Corporate-Owned Life Insurance (COLI) is a common funding vehicle for executive compensation obligations. COLI is a life insurance policy owned by the employer that
insures the lives of one or more employees of the employer. The policy typically covers the lives of several executive employees and can be used for a variety of purposes that may or may not bear any relation to the anticipated actual financial loss to the employer on the death of the covered employees.
Since the employer is the owner and beneficiary of the COLI policy, the employer retains all rights to the benefits under the policy, including the cash value buildup and the death proceeds.
The employee has no interest in the policy (other than being named as the insured). Typically, the employer purchases cash value life insurance policies on individual
employees and pays the premiums for the policies. Alternatively, the employer may choose to borrow the premiums from a bank.
If structured properly, the cash value that accumulates under the policy will not be subject to tax as it accumulates.
The employer is permitted to borrow against the policy. These borrowed funds then may be used to fund non-qualified plans.
Furthermore, the interest paid on any loan against the policy cash value may be deductible by the employer.
In terms of funding non-qualified plans, COLI is attractive because it provides:
- Actual (and psychological) assurance to employee plan participants that their benefits under the non-qualified plan are being funded on a current basis and are
less likely to be endangered by the employer’s cash flow demands;
- Access by the company to policy investment alternatives that may not be available through traditional investments (index crediting mechanism); and,
- A cost recovery / reinvestment mechanism through the policy death benefit.