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The ethical case for company-owned life insurance

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It’s an old observation but still apropos; truth in advertising would dictate we call it death insurance, not life insurance. You’re insuring against the unexpected and unwarranted onset of death. Maybe an annuity could really be called life insurance, since it’s attempting to ensure against living too long—or rather outliving one’s financial resources.

Whatever you call it, it’s rarely pleasant. It’s about someone’s demise, something most people don’t like to contemplate. Doubly so when someone else is profiting from it—as in stranger-owned life insurance, life settlements and, increasingly, company-owned life insurance.

Company-owned life insurance is a common practice and widely-known among advisors, but largely kept quiet by interested parties, that is until recently. A high-profile story in The New York Times in the last year brought it to the attention of the public at large. Condemnation from certain circles was immediate and swift: it’s immoral for companies to profit from the death of employees, critics said, while employees themselves do not directly benefit.

“Companies are holding this humongous amount of coverage on the lives of human beings,” Michael D. Myers, a lawyer in Houston who has brought class-action lawsuits against several companies with such policies, told said in the the Times article.

Well, yes; it’s life insurance, and therefore makes sense that coverage is held on the lives of human beings. But the larger point is the uncomfortable factor that accompanies the designation of third-party beneficiaries, those physically and/or emotionally unrelated to the covered individual. It’s one reason for the death of the viatical settlement industry in the 1990s (until it’s rebirth, death and now rebirth again as life settlements).

But just because it’s unpleasant doesn’t mean it isn’t effective, or necessary. A root canal isn’t pleasant, but preferable to gumming baby food. Whatever the moral argument, the simple fact remains that the purchase of life insurance policies by investors provides for end-of-life medication and comfort for the terminally ill, as well as some measure of return for elderly clients who no longer need them. As we all know, if the policies lapse the latter gets nothing, and they get far less if they’re surrendered back to the company than they would from investors.

Which comes around to company-owned insurance, something especially necessary for companies that still offer pensions. Longer life spans necessitate more hedging, one of its many benefits. And it isn’t as if it isn’t regulated. An outgrowth of key man insurance, a provision of the Pension Protection Act requires companies to restrict the practice to insuring only the highest-paid 35 percent of employees, who must give their consent. Indeed, even The Times, who reported the story in what could be argued a negative light, was forced to admit that it too employs the practice. It provides for a cushion against shocks like 2008, and protects against the loss of talent and intellectual capital of critical employees. In other words, it works for all involved, and if it’s freely entered into by all parties, it tough to see the problem.