Business-Owned Life Insurance
More Data Could Be Useful in Making Tax Policy Decisions
Gao ID: GAO-04-303 May 13, 2004
Business-owned life insurance is permanent insurance held by employers on the lives of their employees, and the employer is the beneficiary of these policies. Its attractive features, common to all permanent life insurance, generally include both tax-deferred accumulation of earnings on the policies' cash value and tax-free receipt of the death benefit. Legislators have expressed concerns about the ability of employers to receive tax-favored treatment from insuring their employees' lives. GAO was asked to discuss (1) the prevalence and use of business-owned life insurance, (2) federal and state regulation and oversight of these policies, and (3) the potential usefulness of and costs associated with obtaining more comprehensive data on business-owned life insurance.
Limited data are available on the prevalence and use of business-owned life insurance. Federal bank regulators have financial reporting requirements, but not all institutions holding policies meet reporting thresholds. The Securities and Exchange Commission (SEC), the Internal Revenue Service (IRS), and state insurance regulators told GAO that they generally have not collected comprehensive policy data because they have not had a need for such data in fulfilling their regulatory missions. GAO found, however, that some insurers have disclosed information about policy sales. Also, the Joint Committee on Taxation and the Office of Management and Budget have reported estimates of forgone tax revenues from these policies as $7.3 billion to $13 billion for the period 2004-2008, excluding forgone tax revenues on additional income from death benefit payments. Regulators said that they do not generally collect data on the intended use of policies, but that businesses can, for example, use business continuation policies to insure against the loss of a key employee or broad-based policies to fund employee benefits. The federal bank regulators told GAO that they have reviewed the holdings of institutions with significant amounts of business-owned life insurance against their guidelines and concluded that no major supervisory concerns exist. SEC officials said that the agency has relied on its broadly applicable requirement that public companies disclose information material to investors in their financial statements, which would include any material information related to business-owned life insurance; SEC did not have investor protection concerns about public firms' ownership of the insurance. IRS had some requirements related to the tax treatment of the insurance and is reviewing compliance with these requirements. State laws governing the insurance differed; the four states' regulators that GAO contacted described limited oversight of the policies, and these regulators and the National Association of Insurance Commissioners (NAIC) generally reported no problems with the policies. More comprehensive data could be useful to Congress in assessing the potential effects of legislative proposals that address the tax-favored treatment of business-owned life insurance. Costs would be incurred in obtaining the data. Such data would be most useful if reported separately for business continuation and broad-based policies because legislative proposals have generally treated these policies differently. Data on the amount of tax-free income that businesses received from death benefits could help explain the potential effect of changes to the tax treatment of policies on tax revenues. Businesses holding the policies or insurance companies that sold them could provide this and other data. SEC, Department of the Treasury (Treasury), and NAIC already collect financial information from businesses and insurers and could be required or asked to collect the data. Should Congress decide that the data would be useful, decisions would be required on, among other things, whether the benefits of collecting the data outweigh the costs of doing so.
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GAO-04-303, Business-Owned Life Insurance: More Data Could Be Useful in Making Tax Policy Decisions
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Report to Congressional Requesters:
May 2004:
BUSINESS-OWNED LIFE INSURANCE:
More Data Could Be Useful in Making Tax Policy Decisions:
GAO-04-303:
GAO Highlights:
Highlights of GAO-04-303, a report to congressional requesters
Why GAO Did This Study:
Business-owned life insurance is permanent insurance held by employers
on the lives of their employees, and the employer is the beneficiary of
these policies. Its attractive features, common to all permanent life
insurance, generally include both tax-deferred accumulation of earnings
on the policies‘ cash value and tax-free receipt of the death benefit.
Legislators have expressed concerns about the ability of employers to
receive tax-favored treatment from insuring their employees‘ lives.
GAO was asked to discuss (1) the prevalence and use of business-owned
life insurance, (2) federal and state regulation and oversight of these
policies, and (3) the potential usefulness of and costs associated with
obtaining more comprehensive data on business-owned life insurance.
