What is dead peasant insurance?
“Dead peasant” insurance is an outdated term for what’s now known as corporate-owned life insurance (COLI). While the old name may sound grim, COLI is actually a strategic tool companies use to protect their financial interests. Instead of covering just any employee, businesses typically use these policies to insure key figures — like CEOs or top executives — whose sudden loss could hit the company hard. The payout helps the company recover, providing funds to hire and train a replacement or cushion the financial impact. Though the term has faded, the purpose behind these policies remains vital for business stability.
What is corporate-owned life insurance?
Corporate-owned life insurance is a type of life insurance that businesses purchase on their employees, with the company itself named as the beneficiary. This type of insurance is typically used to safeguard the company’s financial interests in various situations where the loss of key personnel would have significant effects. COLI is commonly purchased for specific purposes such as:
- Key person life insurance: Protects the company financially if a crucial executive or high-ranking employee dies, allowing funds to cover costs like recruiting and training a replacement.
- Buy-sell agreements: An entity buy-sell agreement is when a business owns life insurance on each co-owner of the company. If a death occurs, the company uses the life insurance proceeds to purchase the deceased’s interest from his or her estate.
- Split-dollar life insurance: This arrangement allows both the company and the employee to share in the benefits of the policy. While the employer pays some or all of the premiums, both parties may split the death benefit or cash value.
- Funding retirement and compensation plans: COLI is also used to fund nonqualified deferred compensation and retirement plans, offering tax advantages for the company as the policy’s cash value grows.
It’s important to note that while COLI can be written on multiple employees, it’s not commonly purchased for an entire workforce but rather key individuals critical to the company’s success. Additionally, corporate-owned life insurance is not the same as group life insurance, which may be offered to employees as part of their employment benefits. With most basic group life insurance policies, the employer typically pays the premiums but the employee’s beneficiaries receive the full death benefit.
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Whole life insurance combines life insurance with an investment component.
- Coverage for life
- Tax-deferred savings benefit if premiums are paid
- 3 variations of permanent insurance: whole life, universal life and variable life include investment component
Term life insurance is precisely what the name implies: an insurance policy that is good for a specific term of time.
- Fixed premium over term
- No savings benefits
- Outliving policy or policy cancellation results in no money back
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Why is it called dead peasant life insurance?
Company-owned life insurance is commonly referred to as dead peasant life insurance or even “janitor insurance” because of its historical use. In the 1980s, many major corporations began purchasing corporate-owned life insurance on low-wage workers without telling them.
Their intention was not solely to profit from the employees’ deaths, but the move was viewed as controversial because companies could secretly make millions off employee death benefits and the growth of the policies’ cash value.
As a result, the name “dead peasant insurance” was given to corporate-owned life insurance in reference to a novel called Dead Souls by Nikolai Gogol. The lead character buys dead serfs from a landowner in the book and uses them to secure a high-value loan.
Why do companies buy dead peasant life insurance?
When someone passes away, life insurance typically helps provide financial security to their loved ones. But what happens when a business loses someone crucial to its success, like a CEO or a top executive? Companies can face major financial setbacks, too. That’s where corporate-owned life insurance comes into play.
COLI policies are designed to protect businesses from the financial impact of losing a key employee. Imagine a company losing its founder or an executive who plays a vital role in its operations. The cost of finding, hiring and training someone to fill that void can be enormous. COLI offers companies a financial cushion, helping them cover those costs or stabilize the business during difficult transitions.
But the benefits don’t stop there. These policies often come with tax advantages that can help the business financially, similar to the way individuals benefit from tax-free life insurance payouts. For companies to enjoy these tax perks, however, they need to meet specific IRS requirements.
Notice and consent:
Before the policy is issued, the employee must:
- Be informed in writing that the employer intends to insure them, including the maximum coverage amount.
- Provide written consent to be insured during and after their employment.
- Be made aware that the employer will be a sole or partial beneficiary of the death benefit.
Exceptions:
- If the insured was employed within 12 months before their death.
- If the employee was a director, highly compensated or a major stakeholder (owning 5 percent or more) at the time the policy was issued.
These policies can serve various purposes, from protecting against financial losses to funding employee benefit plans. For businesses, having a policy like this in place ensures that they have a financial safety net if the unexpected happens, keeping the company steady even in uncertain times.
Is dead peasant insurance legal?
Despite the controversy, dead peasant life insurance is legal but highly regulated. In 2006, the Internal Revenue Service (IRS) instituted the Pension Protection Act, which created a strict set of guidelines that made it more difficult for companies to exploit their employees with a corporate-owned life insurance policy.
In the past, specifically during the 1980s and 1990s, companies misused these policies by secretly purchasing insurance on employees without their knowledge and sometimes collecting benefits long after those employees had left the company. However, Congress and the IRS stepped in to address these abuses.
Today, most states require employers to have an “insurable interest” in the employee’s life to justify a COLI policy. This means the company must show it would face financial loss if the employee passed away. Typically, this applies to key individuals, but in some states, the insurable interest can also relate to employees benefiting from the company’s plans.
Additionally, at least 48 states now require that companies notify the employee and obtain their consent before issuing a COLI policy. Employees must be informed in writing about the policy and provide written consent, and they have the right to refuse participation without any form of retaliation from the employer.
