Corporate Life Insurance

Corporate-owned life insurance (COLI) is life insurance on employees' lives that is owned by the employer corporation.

COLI was originally purchased on the lives of key employees and executives by a company to hedge against the financial cost of losing key employees to unexpected death, the risk of recruiting and training replacements of necessary or highly-trained personnel, or to fund corporate obligations to redeem stock upon the death of an owner.

This use is commonly known as "key man" or "key person" insurance.

Death benefits paid under a life insurance policy due to the death of the insured are usually excluded from the taxable income of the beneficiary under the Internal Revenue Code ("IRC").

Because of the tax-free nature of death benefits, the IRC prohibits the deduction of the premiums paid for life insurance when the premium payor is also the owner of the insurance. In addition, loans from insurers secured by policy values are not income and earnings credited to an owner's policy values (known as "inside buildup") by the insurance company are not currently taxed (and may escape taxation altogether if such earnings are not distributed other than as part of the death benefits paid upon the death of the insured).

Interest incurred on indebtedness has historically been deductible, (although the deduction of "personal" interest was largely eliminated in 1986), however, and so in the 1950s a type of "leveraged insurance" transaction began being marketed that permitted an insurance owner to in effect deduct the cost of paying for insurance by (1) paying large premiums to create cash values, (2) "borrowing" against the cash value to in effect strip out the large premiums, and (3) paying deductible "interest" back to the insurer that was in turn credited to the policy's cash value as tax-deferred earnings on the policy that could fund the insurer's legitimate charges against policy value for cost of insurance