What GAO Found:
Limited data are available on the prevalence and use of business-owned
life insurance. Federal bank regulators have financial reporting
requirements, but not all institutions holding policies meet reporting
thresholds. The Securities and Exchange Commission (SEC), the Internal
Revenue Service (IRS), and state insurance regulators told GAO that
they generally have not collected comprehensive policy data because
they have not had a need for such data in fulfilling their regulatory
missions. GAO found, however, that some insurers have disclosed
information about policy sales. Also, the Joint Committee on Taxation
and the Office of Management and Budget have reported estimates of
forgone tax revenues from these policies as $7.3 billion to $13 billion
for the period 2004–2008, excluding forgone tax revenues on additional
income from death benefit payments. Regulators said that they do not
generally collect data on the intended use of policies, but that
businesses can, for example, use business continuation policies to
insure against the loss of a key employee or broad-based policies to
fund employee benefits.
The federal bank regulators told GAO that they have reviewed the
holdings of institutions with significant amounts of business-owned
life insurance against their guidelines and concluded that no major
supervisory concerns exist. SEC officials said that the agency has
relied on its broadly applicable requirement that public companies
disclose information material to investors in their financial
statements, which would include any material information related to
business-owned life insurance; SEC did not have investor protection
concerns about public firms‘ ownership of the insurance. IRS had some
requirements related to the tax treatment of the insurance and is
reviewing compliance with these requirements. State laws governing the
insurance differed; the four states‘ regulators that GAO contacted
described limited oversight of the policies, and these regulators and
the National Association of Insurance Commissioners (NAIC) generally
reported no problems with the policies.
More comprehensive data could be useful to Congress in assessing the
potential effects of legislative proposals that address the tax-favored
treatment of business-owned life insurance. Costs would be incurred in
obtaining the data. Such data would be most useful if reported
separately for business continuation and broad-based policies because
legislative proposals have generally treated these policies
differently. Data on the amount of tax-free income that businesses
received from death benefits could help explain the potential effect of
changes to the tax treatment of policies on tax revenues. Businesses
holding the policies or insurance companies that sold them could
provide this and other data. SEC, Department of the Treasury
(Treasury), and NAIC already collect financial information from
businesses and insurers and could be required or asked to collect the
data. Should Congress decide that the data would be useful, decisions
would be required on, among other things, whether the benefits of
collecting the data outweigh the costs of doing so.
What GAO Recommends:
If Congress decides that it needs more data on business-owned life
insurance, it may wish to consider having SEC, Treasury, or NAIC
collect the data from businesses or insurance companies. SEC and
Treasury expressed reservations about collecting the data, noting that
the data is not needed to fulfill their regulatory missions. GAO
recognized that these agencies do not need the data to fulfill their
regulatory missions. That is, the data would be used in making tax
policy decisions rather than doing regulatory oversight.
