Company-owned life insurance, or COLI, is enjoying renewed popularity in helping companies recruit highly skilled talent, reward high performing employees and retain key executives. Fundamentally, the concept is the same as when COLI was introduced over 50 years ago, but new factors, including innovative products and economic changes, are creating new opportunities for the benefits of COLI.
With COLI, a company typically purchases and owns a permanent life insurance policy on an executive or key employee under an agreement to provide the employee or employee’s family some future benefit, informally funded by either the policy’s cash value or death benefit. COLI can be used to fund a variety of arrangements between employers and employees, but the three most common are:
- Executive benefits — With executive benefits, the company makes a promise to provide future benefits and purchases a life insurance policy to fund the benefits. Assuming the executive is alive when the benefit payment is due, the company can access the life insurance policy’s cash value to recoup the after-tax cost of the benefit or recover those benefit costs, as well as the company’s premiums, through the policy’s death benefit. If the executive dies prematurely, depending on the terms of the agreement, the company may use the death benefit, or a portion of it, to pay the benefit to the executive’s beneficiaries.
- Unexpected loss of a key employee — Life insurance also provides companies a flexible option to protect themselves from the costs associated with losing a key employee, including recruiting and training a replacement and potentially restoring lost profits.
- Buy/sell agreement — Small businesses with multiple owners may face a dilemma if one owner dies and there is no buy/sell agreement in place for the orderly transfer of that owner’s share. Life insurance provides a cost-effective option for the company to use the proceeds to buyout a deceased owner’s share.
A brief history of COLI
While the COLI market has existed for more than 50 years, it has not always thrived. Through the 1980s and 1990s, the COLI market surged thanks to tax and accounting advantages and general economic strength, as well as the emergence of private placement variable life insurance products. COLI cases were large and plentiful. In the 2000s, the COLI business fell out of favor on the heels of tax changes, volatile markets and recessions. In addition, higher unemployment led to companies finding it easier to recruit and retain top talent.
This decade, the COLI market is once again gaining strength. The economy has improved, specialized industries are doing well and companies, such as technology firms and financial institutions, are once again competing for highly compensated executives. In addition, a variety of other factors are coming into play, making COLI a compelling option.
Some specialized industries are evolving and challenging companies to retain key talent. This phenomenon can particularly be seen in the medical and automotive industries, which are both becoming more “corporate-ized.”
Health care changes have pushed self-employed doctors and small group medical practices into large health care networks. Similarly, large, national automobile dealership networks are consolidating dealerships across the country. As this occurs, the loss of key physicians and sales professionals, as well as medical and automotive technicians, can be damaging. Retention is key.
In addition to the tax-deferred growth of life insurance cash value, there are some additional advantages for both the employee and employer. COLI can provide a tax-compliant way for employers to offer highly compensated employees an additional tax-deferral strategy while helping to increase their retention.
Low interest rates
While using corporate reserves to fund any of these business arrangements is certainly an option, today’s low interest rates are making companies look for alternatives that are substantially liquid and secure, but still provide better growth opportunities than traditional methods. Especially in combination with the other benefits of life insurance, this makes COLI an attractive option.
New products that can provide lower risk than variable universal life but still provide more upside potential than traditional fixed products have caught the attention of companies considering COLI. Indexed universal life insurance in particular provides for upside potential based in part on the upward movement of a stock market index, subject to certain limitations, while offering protection against the impact of market downturns.
Time for a fresh look
Due to this convergence of conditions, the once booming COLI market is again gaining momentum. The time is right to take a new look at the COLI market with business-owner clients to explore the current product offerings that are helping to drive the growth and solve some of the unique challenges companies face.