What Is Corporate Owned Life Insurance and How Does It Work?

Corporate owned life insurance (COLI) allows companies to purchase life insurance policies on key employees, with the corporation serving as both owner and beneficiary while employees provide consent but retain no ownership rights. The company pays premiums and receives death benefits upon the employee’s passing, providing immediate liquidity to offset recruitment costs, training expenses, and business disruption. COLI policies accumulate cash value over time, which corporations can access through policy loans to finance employee benefits, deferred compensation programs, or retiree health coverage, while exploring the various policy structures reveals additional strategic applications.

When businesses face the unexpected loss of key personnel, the financial ramifications can extend far beyond immediate grief and operational disruption, creating cash flow challenges, recruitment costs, and potential threats to company stability. Corporate Owned Life Insurance (COLI) serves as a strategic risk management tool that enables corporations to protect themselves against these financial vulnerabilities by purchasing life insurance policies on essential employees, with the company serving as both owner and beneficiary.

The fundamental structure of COLI involves the corporation paying premiums for life insurance coverage on key employees, who must provide consent but retain no ownership rights over the policy. This arrangement allows companies to receive death benefits directly, providing immediate liquidity during periods when operational continuity might otherwise be compromised by the loss of critical talent, specialized knowledge, or leadership expertise.

COLI policies typically accumulate cash value over time, creating a dual-purpose financial instrument that corporations can utilize for various strategic objectives. Companies often employ these accumulated values to finance employee benefit programs, fund deferred compensation plans, or address unfunded liabilities related to retiree health benefits, effectively transforming insurance premiums into versatile corporate resources. When facing unexpected financial needs, corporations can access policy loans against the accumulated cash value, providing quick access to funds without affecting the company’s credit rating.

Two primary policy types dominate the COLI landscape, each offering distinct investment characteristics and risk profiles. General account policies invest in high-quality corporate bonds and mortgages, providing guaranteed interest rates typically ranging from 1% to 4%, while variable account policies offer diverse investment options with higher volatility potential but no guaranteed minimum returns.

Beyond basic death benefit protection, COLI serves multiple corporate functions including financing stock redemption agreements, offsetting recruitment and training expenses for employee replacement, and supporting business continuity planning. The tax advantages associated with COLI policies often make them particularly attractive, as death benefits generally receive tax-free treatment while providing companies with accessible liquidity sources. These policies can be structured as term life or permanent life insurance depending on the company’s specific needs and duration of coverage requirements. Under current regulations, employers must follow COLI Best Practices requirements that include obtaining proper notice and consent from employees to maintain favorable tax treatment.

Regulatory compliance remains essential, with policies subject to guidelines established by authorities such as the NAIC and accounting standards governed by FASB requirements. Companies implementing COLI strategies must navigate specific reporting requirements and legal constraints regarding premium deductibility, ensuring transparency in costs and investment returns while maintaining compliance with evolving regulatory frameworks that govern corporate-owned life insurance programs.

Frequently Asked Questions

What Are the Tax Implications of Corporate Owned Life Insurance Premiums?

Corporate-owned life insurance premiums are generally not tax-deductible under Section 264(a)(1), requiring payment with after-tax dollars.

Cash value accumulates tax-deferred within the policy, while death benefits may face taxation under Section 101(j) rules for policies issued after August 17, 2006, unless specific notice and consent requirements are met by the corporation.

Can Employees Opt Out of Corporate Owned Life Insurance Policies?

Employees typically cannot opt out of corporate-owned life insurance policies because employers possess these policies as corporate assets, bearing all premium costs and receiving death benefits. While some jurisdictions require employee notification or consent before policy purchase, this seldom grants opt-out rights.

Employers may occasionally offer alternative arrangements through company policy or labor agreements, but legal opt-out provisions remain uncommon since employees aren’t policyholders.

What Happens to the Policy if an Employee Leaves the Company?

When employees leave the company, Corporate Owned Life Insurance policies typically remain with the employer, who continues paying premiums and retains death benefits in the form of their asset portfolio.

However, some arrangements allow ownership transfer to departing employees, enabling them to maintain coverage by assuming premium payments. Group life insurance generally terminates upon departure unless portable or convertible options are available within specified timeframes.

Are There Legal Restrictions on Which Employees Can Be Covered?

Yes, federal regulations restrict employer-owned life insurance coverage to current employees, officers, and directors actively engaged in the business at policy inception. Non-employees cannot be covered under these policies without violating legal requirements.

For rank-and-file employees, coverage amounts must reasonably relate to employee welfare benefits provided, while key employees may receive higher coverage levels based on their economic value to the organization.

How Does Corporate Owned Life Insurance Affect Business Valuations?

Corporate-owned life insurance considerably increases business valuations by adding death benefit proceeds as company assets. Following the Supreme Court’s *Connelly v. U.S.* ruling, COLI proceeds must be included in fair market value calculations for estate tax purposes, regardless of contractual obligations to fund share repurchases.

This inclusion raises estate tax liabilities for surviving owners and necessitates restructuring buy-sell agreements to address valuation discrepancies.