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DEAD PEASANT INSURANCE - ARE THERE ANY WAYS LEFT TO LOSE?

May 13, 2005

The purchase of life insurance on large groups of employees has always been controversial. The practice is politely called "COLI," for "Corporate-Owned Life Insurance." It is more rudely known as "dead peasant insurance."

While it sounds ghoulish, COLI was tax-motivated. The goal was to deduct the interest on purchases of large pools of insurance, while collecting the cash-value buildup of the policies tax-free.

ONCE, TWICE, THREE TIMES A LOSER

Most, though not all, courts that have ruled on this issue have disallowed the tax benefits. Congress changed the law to make sure that it didn't work. Now it's gotten even worse for the COLI corporations. In a decision issued this week, the 10th Circuit court of Appeals has held that a COLI-owning corporation didn't even have an insurable interest in a now-dead employee, and it may have to pay the policy proceeds to his family.

Camelot Music used the COLI scheme to try to reduce its corporate taxes. The Third Circuit ruled the plan a "sham" in 2002, disallowing the tax benefits. Camelot employee Filipe Tillman was insured for $340,000 when he died, and Camelot collected the proceeds. His widow sued under Oklahoma insurance law to collect the policy proceeds; Oklahoma law provides that if you don't have an insurable interest in a decedant, the proceeds are payable to the insured's estate. The 10th Circuit overturned a lower court ruling and upheld the widow's claim.

It's not accurate to say that the COLI-buyers bought policies in a vampire-like ploy to profit from employeed deaths. It is accurate to say that the tax shelter doesn't work if the employer doesn't get to keep any policy death benefits. For Camelot, it is a debacle - no tax benefits, no policy proceeds - just insurance premium payments.

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