Posted on 12/30/2002 10:19:17 AM PST by TroutStalker
Edited on 04/22/2004 11:47:48 PM PDT by Jim Robinson. [history]
After the Sept. 11 terror attacks, some of the first life-insurance payouts went not to the victims' families, but to their employers.
Unknown to most people outside the insurance world, corporations now are among the largest beneficiaries of life insurance, collecting on policies they purchased on the lives of employees.
(Excerpt) Read more at online.wsj.com ...
Tax Benefits of Life Insurance
Help to Boost the Bottom Line
By THEO FRANCIS and ELLEN E. SCHULTZ
Staff Reporters of THE WALL STREET JOURNAL
Corporate owners get a variety of tax and accounting benefits from life insurance on employees.
The kind they load up on is "cash value" life insurance, so-called because besides a death benefit, it includes a tax-sheltered investing account. This account is like a big, nondeductible IRA: The policyholder deposits money into it, the insurer subtracts a slice to pay for fees and insurance, and the remainder grows tax-free. That growing remainder is known as the cash surrender value, or cash value. It's an asset.
For families, these cash-value policies are often a poor deal, because the commissions are usually high. But employers negotiate low commissions. It can make sense for them to round up cash they might have lying around, on which they're earning taxable returns, and plow it into a life-insurance policy, where the returns aren't taxed.
The downside is that the money is tied up for long periods, essentially until the insured employees die. The employer could get at it by surrendering the policy, but that would make the gains taxable. Employers used to take big simultaneous loans against the policies, but interest on such loans is no longer deductible. What does free up the money, sooner or later, is the death of the employee. It brings a death benefit, which isn't taxable.
These death benefits, except in rare cases where a number of employees die unexpectedly soon, aren't usually a windfall to the employer. Insurers price their products carefully, so that, over time, the sums an employer pays for the insurance coverage will roughly balance what the insurer has to pay out in death benefits.
Income Stream
So if the deal ties up money so badly, why bother? The answer: All the years that this (tied-up) money is growing, the employer can keep reporting the accumulating gains as income.
The reason is that under generally accepted accounting principles, life insurance investments are treated differently from many other kinds of investments. If the employer had invested in a stock portfolio, and it gained in value, the gains wouldn't add to the company's income until it sold the stock. All the company could do in the interim is add the portfolio gains to its balance sheet.
But if an investment in life insurance grows, the gains flow straight to the income statement every quarter, boosting earnings. And, of course, those are tax-free gains, unlike the kind the company would get from a stock portfolio.
What about an investment loss? The chance of that is remote with policies that pay fixed returns, which are common. Some policies are invested in stocks, and they of course do lose money at times. Insurers offer mechanisms that help companies to smooth out the gains and losses over several periods, and generally avoid recording hits to income.
Policy Loans
In the late 1980s and early 1990s, many companies took the tax benefits of life insurance one step further, by taking out big loans against the policies at the same time as they bought them.
Here's how it worked. An employer would pour $100 million into insurance on its employees, paying the insurer that much money, plus fees. The insurer credited the employer with, say, a 10% rate of return on this money, or $10 million in the first year, tax-free.
But the employer immediately borrowed out the entire $100 million, paying the insurer 12% interest, or about $12 million the first year.
Wonder how the policy could earn 10% if the proceeds had all been lent back to the employer? The answer is that the employer, technically, borrowed from the insurer, rather than withdrawing its premiums. They remained there, earning their 10%.
So now the employer, paying $12 million in interest and earning $10 million, was out $2 million. Not a good deal? Not until you consider that the $10 million is tax-free, while the $12 million of interest paid is deductible. At a 40% tax rate, that saved the employer $4.8 million off its other taxes.
Bottom line: The employer still had its $100 million, it was paying $2 million to the insurer, and it saved $4.8 million on its taxes -- a net gain of $2.8 million.
As for the insurer, it had made an essentially riskless two-percentage-point spread.
In 1996, Congress put a stop to this by abolishing deductions for interest on policy loans. In response, companies began taking out other loans -- on which interest was still deductible -- and then buying more life insurance. This move has virtually recreated the deal Congress thought it had abolished. It's particularly attractive for employers with cheap access to borrowed money, such as banks.
