Why Are Businesses Purchasing Life Insurance On Their Employees?

Why Are Businesses Purchasing Life Insurance On Their Employees?

Company Owned Life Insurance PolicyYou probably wouldn’t be surprised to learn that your spouse was covered by a group life insurance policy at work. But would you be surprised to learn that the company is the beneficiary when your spouse dies?

This is not nearly as uncommon as you might think.

This practice even has a rather horrifying name:  “dead peasant insurance.” The name is a throwback to a time in Russia when the rich treated peasants as property that they bought, sold and insured.

A complicated subject:

There are several reasons that a business might purchase life insurance on its employees. And, as you can imagine, there are also some pretty strict regulations as well.

I’ll stay away from all of the very complicated tax laws and insurance laws that come into play and touch more on the impacts on the employees and business.

Why do businesses buy life insurance on their employees?

Dead peasant insurance, more appropriately referred to as “company owned life insurance” or COLI, is often purchased for owners of small businesses to fund buy-sell agreements for the buyout of a deceased partner’s interest in the business.

But sometimes it’s not all that cut and dried.

Company owned life insurance defrays the financial burden created by the death of an employee:

COLI can also be used to insure key employees to help defray the financial burden in the instance that the business suddenly loses a top executive whom passes away.

The proceeds can be used to recruit and train someone new, and to pay for obligations such as stock options that may be redeemed.

The use of company owned life insurance is rapidly growing:

Several years ago, some companies caught on to the fact that utilizing COLI policies had some positive benefits to their bottom lines and the practice really took off.

Banks in particular made them a part of their investment portfolio. In fact, Aon Hewitt reported last year that corporate-owned and bank-owned life insurance policies are increasing by about $1 billion annually each year. There are many tax and investment benefits for businesses to take advantage of.

The abuse of company owned life insurance:

As you can imagine, there is controversy about this practice as well.

Envision the surprise of a grieving widow who learns that the proceeds of her husband’s company provided life insurance policy will actually go to his employer!

Worse yet, companies were continuing to pay for policies after employees no longer worked for them, thus capitalizing on the deaths of people they no longer had a financial interest in.

The media focused on this issue when it began happening to more and more employees, at companies like Wal-Mart and Winn-Dixie Stores.  After that, rules began to change.

Company owned life insurance regulations:

In 2006, the Pension Protection Act was signed into law.

Companies are still able to take out life insurance policies on the highest paid 35% of employees, but the employees must now provide their written consent. And the companies may no longer continue to keep those policies after the employee discontinues working for them.

The wrap-up:

As you can imagine, it remains a controversial practice in some situations, and it puts a new spin on the saying, “we invest in our employees who are our biggest asset.”

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