Corporate-Owned Life Insurance (COLI)

Corporate-owned life insurance has been a mainstream corporate finance tool since the mid-twentieth century. In a COLI arrangement, the corporation applies for and purchases a permanent life insurance policy on a covered employee, pays the premiums, owns the policy, and is designated as the beneficiary for the death proceeds. The employee whose life is insured must provide written consent under the Pension Protection Act of 2006, which was enacted partly in response to abuses involving insuring lower-level employees without their knowledge.

The primary economic rationale for COLI is the tax treatment of a permanent life insurance policy held in the corporate context. The death proceeds received by the corporation upon an insured employee's death are generally excluded from federal income tax under Section 101(a), provided the policy meets the notification and consent requirements of Section 101(j). The cash value inside the policy grows on a tax-deferred basis, and policy loans do not trigger current income tax as long as the policy remains in force. These tax characteristics make COLI an attractive vehicle compared to taxable corporate bond alternatives when the corporation has a long time horizon and predictable liquidity needs.

COLI is most frequently used to informally finance nonqualified deferred compensation plans (NQDCs) and supplemental executive retirement plans (SERPs). A corporation that has promised to pay retirement benefits to executives has a long-dated liability on its balance sheet. Investing in COLI whose cash value grows at a rate comparable to the notional crediting rate of the deferred compensation liability allows the corporation to match assets to liabilities on an after-tax basis, potentially at a lower effective cost than taxable fixed income alternatives.

Bank-owned life insurance (BOLI) is the banking industry's version of the same concept, subject to additional regulatory guidance from federal banking regulators. Both BOLI and COLI are subject to the corporate alternative minimum tax provisions under the Inflation Reduction Act of 2022, which created a new 15% corporate minimum tax on adjusted financial statement income that includes income from COLI and BOLI in its calculation, potentially reducing the tax efficiency of these programs for the largest corporations.

For employees, COLI on their lives may be disclosed in employment agreements or benefit documentation, but the policy's benefits flow to the corporation, not their estate. Understanding this distinction is important for employees who may otherwise assume that corporate-sponsored life insurance provides personal death benefit protection.