Whether or not it is leveraged this way, corporate-owned life insurance provides a relatively predictable stream of tax-free investment returns, flowing to the bottom line for years.
Write to Theo Francis at theo.francis@wsj.com and Ellen E. Schultz at ellen.schultz@wsj.com
See also a post on FreeRepublic from April on the same subject:Case Shows How 'Janitors Insurance' Works to Boost Employers' Earnings
Companies Profit on Workers' Deaths Through 'Dead Peasants' Insurance
The anti-corporate stance on all this is: those ghouls profiting off the death of employees.
The reality is quite different: the government says that money from life insurance proceeds is tax-free. Corporations can choose to put their profits into tax-free investment vehicles or into taxable investment vehicles. All things being equal, companies prefer not to have to pay taxes.
By paying money for insurance premiums, they create an asset on which they do not have to pay taxes. Every once in a while this practice may result in an inadvertent windfall due to a tragedy, but that isn't the goal.
The goal is to shelter assets from the taxman. As long as the company makes its policy clear to its shareholders, it shouldn't cause anyone any consternation.
Blame the tax code - not the company. They're just using every tool the government allows to minimize theft through taxation and maximize shareholder value.
Worth repeating.
That is exactly right!
I was surprised to see it in The WSJ. Corporations, which explored American a few centuries ago and subsequently made this nation wealthy, are now synonymous with "bad guy." Very sad indeed.
KeyCorp declines to comment on Mr. Reid's experience. A spokesman says that "employees do not pay premiums, and therefore there's no reason to disclose the details of the policy to them."
That's just wrong.
Spouses often take out life insurance policies on their husband or wife without their knowledge.
Technically, the company is insuring itself against the loss of the value you contribute to the company - something which one is already compensated for through salary.
It isn't the collecting that's so important.
If you've got a whole-life insurance policy you can manage the contributed funds as you please and when the fund is eventually liquidated, instead of being hit with a capital gains tax, the money is tax free.
Saying that the policy isn't really an investment while you're still alive is like saying that your retirement savings aren't really an investment until you retire. Untrue.
If you put $10,000 of retirement money into your retirement account and the stock shoots up 100%, you now have $20,000 in your retirement account. Just because you can't draw on it today without penalties doesn't mean it isn't an investment. It's still part of your net worth.
Likewise, when a company that invested $5,000,000 in employee life insurance sees the money invested in that insurance shoot up to $10,000,000 it now has a $10,000,000 asset on its balance sheet, which strengthens its credit profile and adds to the company's inherent value.
That's just wrong.
If she wanted to pay the premiums, my wife could take out a $1,000,000 policy on me tomorrow without telling me. Is that just wrong?
I wonder if Dr Jack Kervorkian had a "policy" on his first wife?
I definitely do NOT want anyone having a "policy" on me!
This is an unrealistic way to look at it.
When a person pays into an insurance policy over the years, all they get back is the value they put into it, compounded over time plus the appreciation of any investments within the policy.
There is a windfall in the case of a premature death - but even if a top executive died prematurely, the company's total benefit would be a tiny portion of the average quarterly profit. It would necessitate the premature deaths of many, many employees for this to be a profitable "death contract" - and even a suspicion of foul play would destroy the company.
It's just a legal way of parking assets in a tax-free investment.
I wager that any study would demonstrate that people are much safer from foul play when they have their employer as a policy holder rather than a close family member.
Well, if I were you I'd be a little nervous!
Gives a whole new meaning to the term "He was terminated."!
But it might be difficult for her to arrange the physical without your knowlege and participation.
In terms of the law being "abused" one could argue that it already is - insofar as the tax code is being used for a purpose which was never intended.
One could argue alternately that the tax code itself is abusive, since it imposes a tax on company earnings when they are reported, again when dividends are taxed and arguably a third time, when capital gains are taxed.
If companies could invest earnings without having to fear capital gains taxes, no policy would ever have been taken out in the first place.
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