www.gao.gov/cgi-bin/getrpt?GAO-04-303.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Davi M. D'Agostino at
(202) 512-8678 or dagostinod@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Available Information on the Prevalence and Use of Business-Owned Life
Insurance Is Limited:
Regulators Have Applied Their Guidelines or Requirements and Have
Generally Not Had Significant Regulatory Concerns about Business-Owned
Life Insurance:
More Comprehensive Data Could Be Useful to Congress; Costs Would Be
Incurred in Obtaining the Data:
Conclusions:
Matter for Congressional Consideration:
Agency Comments and Our Evaluation:
Appendixes:
Appendix I: Scope and Methodology:
Appendix II: State Insurable Interest and Consent Provisions:
Appendix III: Comments from the Department of the Treasury:
GAO Comments:
Appendix IV: Comments from the Internal Revenue Service:
Appendix V: Comments from the Securities and Exchange Commission:
GAO Comments:
Appendix VI: Comments from the National Association of Insurance
Commissioners:
GAO Comments:
Appendix VII: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Staff Acknowledgments:
Tables:
Table 1: Banks and Thrifts with the Largest Concentrations of Business-
Owned Life Insurance as of December 31, 2002, and Issues Cited in
Regulators' Most Recent Examinations:
Table 2: State Insurable Interest and Consent Laws Applicable to
Business-Owned Life Insurance in Selected States as of December 31,
2003:
Table 3: State Insurable Interest and Consent Laws Applicable to
Business-Owned Life Insurance as of December 31, 2003:
Figures:
Figure 1: Cash Surrender Value of Business-Owned Life Insurance Reported
by Some Banks and Thrifts as of December 31, 2002:
Figure 2: NAIC Model Guidelines on Business-Owned Life Insurance,
December 2002 Revision:
Abbreviations:
FDIC: Federal Deposit Insurance Corporation:
IRS: Internal Revenue Service:
NAIC: National Association of Insurance Commissioners:
OCC: Office of the Comptroller of the Currency:
OMB: Office of Management and Budget:
OTS: Office of Thrift Supervision:
SEC: Securities and Exchange Commission:
Letter May 13, 2004:
The Honorable Daniel K. Akaka:
The Honorable Jeff Bingaman:
United States Senate:
Congress has debated the appropriate income tax treatment of business-
owned life insurance since at least the mid-1980s and is likely to
continue doing so. Most recently, some members of Congress have
expressed concern that more complete data are not available describing
the prevalence and use of the insurance, information that could be used
in assessing its income tax treatment and related policy issues.
Business-owned life insurance--including corporate-owned, bank-owned,
and trust-owned life insurance--is permanent insurance[Footnote 1] that
an employer purchases on the lives of its employees, with the business
as the policy beneficiary.[Footnote 2] Attractive features of business-
owned life insurance, which are features common to all permanent life
insurance, generally include both tax-deferred earnings on the
policies' cash value and, if the policy is held until the death of the
insured, tax-free income from the death benefit itself. Some business-
owned life insurance protects against the death of owners or key
employees (business continuation insurance), while some of it covers
larger groups of employees (broad-based insurance). Generally,
businesses can retain ownership of these policies after the employment
relationship has ended.
Before 1986, businesses could take loans against the cash value of
their business-owned life insurance policies and deduct the interest
expense from their taxable income without limitation. To address
concerns that businesses were abusing their ability to deduct these
interest expenses, Congress passed legislation in 1986 and 1996 to
limit this practice. The Internal Revenue Service (IRS) and Department
of Justice also pursued litigation against some businesses.
Nonetheless, public policy issues have remained regarding the extent to
which businesses should be allowed to benefit from insuring their
employees' lives, with or without their consent, and the extent to
which they should be allowed to receive tax advantages from holding
these policies. Proponents of continuing the tax advantages of broad-
based business-owned life insurance assert that these advantages are
important to financing employee benefits because rules relating to
other tax-favored financing mechanisms for employee benefits are too
restrictive.[Footnote 3] Some proponents also assert that changing the
tax treatment of business-owned life insurance would affect businesses'
ability to provide employee benefits. Opponents of continuing the tax
advantages of broad-based business-owned life insurance, while not
directly addressing the potential effect of a change in tax treatment
on the provision of employee benefits, state that Congress has already
provided specific tax-favored financing mechanisms for these benefits
and has determined the appropriate scope of such financing. Some
opponents are also concerned that policy proceeds can be used for any
purpose, even when the purchase was justified based on projected
employee benefit liabilities, and that the tax-favored treatment of the
policies gives them a competitive advantage over other investments.
This report provides information for use in discussing the public
policy issues related to permanent business-owned life insurance and
expands on the preliminary observations we presented in October 2003
testimony before the Senate Finance Committee.[Footnote 4] As agreed
with your staff, the report discusses (1) the prevalence and use of
business-owned life insurance, (2) federal and state regulatory
requirements for and oversight of business-owned life insurance, and
(3) the potential usefulness of and costs associated with obtaining
more comprehensive data on business-owned life insurance.
