Corporate owned life insurance can
help a corporation fund obligations other than retirement or survivor benefits.
While favorable tax incentives and
employee benefits have enabled the employee stock ownership concept to increase
in popularity and numbers, growing concern about stock repurchase liability is
beginning to surface. If the
liability suddenly becomes a large, immediate cash burden, a company may be
forced to terminate its ESOP, liquidate, go public, or merge with another
larger company simply because it was unable to meet its repurchase obligations.
To solve this problem, a company may purchase COLI policies on the lives of older
(and usually key) ESOP participants.
These policies accumulate cash on a tax-deferred basis, and pay death
benefits income tax free to the employer. Should the participant die, the death benefit can be used by the
corporation to repurchase stock from terminated participants who have received
a distribution of stock from the ESOP. Alternatively, the company can make deductible contributions of cash to
the ESOP (using the death benefit proceeds) to the extent needed for the ESOP
to cash out a terminated participant's stock account. The company can also borrow (within certain limits) against
the cash value of the policies to the extent needed to repurchase stock from terminated participants
Under FAS 106 corporations are now required to account for future post-retirement medical costs for retired and
active employees on an accrual basis. Implementation of this regulation has substantial impact on a company's
income statement. One corporate
response is to implement a tax-free investment trust (VEBA) funded by life
insurance policies taken out on employees.
If VEBA assets are invested in life insurance, earnings are not taxable and
contributions are deductible. In
addition, assets within the VEBA can be used to offset the balance sheet
liability; the secondary purchase of bonds, equities and other investment funds
by the insurance carrier can provide good investment flexibility; secondary
investments in equities provide the best long-term opportunity to offset
potential health care cost increases; the VEBA receives insurance policy death
proceeds tax free; and funds from the investments can be used to pay for
retiree medical expenses as an "unwind" strategy, in the event of changes in health care regulations.