Corporate-Owned Life Insurance (COLI) is a specialized policy tailored for businesses, distinct from traditional life insurance that typically supports an individual’s family. With COLI, the company itself is the beneficiary, a design that carries profound financial advantages—and ethical considerations—for both the organization and its employees.

At its core, COLI functions as a strategic financial tool. It acts as a safety net, shielding businesses from the economic fallout of losing a key employee unexpectedly. Such a loss can trigger costly disruptions—think recruitment expenses, training new hires, or even temporary declines in productivity. Beyond protection, COLI policies build cash value over time, which companies can tap into to fund future employee benefits, such as retirement plans or supplemental compensation programs.

Yet, COLI’s appeal extends beyond risk management and employee support. It doubles as a tax-advantaged investment. While premiums aren’t tax-deductible, the death benefits are typically received tax-free, and the policy’s cash value grows on a tax-deferred basis. This favorable tax treatment, combined with the ability to list the policy’s cash value as an asset on the balance sheet, can bolster a company’s financial health and appeal to investors or lenders.

The story of COLI doesn’t end there—it’s also intertwined with the life settlement market. Companies may opt to sell their COLI policies, perhaps to pivot their financial strategy or adjust to a shifting workforce. These transactions can yield returns exceeding the policy’s cash surrender value, offering a lucrative exit. However, they also introduce complexities and ethical dilemmas, such as how the sale impacts employees tied to the policy or whether it aligns with the company’s values.

In this article, we unpack the intricacies of COLI—its tax benefits, its role in life settlements, and its broader implications. Approaching this topic demands a critical lens: weighing the clear upsides against potential drawbacks and considering what it means for businesses and the people who power them.

What is Corporate-Owned Life Insurance?

Corporate-Owned Life Insurance (COLI) is a type of life insurance policy taken out by a company on the lives of its employees. The company pays the premiums and is also the policy’s primary beneficiary. If the insured employee passes away, the death benefit is paid out to the company, not to the employee’s family or other personal beneficiaries.

COLI is typically used for several purposes:

• Key Person Insurance: To protect the company against the financial loss that could occur if a key employee, such as a top executive or specialist, were to die. The death benefit can help offset the costs of recruiting, hiring, and training a replacement and any potential lost business or profits.
• Funding Employee Benefits: The cash value growth within a COLI policy can help fund future employee benefits, such as retirement plans.
• Tax Benefits: The premiums paid by the company are not tax-deductible, but the death benefits received are generally tax-free. Additionally, the cash value growth within the policy is tax-deferred.
• Balance Sheet Improvement: The cash value of a COLI policy can be recorded as an asset on the company’s balance sheet, which can enhance the company’s financial position.

How Does Corporate-Owned Life Insurance (COLI) Work?

Corporate-Owned Life Insurance is a policy taken out by companies on their employees. The company pays the premiums and is also the beneficiary, meaning the death benefit goes to the company if the insured employee passes away. These policies can serve as financial tools, helping companies fund obligations related to employee benefits or protect against the financial impact of losing a key employee.

Requirements of Corporate-Owned Life Insurance (COLI)

Certain requirements must be met for a company to take out a COLI policy. The insured employees typically belong to the company’s top tier or highest-compensated group. Additionally, the employee must be informed about the policy, including the company’s intent to insure them and the coverage amount. The employee must also be notified if the company stands to benefit from the policy.

Tax Implications of Corporate-Owned Life Insurance (COLI)

Life insurance is a tax-advantaged vehicle. However, COLI policies come with specific tax rules. While the death benefits are generally tax-free, stipulations are in place to ensure companies don’t misuse COLI for tax arbitrage. For instance, the company must adhere to notification and consent requirements to avail tax-free death benefits.

The Intersection of COLI And Life Settlements

A Corporate-Owned Life Insurance (COLI) policy can be sold as a life settlement. If a company determines that it no longer requires the COLI policy, perhaps due to changes in its financial objectives or the departure of a key employee, it can sell the policy in the life settlement market. 

By selling the corporate life insurance policy, the company might obtain a value higher than the policy’s cash surrender value offered by the insurance company. When sold, the life settlement buyer becomes responsible for future premium payments and, in return, will receive the death benefit upon the passing of the insured individual.

FAQs on Corporate-Owned Life Insurance

How does corporate-owned life insurance work?

COLI is a life insurance policy taken out by a company on its employees. The company pays the premiums and, in return, is the policy beneficiary.

What are the disadvantages of corporate-owned life insurance?

One potential disadvantage is the public perception, as some view COLI as companies profiting from employee deaths. Additionally, there are strict tax regulations and requirements to adhere to.

Can a corporation pay for owner life insurance?

Yes, a corporation can pay for the owner’s life insurance, but the purpose and beneficiary arrangements must be clearly defined to comply with tax regulations.

Is company-owned life insurance an investment?

While COLI provides financial benefits, it’s primarily a risk management tool, not a traditional investment.

What are the advantages of corporate-owned life insurance?

COLI offers tax advantages, helps fund employee benefits, provides financial protection against losing key employees, and can improve a company’s balance sheet.

Is company-owned life insurance worth it?

COLI can be a valuable tool for many companies, especially those with key employees whose loss would significantly impact operations.

What is the cash surrender value of corporate-owned life insurance?

The cash surrender value is the amount the policyholder (the company) would receive if they chose to terminate the policy before the insured event occurs.

How are corporate-owned life insurance proceeds taxed?

Generally, death benefits from COLI are tax-free. However, there are specific requirements and regulations to ensure compliance.

What type of life insurance is best for business owners?

The best type depends on the business needs. Some options include term life insurance, whole life insurance, or key person insurance.

Can you open a life insurance policy in a business name?

Yes, businesses can take out life insurance policies on key employees or owners, with the business as the beneficiary.