An Employee Dies, and the Company Collects the Insurance
Monica Almeida/The New York TimesFreedom Communications’ chief executive, Aaron Kushner, defends the use of life insurance.
Employees at The Orange County
Register received an unsettling email from corporate headquarters this
year. The owner of the newspaper, Freedom Communications, was writing to
request workers’ consent to take out life insurance policies on them.
But the beneficiary of each policy would not
be the survivors or estate of the insured employee, but the Freedom
Communications pension plan. Reporters and editors resisted,
uncomfortable with the notion that the company might profit from their
deaths.
After an intensive lobbying campaign by
Freedom Communications management, a modified plan was ultimately put in
place. Yet Register employees were left shaken.
The episode at The Register reflects a common
but little-known practice in corporate America: Companies are taking
out life insurance policies on their employees, and collecting the
benefits when they die.
Because so-called company-owned life
insurance offers employers generous tax breaks, the market is enormous;
hundreds of corporations have taken out policies on thousands of
employees. Banks are especially fond of the practice. JPMorgan Chase and Wells Fargo
hold billions of dollars of life insurance on their books, and count it
as a measure of their ability to withstand financial shocks.
But critics say it is immoral for companies
to profit from the death of employees, while employees themselves do not
directly benefit. And despite a law enacted in 2006 that sought to curb
the practice — companies now are restricted to insuring only the
highest-paid 35 percent of employees, who must give their consent — it
remains a growing, opaque and legal source of corporate profit.
“Companies are holding this humongous amount
of coverage on the lives of human beings,” said Michael D. Myers, a
lawyer in Houston who has brought class-action lawsuits against several
companies with such policies.
Companies and banks say earnings from the
insurance policies are used to cover long-term health care, deferred
compensation and pension obligations.
“Life insurance is one of the ways of
strengthening the long-term health of the pension plan and ensuring its
ability to pay benefits,” Freedom Communications’ chief executive, Aaron
Kushner, said in an interview.
And because such life insurance policies
receive generous tax breaks — the company-paid premiums are tax-free, as
are any investment returns on the policies and the death benefits
eventually received — they are ideal investment vehicles for companies
looking to set aside money to pay for pension plans. Companies argue
that if they had to finance such obligations with investments taxed at a
normal rate, they would incur losses and would not be able to offer the
benefits to employees.
But in many cases, companies and banks can
use the tax-free gains for whatever they choose. “If you want to take
that money and go build a new bank branch, fine,” said Joseph E.
Yesutis, a partner at the law firm Alston & Bird who specializes in
banking regulation. “Companies don’t promise regulators they will use it
for any specific purpose.”
Hundreds of billions of dollars of such
policies are in place, providing companies with a steady stream of
income as current and former employees die, even decades after they have
retired or left the company.
Aon Hewitt estimates that in new policies
worth at least $1 billion are being put in place annually, and that
about one-third of the 1,000 largest companies in the country have such
policies. Industry analysts estimate that as much as 20 percent of all
new life insurance is taken out by companies on their employees.
But determining the exact size of the market
for corporate- and bank-owned life insurance is impossible. With the
exception of banks, companies do not have to report their insurance
holdings.
“There is no reliable reporting of the use of
who’s buying life insurance, of what they’re buying it for,” said
Steven N. Weisbart, chief economist of the Insurance Information
Institute.
Banks have to report their holdings because
regulators want to know how much cash they could access if they had to
redeem the policies in a pinch before the death of the insured employee.
That figure, known as the “cash surrender
value” — or the amount they could withdraw immediately — provides a
glimpse of just how big such policies can be.
Bank of America’s
policies have a cash surrender value of at least $17.6 billion. If
Wells Fargo had to redeem its policies tomorrow, it would reap at least
$12.7 billion. JPMorgan Chase would collect at least $5 billion,
according to filings with the Federal Financial Institutions Examination Council.
Because banks could collect the cash from
insurance companies quickly, if needed, life insurance holdings are
considered Tier 1 Capital, a basic measure of a bank’s strength. Many
banks have 10 to 25 percent of their Tier 1 Capital invested in life
insurance policies, according to Goldstein Financial Group, a broker
dealer.
Insurance industry experts say that most big
banks have delayed new life insurance purchases, in part because of
limits on how much insurance they can hold. Yet the value of existing
policies continues to grow, with the gains from invested capital
outpacing the benefits paid out as employees die.
Corporate- and bank-owned life insurance grew
out of so-called key person insurance policies that protected companies
against the economic consequences related to the death of top
executives. The New York Times Company has taken out life insurance policies on some top employees.
But absent meaningful regulation around the
practice, it grew unchecked, and soon companies were taking out policies
on many poorly paid employees like janitors, then reaping millions in
profit when they died.
A string of class-action lawsuits, some filed
by Mr. Myers, went after companies abusing the practice. Several
companies, including Walmart, settled the suits, paying millions to low-ranking employees who had been covered. The I.R.S. took companies including Winn-Dixie and Camelot Music to court for using policies as tax avoidance schemes.
Critics began calling the policies “dead peasant” insurance, an allusion to Nikolai Gogol’s novel “Dead Souls,” in which a con man buys up dead serfs to use them as collateral in a business deal.
Despite the criticism, companies and banks
continued to use the policies to chase returns. In the years before the
financial crisis, life insurers for banks including Wachovia and Fifth Third Bancorp invested their premiums in a hedge fund run by Citigroup.
As the value of the fund rose, the profits
were recorded on the companies’ balance sheets, raising earnings. But
when the hedge fund collapsed during the market panic, so did the value
of the policies, leading the banks to take substantial write-downs.
Efforts have been made to better regulate the
practice. The 2006 Pension Protection Act included a set of best
practices for companies taking out life insurance on employees.
“The government has taken great strides to
clean it up,” said J. Todd Chambley, who runs the executive benefits
practice at Aon Hewitt.
Still, the notion of life insurance policies
benefiting company balance sheets, rather than individuals, remains
subject to criticism.
Responding to attacks on the Freedom
Communications plan, Mr. Kushner defended himself in a letter to
employees. “Life insurance is not ghoulish, nor are the people who sell
it, nor are those who buy it,” he wrote. “Life insurance, by its very
nature, was created to benefit the people we love and care about most.”
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