DISCUSSION QUESTIONS1. Is COLI unethical? If you think there is something unethical about the practice, what is it? If you do not think so, why do you think so many people find it unethical? 2. Suppose a company provided life insurance to each employee and also had a COLI policy on each employee? Would that settle the fairness question? 3. Does the fact that from a financial perspective some employees are worth more dead than alive represent a genuine conflict of interest? Companies often provide life insurance to employees as a benefit. Several decades ago, a new twist was developed: company-owned life insurance (COLI). A COLI policy is taken out by a company on the life of an employee. The company pays the premium on the insurance but also owns the policy’s cash value and is its primary beneficiary. Historically, companies were able to purchase insurance on an employee only if they had a significant financial or emotional stake in the person’s survival, known as an “insurable interest.” Thus, a company could buy life insurance on key executives, and partners in accounting and law firms could buy life insurance on each other. In the 1980s, however, insurance companies convinced the insurance regulators in most states to change the rules to allow companies to buy life insurance policies on any and all employees. As firms became aware of the tax advantages associated with these plans, there was an explosion in the number of COLI programs that covered rank-and-file workers. These programs became known in the industry as “janitor’s insurance” because everyone “including the janitor” was covered. How COLI Programs Work Companies have earned millions of dollars on broad-based COLI programs because of the favorable tax treatment of life insurance policies. The policies yield tax-free income as the investment value of the insurance policy rises; companies can also borrow against the policies to raise cash. Moreover, any interest payments on money borrowed against these policies are tax deductible, and the premium payments are tax deductible as well. If the employee dies prematurely, the death benefits are also exempt from taxation. Thus, on an after-tax basis, on average the value of the cash benefits will exceed the cash value of the premiums. The implication of these tax advantages is that in certain cases, from a purely financial perspective, some employees are worth more to their company dead than alive. Broad-based COLI programs soon became widespread. Firms like Wal-Mart, Nestlé, Pitney Bowes, Procter & Gamble, Winn-Dixie, and Dow Chemical instituted such programs. For example, in the 1990s, Wal-Mart took out COLI on 350,000 of its workers. Janitor’s insurance was also big business for life insurance companies. Hartford Life, a major COLI provider, had $4.3 billion in force at the end of 2001. Public Outcry against COLI Programs When the existence of COLI became public knowledge in 2002, there was a tremendous outcry. Some argued that it was unseemly for a company to profit from the death of its employees. To the families of dead employees who could not afford to own much, if any, insurance on their loved ones, the whole scheme was unfair. For example, CM Holdings, Inc., had a COLI policy on its employee Felipe Tillman. When Tillman died at 29 from complications of AIDS in 1992, CM Holdings received a death benefit of $339,302. But since Felipe had no policy on his own life, there was no death benefit for his family. When Felipe’s brother Anthony learned how his brother’s death benefited CM Holdings, his response was “It isn’t fair.” Is janitor’s insurance unfair, and is it unseemly to profit from the death of employees? People do not always object to profiting from death. The funeral business, for example, is highly profitable, as is the life insurance business. And defense is a very big industry. In fact, lots of industries profit from death in one way or another. Perhaps what seems morally wrong in the case of COLI policies is profiting from the death of one’s own employees—especially when the benefits do not work in the interest of the employees. Interestingly, though, most companies claim that the death benefits are used to help finance general employee benefits, including health insurance. Procter & Gamble uses the death benefits in this way. Pitney Bowes and Nestlé make the same point: the death benefits are used to help finance general employee benefits. It is hard to see why janitor’s insurance used for such purposes is wrong. Perhaps one could fault Public Service of New Mexico for using the death benefits from its employees to help put a nuclear power plant out of service. But even here, the moral case is not clear. Although the death benefits were not used directly to help employees, they did benefit stockholders. Moreover, some might argue that phasing out nuclear power plants benefits customers and society at large. Some cynical people might see a conflict of interest here. If an employee really is worth more to a company dead than alive, then a company has an interest in hastening that employee’s death. That may be technically true, but it does seem a bit of a stretch to think that an executive would do away with an employee for financial gain. COLI Programs Often Lack Transparency Other issues arise with respect to COLI policies, however. In many cases, employees were never told about the policies. It came as a surprise to them or to their families when the existence of the policies became public knowledge. In one poignant case, an employee of Advantage Medical Services, Inc., Peggy Stillwagoner, was killed in a car accident. Before succumbing to her injuries, she ran up tens of thousands of dollars in medical bills. The Stillwagoner family asked the owner of the company if it provided life insurance. The owner of the company said it did not. A few months later, the family discovered that the company had a $200,000 policy on Peggy Stillwagoner. Clearly, the owner of Advantage Medical Services was wrong to have lied. And it does seem an abuse of informational asymmetry when employees are not told about the company’s COLI policies on them. However, suppose the existence of such policies were completely transparent? Would there be anything wrong then? Societal Responses In 1996, in reaction to society’s strong objections to companies that may profit from death unfairly, Congress passed a law phasing out the tax-deductible interest payments. Still, it preserved many of the financial benefits for companies. More recently, federal appeals courts in the Sixth and Tenth Circuits have determined that companies do not have an insurable interest in most of their employees. In addition, some courts have explicitly mentioned the lack of transparency around COLI. Thus, the attitude of the courts has changed since many states changed their regulations in the 1980s. Companies that do not change their policies in accordance with current laws and court decisions can be hit financially. For example, Dow Chemical was charged $22.2 million in back taxes from losses created by COLI. The National Association of Insurance Commissioners has developed transparency guidelines that require the consent of individuals if insurance is to be purchased on their behalf. Most states have enacted similar guidelines. Such revised laws and professional guidelines speak to some of the examples mentioned earlier. Even so, COLI policies on executives remain a booming business and for the same reason that COLI boomed: significant tax advantages.
