Corporate-owned life insurance (COLI), also known as company-owned life insurance, is a life insurance policy an employer takes out on a highly valuable employee, like a founder. The business is the beneficiary of the policy and pays the premiums. If the employee dies, the company gets the death benefit.
A company-owned policy is especially important if your business can’t replace key executives quickly or easily.
How does corporate-owned life insurance work?
Companies use COLI to replace lost profits or expenses if one of their top executives dies. Just as there are different forms of insurance to protect individuals, there are also different types of insurance that a company can use to protect their business. There are two common types of corporate-owned life insurance: key person insurance and split-dollar life insurance.
What is key person life insurance?
Key person insurance insures top executives or other highly skilled employees whose deaths would cause a financial loss to the company. Key person policies are usually term life insurance, but can be permanent life insurance. The business owns the policy, pays the premiums, and is the beneficiary of the payout, which can be used to:
Absorb losses in revenue after the death
Buy out the deceased’s share in the business
Cover outstanding business loans
Pay for recruiting and hiring a replacement
Provide severance if the business has to shut down
Key person insurance is also transferable if the business shuts down. Usually the insured person can either transfer their policy to their next employer or convert it into a private policy. As with all COLI, businesses can’t take out a key person policy on an employee without their knowledge and consent.
Who needs key person insurance?
Businesses of all sizes can benefit from key person life insurance.
Large businesses and corporations: Doctor’s offices, publicly traded companies, and big financial firms need key person life insurance policies. If a top executive’s name or client base helps keep the business afloat, their death can affect every employee.
Startups: Early and late-stage startups often have founders or a small group of key employees whose expertise is hard to replace. However, buying key life insurance for startups can be more complicated because they don’t have a long track record of success.
Small or private businesses: Small businesses typically have owners or partners who would be hard to replace either because of their reputation with clients or their involvement in day-to-day operations.
Business owners should consider protecting any employee whose death would cause a significant financial or operational loss. For most businesses, that’s a CEO, CFO, owner, or partner.
“There’s no excuse for most businesses, especially small businesses, not to have a life insurance policy such as key person insurance,” says Warren Robbins, senior sales associate at Policygenius. “Businesses often skip this step in risk evaluations for business planning, but if you don’t have life insurance for your top employees, you are not mitigating a potentially devastating risk.”
How to buy key person insurance
The process for buying key person coverage is generally the same as buying individual life insurance. The big difference is that in addition to underwriting the insured employee, the business itself also goes through the underwriting process, which is when the insurance company evaluates the risk of covering you with a policy.
Insurers evaluate the organization’s overall financial health and the business value of the key employee you’re insuring. They may ask for:
Annual sales figures
Estimated cost to replace key employee
Fair market value of the company
Gross compensation of key employee
Net profit of the business
This information, plus the health of the employee and amount of coverage you need, will impact how much the policy costs.
We recommend combining key person life insurance with a buy-sell agreement. If a key person (like a partner) dies, the payout from a key person policy gives the surviving executives enough cash to buy out the deceased partner’s shares.
If you know you need a key-person life insurance policy and want to get the process started, you can contact a Policygenius agent for free.
How much key person coverage do businesses need?
Experts recommend key person coverage of between five to 10 times the employee’s gross compensation. Gross compensation includes:
For example, a CEO might have a gross salary of $250,000. But if they also own $80,000 in restricted stock, earn $20,000 in annual bonuses, and have a $10,000 yearly stipend for meals, their gross compensation is $360,000. The business would need between $1.8 million and $3.6 million in key person life insurance for the CEO.
For key person life insurance, like individual life insurance, the advantages of having a policy outweigh the disadvantages. “When shopping for life insurance, many businesses, like many families, say, ‘we’ll do it later,’” says Robbins. “But life insurance is just as vital to a business as it is to a family.”
What is split-dollar life insurance?
Split-dollar insurance is an agreement where two or more parties, often an employer and employee, split the ownership and benefits of a permanent life insurance policy that has a cash value feature. It’s sometimes offered as an executive employee benefit. Split-dollar contracts are most often used by companies to decrease the financial impact of losing a key executive (like a CEO) or as a benefit in executive compensation packages.
Unlike key person insurance, the employer and the employee’s family both benefit from the policy’s payout or cash value. The exact breakdown of how each employer splits the cost and benefits with their employee varies.
Every split-dollar policy must involve two or more parties and share the costs and benefits, but agreements can differ in:
Who pays the premiums
Who owns the policy
Who names the beneficiaries
How the death benefit and cash value is split
When and under what circumstances the agreement ends
All of these details should be laid out in the contract establishing the split-dollar life insurance agreement.
Who owns a split-dollar life insurance policy?
