Most of us think of life insurance as something a family breadwinner purchases to protect a spouse, children, or a mortgage. That personal-protection angle is important, of course, but life insurance also has a quieter, more corporate side. Behind closed boardroom doors, many mid-size and large employers take out policies on key executives—or even on broad groups of employees—as part of a strategy known as Corporate-Owned Life Insurance, or COLI.
If you run a business, sit on a finance committee, or simply like to understand the tools companies use to shore up their balance sheets, it pays to know how COLI works and why it enjoys a permanent seat in the corporate finance toolkit. This article keeps the jargon to a minimum and walks through the basics, the benefits, the caveats, and the practical steps for getting started.
Contents
What Exactly Is COLI?
At its core, COLI is straightforward: the company is both the owner and the beneficiary of a life insurance policy taken out on an employee. The employee must provide written consent, and state regulations typically cap the amount of coverage to a multiple of salary. When that employee eventually passes away, the death benefit flows to the corporation, not to the individual’s family. (In most cases the company separately provides conventional group life insurance for the family’s protection.)
Why would an employer want to do this? Several reasons surface again and again:
- Long-term funding for executive benefit programs
- Tax-advantaged growth of policy cash values
- A cushion for the sudden cost of replacing a critical leader
- Balance-sheet strength when other assets feel shaky
Mechanics You Can Picture
Think of COLI as a side fund that lives on the asset side of the ledger. Premiums are paid with after-tax dollars, but the cash value inside the policy grows tax-deferred. Unlike a typical savings account that spits out a 1099-INT each January, the COLI policy does not generate current-year taxable income as long as it remains in force. At the time of the insured’s death, the death proceeds are generally received income-tax-free.
That combination—tax-deferred buildup followed by tax-free distribution—explains a good slice of the corporate enthusiasm. A treasurer eyeing future obligations such as supplemental executive retirement plans (SERPs) can earmark COLI cash values for those payouts without worrying about interim tax drag.
Common Uses (Beyond Just Collecting a Payout)
Funding Non-Qualified Deferred Compensation
Highly compensated executives often max out 401(k) contributions in the blink of an eye. Companies bridge the retirement-savings gap with deferred-comp plans that promise future dollars. COLI cash values can be matched, dollar for dollar, with the growing liability the company owes its executives.
Key-Person Protection
Losing a visionary founder or star rainmaker can knock revenue off course. The death benefit provides emergency liquidity for recruiting, severance, and investor reassurance.
In closely held C-corporations, the policy proceeds may buy back shares from a deceased shareholder’s estate, preventing unwanted outside ownership.
Balance-Sheet Management
Because statutory accounting for COLI treats the cash value as an admitted asset (in many industries), insurers, banks, and utilities view the policies as a reliable, low-volatility holding.
| Common Use | Plain-English Summary | When It’s Helpful | How It’s Typically Set Up | Finance / Accounting Impact | Key Watchouts |
|---|---|---|---|---|---|
| Funding Non-Qualified Deferred Compensation | Use COLI cash values to informally fund promised future benefits for highly compensated executives. | Executives max out qualified plans (e.g., 401(k)); company owes future benefits under a deferred-comp plan. | Match COLI cash value growth to the plan’s growing liability; monitor crediting vs. plan assumptions. | Cash value is an admitted/recorded asset (industry dependent); tax-deferred growth reduces drag on funding. | Interest-rate/crediting risk; policy charges; alignment with 409A rules and plan obligations. |
| Key-Person Protection | Provide liquidity if a critical leader dies—cover hiring, transition, and revenue disruption. | Dependence on a founder, top rainmaker, or uniquely skilled executive. | Insure key roles; size death benefits to recruitment costs, runway needs, and investor reassurance. | Death proceeds generally income-tax-free; stabilizes cash and optics with stakeholders. | Optics risk (“profit from death”); ensure clear employee consent and separate family coverage. |
| Share-Redemption Agreements | Use policy proceeds to buy back a deceased shareholder’s shares and keep ownership in house. | Closely held C-corps needing certainty around ownership transitions. | Policies on key shareholders; coordinate with buy-sell/redemption agreements and valuations. | Provides tax-advantaged liquidity for redemptions; reduces strain on operating cash or borrowing. | Agreement must be current and well-documented; valuation disputes; consent and 101(j) compliance. |
| Balance-Sheet Management | Hold a relatively stable, long-term asset with tax-deferred growth inside the policy. | When seeking lower-volatility assets or diversifying reserves (common for insurers, banks, utilities). | Allocate premiums across carriers/products (WL, UL, IUL) with conservative crediting assumptions. | Admitted asset treatment in many industries; improves asset/liability matching over long horizons. | Surrender charges; illiquidity; carrier concentration risk—diversify and monitor ratings. |
Tax Talk—The Rules You Must Follow
The Internal Revenue Code section 101(j) governs employer-owned contracts issued after August 17, 2006. In plain language:
- Written Notice and Consent: Before a policy is issued, the employee must receive written notification of the amount, the fact the employer is beneficiary, and the coverage duration, and must sign consent.