To obtain information on the prevalence and use of business-owned life
insurance, we met with officials from federal agencies that require
financial reporting from businesses, including: the federal bank
regulators--meaning for this report, the Board of Governors of the
Federal Reserve System (the Federal Reserve), Federal Deposit Insurance
Corporation (FDIC), Office of the Comptroller of the Currency (OCC),
and Office of Thrift Supervision (OTS);[Footnote 5] the Securities and
Exchange Commission (SEC); and IRS. We analyzed quarterly financial
reports that banks and thrifts filed with federal bank regulators and
annual financial reports (Forms 10-K) that publicly traded companies
filed with SEC. In addition, we obtained some information on the
prevalence and use of such insurance from the National Association of
Insurance Commissioners (NAIC) and two life insurance trade
associations.[Footnote 6] We considered conducting a survey of life
insurance companies to gather additional data but did not do so after a
survey pretest in which insurance companies' representatives told us
that their companies did not routinely maintain the data we sought. We
did not verify the accuracy of their statements. To describe federal
and state regulatory requirements for and oversight of business-owned
life insurance, we obtained information from officials of the federal
bank regulators, SEC, IRS, NAIC, and the insurance departments of four
states with differing business-owned life insurance provisions. To
address the potential usefulness of and costs associated with obtaining
more comprehensive data on business-owned life insurance, we reviewed
legislative proposals to determine the types of data that could be
useful and IRS, SEC, and NAIC's reporting forms and instructions to
understand what role these organizations or the Department of the
Treasury (Treasury) might play in collecting more comprehensive data.
We also discussed the challenges insurers might face in providing data
and organizations might face in collecting it with insurance companies,
Treasury (including IRS), SEC, and NAIC representatives, as applicable.
Appendix I provides detailed information on our scope and methodology.
We conducted our work between February 2003 and December 2003, in
accordance with generally accepted government auditing standards.
Results in Brief:
Federal and state regulators, in pursuing their regulatory
responsibilities, have collected limited data on the prevalence and use
of business-owned life insurance. Federal bank regulators have
collected more data than other regulators. Our analysis of the data
showed that at least one-third of banks and thrifts held business-owned
life insurance with a total cash surrender value of more than $56
billion as of December 31, 2002, and that banks and thrifts earned at
least $2 billion from such policies in 2002.[Footnote 7] We also found
that, although SEC does not specifically require reporting on business-
owned life insurance, nine of the largest life insurance companies
reported to SEC in their Forms 10-K total premiums of more than $3
billion in 2002 from their sales of such insurance. Also, surveys of
life insurance companies estimated that premiums from new sales of
business-owned life insurance totaled more than $9 billion in 2001.
Further, although IRS has not collected comprehensive tax-related data
on business-owned life insurance policies, the Joint Committee on
Taxation and the Office of Management and Budget (OMB) have reported
estimates of forgone tax revenues from these policies as $7.3 billion
to $13 billion for the period 2004-2008, excluding forgone tax revenues
on additional income from death benefit payments. State insurance
regulators have collected extensive financial information from
insurance companies, but the data have not addressed the prevalence of
business-owned life insurance. Some state insurable interest laws
permit businesses to purchase business-owned life insurance to provide
for business continuation when a key employee dies or as a strategy to
help defray the costs of providing a variety of benefits to current and
retired employees. However, unless a business places its policies in a
trust that restricts the use of the proceeds to specific purposes, the
business may use the proceeds for any purpose. Although federal and
state regulators generally have not collected data that distinguish
among the uses of business-owned life insurance, we found examples of
how businesses stated they intended to use such policies from our
analysis of Forms 10-K and a consulting firm's survey.
