Reference no: EM132651594
"Dead Peasant" Life Insurance Policies
Caroline Murray was mourning the death of her husband, Mike, when she received a call from the employee benefits division of his company requesting a copy of the death certificate. After asking why they needed the certificate, Caroline was surprised to learn that her husband's company had purchased a life insurance policy on her husband. Especially surprising was the fact that Caroline had no record of the policy, and apparently, neither did her husband. This particular policy listed only the company as beneficiary and allowed the company to borrow against Mike's policy, write-off the loan's interest on its taxes, and receive a tax-free payout upon Mike's death. Mike's position at the company was not an executive one; he was the security guard at a local manufacturing company, and his company received $80,000, tax-free, upon his death. His family received nothing. How did this happen? Through the company's purchase of a life insurance policy nicknamed "dead peasant" life insurance.
Corporate-Owned Life Insurance Policies
The Prevalence of COLIs. Corporate-owned life insurance policies (COLI) have been around for years. They are used as funding mechanisms for protecting businesses against the loss of its "human capital." Additionally, until the 1990s, these policies provided financial gains for companies as a form of "tax arbitrage" where they could deduct the interest on leveraged insurance transactions while simultaneously avoiding tax payments on the interest credited to the policies' cash values. In the mid-1990s, the federal government closed most of the tax loopholes and opportunity for arbitrage; however, the tax-free benefits and tax deferrals on the policies still exist as financial incentives for companies. It is estimated that about a quarter of the Fortune 500 either have or had "broad-based" COLI policies covering about 5 million employees.
The pseudonym, "broad-based" refers to the policies' coverage of both executive and lower-level employees. Until the mid-1980s, most states required that an employer have an "insurable interest" in the lives of the employees that they insured, so these plans were limited to executives. Because of federal tax law changes that limited the amount that companies might deduct per insured employee, many states relaxed the "insurable interest" requirement, and businesses began taking life insurance policies out on rank-and-file workers to retain profitability on their policies. Hence, the term, "dead peasants," was used to reference the lower social status of some employees.
In 2009, a Michael Moore documentary, "Capitalism: A Love Story" highlighted this practice and drew attention to some of the problems. Lawsuits of families of deceased employees challenged the practice and began suing corporations and their insurers for allegedly misrepresenting what the policies offer. Many cases settled out of court, including a 2004 class action suit against Wal-Mart that settled for $10.3 million and another in 2006 that settled for $5 million. However, the practice continues today. Despite the negative press and lawsuits, statistics show that employers are still utilizing Dead Peasants Life insurance policies. In 2004, the Wall Street Journal reported the estimated value of these policies was $65.8 billion. In 2008, it had doubled to $122.3 billion.
Currently, top employers engaged in this practice include Wells Fargo ($17 billion), Bank of America ($17 billion), JP Morgan Chase ($11 billion), Winn-Dixie, Citi Bank, Walt Disney, Wal-Mart, American Electric Company, Dow Chemical, Procter & Gamble, and many others. In a horrible twist of fate, in 2011, police in Ohio arrested the owner of an oil-change business and charged him with trying to hire a hit man to kill a former employee to collect on a $250,000 COLI policy.
The Laws Regarding Colis
How is it that companies were able to take life insurance out on employees without their knowledge? Part of the confusion was with the different state laws back in the 1980's and 1990's when these policies became popular. Some state laws, like those in Texas, required that employees "consent" to having their lives insured while other states, like Georgia, did not require consent. Additionally, some employees "consented" without knowing it. In one Texas lawsuit, Wal-Mart employees alleged that they consented without knowing it when they were offered a special $5,000 death benefit when Wal-Mart launched the program. Wal-Mart disputed the claim by stating that the policies were signed in Georgia with an insurance management company located in Georgia, and therefore the more lenient Georgia law applied, regardless of the consent issue. However, the term "consent" was, and is still, vague because some states consider consent granted if an employee does not object to a notice of the employer's intent to purchase a policy.
In recent years, regulators have stepped in to address the practice. The IRS cracked down on deductions, Congress approved stricter consent laws, and state laws were modified. Insurance law is regulated by states, and some have responded by passing "insurable interest" laws, which require that employers have the possibility of financial loss because of an employee's death before they can take out a life insurance policy on them.
In 2006, The COLI Best Practices Provision, within The Pension Protection Act of 2006, was signed into federal law. Among other issues, it addressed COLI employee notice and consent requirements-noting that the employee must be notified in writing, as well as provide written consent. Of course, the law was designed to codify the industry and identify "best practices." In fact, many policies for which employers did not obtain consent are still in effect because those purchased before the law became effective in 2006 were grandfathered from its provisions. Additionally, as noted above, what constitutes "consent" could simply be an employee not noticing that he or she had to "opt out."
The Coli Debate
Critics of dead peasant insurance policies point to the disincentives for employee safety; after all, if a company is going to collect money on an employee's death, what incentives do they really have to protect that employee? Additionally, critics point to the comparison to slaveholders' policies, the loss of tax revenues, and the use of these policies to fund exorbitant executive compensation programs.
Supporters of these insurance policies cite the fact that it is no different than insuring a business asset and it is perfectly legal. For years, companies have protected their interests with life insurance policies on their CEOs, top management team members and executives whose deaths could seriously affect a company's bottom line. Finally, many supporters point out that these insurance policies provide a beneficial vehicle for funding the growing costs of retiree benefits, so there is financial soundness to these policies that offer benefit to all employees of the companies. However, there is room for more debate in that the proceeds are often directed toward funding executive benefits, not for general retirees.
The Current Situation
While different states continue to set the parameters for the legalities of these policies, some companies have decided to cancel these COLI policies to avoid the risk of lawsuits from family members of the deceased who say that they are the rightful owners of the policies. Wal-Mart canceled most of these policies after several lawsuits with similar companies resulted in stiff penalties and settlements. Wal-Mart continues to settle claims from the estates of deceased Wal-Mart employees.
In 2011, President Obama's proposed budget included further decreases in the amount of allowable interest deductions for borrowing against COLI policies. Although this did not outlaw the practice, it was designed to influence businesses to put a halt to these policies. By 2015, with the removal of many tax incentives, it was estimated that the dead peasant insurance policies might go away, although it has fostered larger debates about life insurance schemes and corporate tax loopholes. Perhaps at some point, the widows and widowers of "dead peasants" like Caroline Murray will be able to mourn the death of their loved ones without surprise calls from benefits divisions.
Questions for Discussion
- What are the major ethical issues involved in this case? Is it ethical for an employer to benefit from the death of an employee if they took out and paid for the policy?
- How does the idea that these policies help to fund executive compensation and/or retiree benefits affect your answer to #1?
- Should Congress create more stringent guidelines, beyond "best practices," for the administration and use of these types of COLI policies? Should states be pressured to conform to stricter "consent" policies?