- Highly Compensated Test or 12-Month Rule: To keep death benefits tax-free, the insured must have been an employee within the previous 12 months or must have been a director, owner, or highly compensated worker at policy inception.
- Annual Reporting on Form 8925: The company reports the number of policies, amount of coverage, and any lack of consent. Failure = possible taxation of proceeds.
Miss any one of those steps, and the treasured tax-free death benefit can flip to taxable income. Good advisors are worth their fee here.
Economics: What Does It Really Cost?
Premiums are an out-of-pocket expense. The company has to compare that cash outflow with alternative uses—debt reduction, stock buybacks, or plain old reinvestment in operations. What tilts the scales in COLI’s favor is the after-tax internal rate of return, especially over 10, 20, or 30 years.
A quick, very rough illustration:
- Annual premium: $100,000
- Assumed net cash value crediting rate: 4.5 %
- Corporate tax rate: 21 %
- Expected IRR over 20 years on net premiums vs. death benefit: roughly 6.0 % after tax
Compare that with the yield on long-term corporate bonds or high-grade money-market funds, and COLI often looks attractive.
Potential Drawbacks (Yes, There Are a Few)
- Surrender Charges: Bail out early and you may forfeit a chunk of the cash value.
- Illiquidity: While policy loans are possible, borrowing reduces net death benefits and can complicate accounting.
- Public-Relations Optics: “Company profits from employee’s death” headlines make CIOs cringe. Transparent communication and the presence of separate family coverage help defuse the issue.
- Concentration Risk: Don’t pour every penny of the deferred-comp reserve into a single carrier’s policy block. Diversify across insurers with strong financial ratings.
Implementation Road Map
Step 1: Identify the Business Goal
Are you funding a non-qualified plan, covering a key person, or building a general-purpose asset? The objective guides everything else—product type, face amount, and policy design.
Step 2: Assemble the Team
You will need:
- A seasoned life-insurance broker or consultant well-versed in COLI
- Corporate counsel to bless notice-and-consent paperwork
- A tax advisor familiar with 101(j) and 409A deferred-comp rules
- HR or benefits staff to coordinate employee communication
Step 3: Carrier Selection and Product Design
Whole life, universal life, and indexed universal life all appear in the COLI arena. Whole life offers contractual guarantees; universal life gives premium flexibility. Request carrier illustrations with conservative crediting assumptions.
Step 4: Obtain Employee Consent
Hand the insured employee a one-page notice outlining face amount, ownership, and beneficiary details. Secure a dated signature before the policy application is submitted.
Step 5: Fund and Monitor
Once the policy is active, premiums must be paid on schedule. Finance staff should track cash value versus the promised future liability at least annually. Adjustments may be needed if interest rates, crediting rates, or corporate tax laws change.
Final Thoughts
Corporate-Owned Life Insurance is not a silver bullet, yet it punches above its weight when used deliberately. By turning long-duration life-insurance contracts into a balance-sheet ally, a company can hedge future obligations, manage tax exposure, and protect against the financial shock that follows the loss of a pivotal employee.
If your organization faces sizable deferred-comp liabilities, relies heavily on a handful of rainmakers, or simply seeks a tax-efficient long-term asset, COLI deserves a seat at your next finance meeting. Just remember: the strategy works only when it is transparent, thoroughly documented, and aligned with the broader goals of the business.
Talk with a knowledgeable life-insurance professional, loop in your tax counsel, and run the numbers. You might discover that a tool once viewed as exotic is, in fact, a practical way to strengthen your company’s future footing.