The ownership of split-dollar life insurance is determined by the parties involved in the agreement, though each ownership model comes with its own advantages and disadvantages. A policy can be owned by:
You: You can own a life insurance policy while another party makes part or all of the payments.
Your employer: Like key person insurance, your employer can own the policy and use their portion of the payout to recoup business expenses related to your passing.
A business partner: Small business partners may include a split-dollar contract in their buy-sell agreement, which dictates what happens if one owner exits the business.
A trust: Placing your life insurance policy in an irrevocable life insurance trust means it won’t be counted in the value of your estate.
A family member: Assigning ownership of a permanent policy to a loved one is another method of minimizing future estate taxes.
There are two types of ownership agreements between businesses and employees:
Economic benefit & endorsement agreement: If your employer owns and pays premiums for the life insurance policy in a split-dollar agreement, but you and your beneficiaries get some of the benefits, those benefits are assigned to you using an endorsement agreement. The term “economic benefit” refers to the way the IRS taxes the policy. The policy is taxed as employee pay, which is calculated annually based on the benefits in your policy and the premiums paid by your employer.
Collateral assignment & loan regime: If you own the life insurance policy in the split-dollar agreement but your employer pays the premiums and gets some of the policy benefits, you assign those benefits to your employer with a collateral assignment agreement. The IRS treats the premiums paid by your employer as an annual, interest-free loan to you (a loan regime). Their share of the policy benefits repayment for the loan. You pay tax on the interest that would have been charged if this were a traditional loan (known as the applicable federal rate or AFR). 
Loan regime agreements are more complex to set up, but have greater tax benefits because you’re not taxed on the value of your policy benefits.
In either type of agreement, how and when your split-dollar plan ends is laid out in the contract. Most of the time, if you leave the company for another job or retire, the company either terminates your policy or gives you the option to port it at your expense.
Pros & cons of split-dollar life insurance
Because tax regulations for the benefit became stricter in 2003,  split-dollar contracts are not as common anymore. However, this type of policy still has some uses in small business and estate plans.
Employer subsidizes the premiums for a generally costly permanent policy
Helps attract top talent as an employee benefit
Can shield your permanent policy from estate taxes
Cash value may provide additional retirement savings
If you leave your job, your employer must give up your policy or you’ll have to pay the premiums yourself
Cash value accounts generally have a low rate of return when compared to traditional investments
Can making filing taxes complicated for the individual or the employer
Permanent policies are more expensive than term life insurance and usually unnecessary
How does split-dollar life insurance work for estate planning?
Also known as private split-dollar life insurance, these are agreements between individuals or involving an irrevocable life insurance trust. The contracts protect your life insurance proceeds from an estate tax.
Depending on how you execute the plan, you may face a gift tax, which applies to assets gifted between family members. There’s a yearly limit of $18,000 and a lifetime threshold equal to the estate tax limit.  Work with a certified financial planner if you want to explore this option.
If you’re interested in making split-dollar life insurance part of your business or estate plans, make sure to consult a licensed professional. The best plan for you will depend on the financial needs of your business, business partners, and your family.
Why is corporate-owned life insurance called dead peasant insurance?
The nickname “dead peasant insurance” started in the 1980s, when several large companies — including Walmart, Procter & Gamble, Nestle, and Winn-Dixie — bought corporate-owned life insurance policies on thousands of regular employees. 
This was done for tax benefits, not to profit from the deaths of employees. But because companies did it without telling employees — and raked in millions through tax breaks and death benefits — critics started calling it dead peasant insurance.
The term references the Nikolai Gogol novel, Dead Souls, in which the main character buys dead serfs from landowners to use as collateral for a massive loan in a get-rich-quick scheme.
Dead peasant insurance isn’t the same as group life insurance, which is an employee benefit where the company pays some or all of the premiums for your own policy.
Does your employer have corporate-owned life insurance?
It’s very unlikely you’re insured under a COLI policy without knowing it. After media attention and publicized lawsuits exposed employers that abused COLI, the 2006 Pension Protection Act put new regulations on corporate-owned policies. 
Today, if your employer wants to get life insurance coverage for you and name themselves as the beneficiary, they must follow these guidelines:
You must be notified and give written consent.
COLI can only be taken out on the top 35% of highest-paid employees.
Your employer can’t punish you for rejecting the plan.
Corporate-owned life insurance isn’t illegal as long as an employer follows these guidelines. If you’re not sure if you agreed to a corporate-owned policy before, check with your HR department or benefits manager — they’re required to let you know.
If you’re a business owner, you may need a company-owned policy in addition to a personal policy for your loved ones. An independent insurance broker can help you find the right combination of life insurance to protect your family and your business.