Federal bank regulators, SEC, IRS, and four state insurance regulators
that we contacted have issued guidelines or requirements that are
applicable to business-owned life insurance and generally have not had
significant regulatory concerns about such insurance. As part of their
responsibility to oversee the safety and soundness of banks and
thrifts, the federal bank regulators have issued guidelines for
institutions that buy business-owned life insurance. These regulators
told us that they have applied the guidelines in their risk-based
examinations of institutions with significant amounts of business-owned
life insurance and generally have concluded that no major supervisory
concerns exist. SEC officials said that the agency had not issued
specific requirements for holders of business-owned life insurance,
relying instead on its broadly applicable requirement that public
companies disclose information material to investors in their financial
statements. These officials also said that, in the absence of any past
problems, SEC did not have investor-protection concerns about public
firms' ownership of business-owned life insurance. The Internal Revenue
Code includes statutory requirements and IRS has issued regulatory
requirements related to the tax treatment of the insurance. IRS
officials said that the agency has been studying potential concerns
related to the use of the policies. State laws governing business-owned
life insurance differed; the four states' regulators that we contacted
described limited oversight of the policies, primarily involving the
regulators' review of proposed policy forms that insurers must submit
for approval before using the forms to sell policies in their states.
The state officials said that their departments had not routinely
verified that employees covered by the policies had consented to being
insured. However, these regulators and NAIC generally reported no
problems with the policies.
More comprehensive data on the prevalence and use of business-owned
life insurance could be useful to Congress in assessing the potential
effects of legislative proposals that address the tax-favored treatment
of the insurance. Costs would be incurred in obtaining the data. Such
data would be most useful if reported separately for business
continuation and broad-based policies because legislative proposals
that would further limit the tax-favored treatment of these policies
generally have treated these policies differently. Data on both
categories could help in understanding the proportion of the total
business-owned life insurance market that might be affected by future
legislative proposals. Useful data that are not available include the
amount of tax-free death benefit income that businesses received from
these two types of policies--data that could help Congress better
understand the potential effect of changes to their tax treatment on
tax revenues. Other data on business continuation and broad-based
policies that might be helpful to Congress in evaluating the potential
effects of legislative proposals on businesses, their employees, and
insurance companies include the annual premiums paid on new policies,
the number and types of businesses that hold such policies, and the
number of covered employees. Businesses that hold the policies or
insurance companies that sold them could provide the data, but both
types of entities would incur administrative costs in extracting the
required information from their records and summarizing it. We did not
discuss these costs with businesses, however, we expect that they would
maintain records from which the required data could be extracted. Also,
some businesses already aggregate this information for use in
completing forms filed with IRS and SEC, which suggests that some
businesses would not have difficulty providing the data. Nonetheless,
businesses might differ in their willingness to voluntarily provide the
data, depending at least in part on the cost and their perception of
the benefits of doing so. While we did not independently determine the
costs that insurers would incur in collecting the data, officials from
several insurance companies told us that extensive effort would be
required to identify the relevant policies. Although businesses might
be able to identify the policies and provide the data more easily,
requiring insurance companies to provide the data would substantially
limit the number of affected entities. Similar to the data providers,
the organization collecting, analyzing, and reporting the data would
incur costs. SEC, Treasury, and NAIC are candidates for this role
because each already collects financial information from businesses,
insurers, or both and could modify existing reporting forms or,
alternatively, conduct a survey to obtain the data.
This report includes a matter that Congress may want to consider if it
decides that it needs more comprehensive data on the prevalence and use
of business-owned life insurance. Specifically, Congress could direct
SEC or Treasury or encourage NAIC to obtain the needed data from either
the holders of business-owned life insurance or life insurance
companies.
We received written comments on a draft of this report from Treasury,
IRS, SEC, and NAIC that are reprinted in appendixes III-VI,
respectively. Treasury commented that the report is well-researched and
informative. In response to the matter for congressional consideration,
SEC and Treasury expressed reservations about having a potential role
in collecting data on business-owned life insurance, stating that
assuming such a role would not be necessary to fulfill their regulatory
missions. We recognized in the report that these agencies do not need
the data to fulfill their regulatory missions. That is, the data would
be used in making tax policy decisions rather than doing regulatory
oversight. NAIC did not express reservations about collecting the data,
but said that it would like to better understand and evaluate the need
for and utility of the data and favored using a survey as an initial
step in the data gathering process. The comments are discussed in
greater detail at the end of this letter.
