. Of course, the court struck that down as insane, and rightfully so, so that particular argument hasn't gained a lot of traction. But that is the mentality -- 'Let's find a favorable jurisdiction, go there, sign the papers and ignore the laws of the 49 other states.'"
Federal restrictions on the practice have less to do with employee rights and privacy as they do with curbing the once widespread use of these policies as a tax dodge. In the mid-1990s, Congress started phasing out the deduction for interest payments on COLI loans and the IRS began legal efforts to collect back taxes on COLI loan interest.
"There was federal legislation in 2006," Myers says. "It grandfathered in all the old policies and said that for new policies you would have to get the employee's consent. But there was another very important loophole: You only have to get the employee's consent if you want to claim tax deductions before the money becomes general revenue. If you take your death benefits and investment return as taxable income, you don't have to obtain employee consent or even notify them about it."
How widespread is the practice? That is hard to know because most companies refuse to itemize these policies, even in shareholder reports, and there are no requirements they must do so from either the SEC or other regulatory agencies.
"If there was nothing sleazy about it, it wouldn't need to be done in secret. There would be full and complete disclosure," Myers says.
A report by the Government Accountability Office estimated that roughly one-third of every insurance policy sold in the U.S. is corporate owned.
At a November forum hosted by the New America Foundation, the Pension Rights Center and AARP, Ellen Schultz, a former investigative reporter for The Wall Street Journal who has covered "dead peasant" policies, spoke of a twist on the tactic and how it has evolved since the 1980s.
"The reason they did this primarily back then was as a tax dodge, because life insurance policies are almost like a giant IRA — you put a bunch of money in it and it grows tax deferred," she says. "But it morphed into something a little different in the 2000s. What it changed into, essentially, was vehicle for financing executive pensions and pay ... You can't set up a special tax-sheltered plan for executives because you don't get tax breaks, but you can buy life insurance on tens of thousands of your workers and you essentially set up a de facto pension fund for executive pay."
Schultz also details the use of COLI in her book Retirement Heist: How Companies Plunder and Profit from the Nest Eggs of American Workers (Penguin, 2011), writing: "The tax-free flow of investment income -- like the income from investments in pension funds -- offsets the interest cost of the executive obligations ... Even though companies aren't supposed to get tax breaks for funding executive deferred comp and pensions, they get essentially the same tax breaks -- and accounting benefits -- by taking out life insurance on workers."
Among the companies that have been revealed over the years to use "dead peasant" policies are Dow Chemical (Stock Quote: DOW), Disney (Stock Quote: DIS), Procter & Gamble (Stock Quote: PG) and Nestle. Companies that sell COLI, or have in the recent past, include Hartford Life (Stock Quote: HIG), Cigna (Stock Quote: CI), MetLife (Stock Quote: MET), AIG (Stock Quote: AIG), New York Life, Lincoln Financial (Stock Quote: LNC) and Principal (Stock Quote: PFG).
Better insight into their prevalence can be gleaned from filings required of financial institutions. Banks do need to disclose such policies, although it usually requires accounting expertise to find the data.
Myers says that in its regulatory filings, for example, Bank of America (Stock Quote: BAC) reports holding more than $17 billon in coverage. Large banks hold roughly $122 billion, according to Schultz.
"That is cash surrender value," Myers explains. "So, let's say you have a policy on your wife that would pay $500,000 when she passes away. If you went down to the insurance company before then and turned it in for the cash value, it might be $1,000, or maybe $5,000. If Bank of America had $17 billion in cash surrender value, it could easily be holding coverage worth $170 billion in death benefits."
Myers is unconvinced by companies that try to sidestep talk of "janitor's insurance" by claiming it isn't the profitable investment it once was.
"As long as you have enough people die to match the investment projections it turns out to be a really good monetary investment scheme," he says. "But, like any investment, it needs to perform as anticipated. So you need the people to die. You don't need a meteorite to hit a factory, but do need people to die in lockstep with the investment projections. All of this whining about, 'Well the IRS came in, they audited a lot of us and we lost all our anticipated tax advantages,' well, boo-hoo-hoo. You were trying to get a 35% return and if you are still getting 8% to 10% off dead employees. It is just as bad and you are probably doing it just as much."
Myers says he is often asked whether turnabout is fair play.
"A lot of emails ask, 'Can I take out an insurance policy on my boss or can I take out a policy on the CEO of the company?' The answer is no, because the insurance company won't play ball with you. But if you walk into an insurance company and you want to buy 15,000 insurance policies, they will play ball and all these nice state laws that are in force to protect people conveniently get ignored. They get ignored with such nonsense as 'Let's get on an airplane, fly to Atlanta and sign the papers there.'"
Regardless of how your company handles it, life insurance helps many families stay afloat after the loss of a loved one. Check out MainStreet's 5 Things You Need to Know About Life Insurance to help your planning!