Background:
A business is generally allowed to insure an employee's life when the
business has an insurable interest in the employee.[Footnote 8]
Insurable interest is defined by state law and, once established at the
time of purchase, continues for the life of the insured.[Footnote 9]
Thus, a business generally may maintain life insurance on employees
even after their employment has ended. Business-owned life insurance
can refer to corporate-owned life insurance (held by all types of
corporations or only nonbank corporations), bank-owned life insurance,
trust-owned life insurance (held by business-established trusts), or
all three.[Footnote 10]
Business-owned life insurance is permanent life insurance, which has an
insurance component and a savings component. The premium for a newly
issued permanent life insurance policy pays for the insurance
component, but the premium initially exceeds the cost of providing life
insurance protection for the insured person. The excess amount is added
to the policy's cash value, which earns interest or other investment
income--called inside buildup. The inside buildup is accrued income
because the policyholder does not receive cash payment as the policy
earns income.
The Internal Revenue Code allows for the deferral of income tax on the
accumulated inside buildup on life insurance policies and some other
investments that appreciate in value, such as stocks, some bonds, and
real estate.[Footnote 11] However, the Internal Revenue Code provides
for income tax-free death benefit payments on life insurance, so that
unlike other investments, the accrued income is not taxed if the policy
is held until the insured party's death. However, if a policy owner
surrenders a policy before the death of the insured, the owner may
incur a tax liability to the extent that the policy's cash surrender
value exceeds its cost base and may incur a tax penalty. The cost base
is equal to the total premiums paid less dividends and withdrawals
received from the policy. Also, if a business owns life insurance
policies, the annual earnings and death benefit proceeds are among the
factors that could make the business subject to the alternative minimum
tax.[Footnote 12]
To qualify as life insurance for tax purposes, a contract must qualify
as a life insurance contract under applicable state law and meet one of
two tests defined in Internal Revenue Code section 7702 to ensure that
the contract is not overly investment oriented.[Footnote 13] In
addition, while policy owners may access the cash value of their
policies by borrowing against them, policy owners' ability to deduct
the interest on such loans in connection with policies covering
employees, officers, and individuals financially interested in the
business was limited to loans up to $50,000 per policy by the Tax
Reform Act of 1986.[Footnote 14] The Health Insurance Portability and
Accountability Act of 1996 eliminated the interest deductibility for
these individuals, except for policies on a limited number of key
persons.[Footnote 15] Before the limitations adopted in 1986 and 1996,
some businesses purchased "leveraged business-owned life insurance," in
which they leveraged their life insurance ownership by borrowing
against the policies to pay a substantial portion of the insurance
premiums and in doing so incurred a tax-deductible interest expense
while realizing tax-free investment returns.[Footnote 16]
State and federal legislatures considered numerous proposals in 2003
and early 2004 that would change the conditions under which businesses
may purchase business-owned life insurance, the consent requirements
for such purchases, or the tax treatment of the insurance. For example,
California considered and passed a law to prohibit businesses from
purchasing life insurance policies on employees that are not exempt
from the state's overtime compensation requirements. Texas considered,
but did not adopt, a proposal to prohibit business-owned life insurance
except in certain cases, such as when an employee is eligible to
participate in an employee benefit plan and consents to being insured.
Also, several members of Congress introduced legislation in 2003 that
would have required employee consent or limited the tax-favored
treatment of business-owned life insurance on policies taken out on
employees that were not key persons, although none had been enacted by
the end of the first session of the 108th Congress. The legislation
would have affected the tax-favored treatment of such policies in
various ways, such as taxing policy earnings and income from death
benefits except on key person policies, taxing the death benefit
payments on policies where the employee died more than 1 year after
leaving employment, and limiting allowed deductions for a business's
general interest expenses based on its business-owned life insurance
holdings. In addition, pension legislation that the Senate Finance
Committee passed in February 2004 included provisions that would
generally limit the tax-favored treatment of business-owned life
insurance, except for policies on those individuals the legislation
defined as key persons; require employees' written consent for a
business to hold insurance on their lives; and require businesses to
report policy information to IRS.
Available Information on the Prevalence and Use of Business-Owned Life
Insurance Is Limited:
In pursuing their regulatory missions, federal and state regulators
have collected limited information on the prevalence and use of
business-owned life insurance. Federal bank regulators have collected
more data than other regulators on the prevalence of business-owned
life insurance; however, the data are limited because the regulators
did not require all banks and thrifts to report it. While SEC has not
specifically required reporting on business-owned life insurance, we
found that some life insurance companies had reported information on
policy sales in their Forms 10-K and in a life insurance industry
survey. Federal revenue estimators have estimated the annual forgone
tax revenue attributable to earnings on the insurance, although IRS has
not required businesses to report on the prevalence of business-owned
life insurance. Information at the state level is limited, however,
because state insurance regulators have not collected information on
the prevalence of the policies through their financial reporting forms.
Some state laws permit businesses to purchase business-owned life
insurance for business continuation purposes or in connection with
employee benefit plans, but businesses generally are not obligated to
use the death benefit proceeds for a particular purpose. Although
federal and state regulators generally have not collected data on the
uses of business-owned life insurance, we found some examples of how
businesses said they intended to use such policies.
Federal Bank Regulators Have Collected the Most Data on the Prevalence
of the Policies, but Not All Banks and Thrifts Provided Information:
In monitoring the safety and soundness of individual institutions,
federal bank regulators have collected more financial information than
other federal and state regulators on business-owned life insurance
policies. For supervisory purposes, federal bank regulators have
required that regulated institutions disclose in quarterly financial
reports earnings from and the cash surrender value of business-owned
life insurance if the amounts exceed a certain threshold. As discussed
below, the regulators have used the amounts reported to determine the
need for further review of institutions' risk exposure. Business-owned
life insurance is an asset reported at cash surrender value--that is,
the sum of accumulated premium payments and inside buildup, less
accumulated insurance costs, fees, and charges that the policyholder
would be required to pay for surrendering the policy. It does not take
into account income tax liabilities that might result from the
surrender. The Federal Reserve, FDIC, and OCC require the institutions
they regulate to disclose the cash surrender value of policies worth
more than $25,000 in aggregate and exceeding 25 percent of "other
assets," which include such items as repossessed personal property and
prepaid expenses. Through the end of 2003, OTS required the thrifts it
supervises to report the cash surrender value of policies if the value
was one of the three largest components of "other assets;" in 2004, OTS
began requiring all the thrifts it supervises to report the cash
surrender value of their policies.
We found that about one-third of banks and thrifts--3,209 of 9,439,
including many of the largest institutions--had disclosed the cash
surrender value of their business-owned life insurance holdings as of
December 31, 2002.[Footnote 17] The remaining two-thirds either did not
hold business-owned life insurance or held such insurance but did not
meet the reporting threshold. The total cash surrender value of
reporting institutions' policies was $56.3 billion. A total of 259
banks and thrifts with assets of $1 billion or more owned 88 percent
($49.4 billion) of the total reported cash surrender value (fig. 1).
These 259 institutions included 23 banks and thrifts that were among
the top 50 largest institutions and that owned 66 percent ($36.9
billion) of the total reported cash surrender value. Because not all
institutions that owned policies met the reporting threshold, these
data indicate the minimum number of institutions that held business-
owned life insurance and the aggregate cash surrender value of their
policies; with this data we could not estimate the prevalence of
business-owned life insurance or its value among institutions that did
not report on their holdings.
Figure 1: Cash Surrender Value of Business-Owned Life Insurance
Reported by Some Banks and Thrifts as of December 31, 2002:
[See PDF for image]
[End of figure]
The federal bank regulators' thresholds for reporting business-owned
life insurance earnings differed from the ones for reporting cash
surrender value, so not all of the same institutions reported earnings
as reported cash surrender value.[Footnote 18] We found that nearly
one-fifth of banks and thrifts reported their 2002 annual earnings on
the cash surrender value of business-owned life insurance. As of
December 31, 2002, some 1,563 institutions reported $2.2 billion in
such earnings.
SEC Has Not Specifically Required Reporting on the Policies, but Some
Insurers Have Reported Sales:
SEC officials told us that the agency has not specifically required
businesses to report on their purchases or sales of business-owned life
insurance because such data generally are not material to public
companies. According to SEC officials, agency regulations do not
specifically require public companies to disclose the value of their
business-owned life insurance in the financial statements submitted to
the agency. Similarly, SEC does not specifically require public
companies that sell business-owned life insurance to report on those
sales. Rather, in administering federal securities laws, SEC requires
public companies to prepare their financial statements in accordance
with generally accepted accounting principles, which would require them
to disclose information about business-owned life insurance policies
that is material--that is, according to SEC, information that an
investor would consider important in deciding whether to buy or sell a
security or in making a voting decision related to a security that the
investor owns.[Footnote 19] According to SEC officials, however,
following generally accepted accounting principles would rarely require
holdings of and earnings from business-owned life insurance to be shown
as separate line items because they are unlikely to be financially
material to a company.
Although SEC does not explicitly require insurance companies to report
information on the business-owned life insurance policies they have
sold, some insurance companies have disclosed such information on their
Forms 10-K. By reporting their revenue from business-owned life
insurance premiums, life insurance companies show how significant sales
of such policies are compared with total sales; they also provide an
indication of the level of demand for business-owned life insurance. We
reviewed the Forms 10-K of 32 life insurance companies that were among
the 50 largest such companies ranked by assets. We found that nine
insurers reported receiving, in aggregate, over $3 billion in total
business-owned life insurance premiums in 2002 from new and, in some
cases, previous sales. The amount of business-owned life insurance
premiums received in 2002 ranged from 11 to 53 percent of each
company's 2002 total life insurance premiums for the four companies
that reported this information. In addition, three insurance companies
reported the accumulated cash surrender value of business-owned life
insurance policies they had previously sold as totaling about $28
billion as of December 31, 2002.
Separate from reporting to SEC, some insurance companies have also
reported business-owned life insurance sales in response to industry
surveys. CAST Management Consultants, Inc., conducts research on
business-owned life insurance and has reported on premiums paid on new
policies. A life insurance industry association and life insurance
companies cited CAST's surveys as the only currently available
information on aggregate business-owned life insurance premiums. CAST
estimated that in 2001, premiums from new sales of business-owned life
insurance totaled $9.3 billion: $5.2 billion in bank-owned life
insurance premiums and $4.1 billion in corporate-owned (excluding bank-
owned) life insurance premiums. CAST also estimated that in 2002,
premiums from new sales of corporate-owned (excluding bank-owned) life
insurance totaled $3.2 billion. CAST did not estimate bank-owned life
insurance premiums for 2002. CAST's estimates were based on responses
to a 2003 survey concerning corporate-owned life insurance premiums and
a 2002 survey concerning bank-owned life insurance, increased by CAST
adjustments. Each survey received responses from 20 life insurance
companies, although not all of the same companies responded to both
surveys.[Footnote 20] In addition, a representative of the A.M. Best
insurer rating company said that the company collects information on
business-owned life insurance, but does not currently report the data.
A.M. Best reported aggregate premiums from business-owned life
insurance for 1998 (the last year for which it reported data) as more
than $10 billion for 20 large insurers.[Footnote 21] Because these
surveys did not use statistical samples of insurers, the resulting
estimates made from the limited number of respondents do not represent
statistically valid estimates of all business-owned life insurance
sales and, therefore, our interpretation of the resulting data is
limited. The statistics from these surveys are meant to indicate only
that some large insurance companies have had active sales in recent
years and that the premiums in the aggregate are significant.
IRS Has Not Collected Information on the Policies, but Federal Revenue
Estimators Have Estimated the Forgone Tax Revenues:
IRS officials told us that the agency has not generally required
businesses to report on the value of, earnings on, or death benefit
income from business-owned life insurance policies. The officials noted
that these amounts are not typically included in taxable income and
that, therefore, the information is generally not needed. Businesses
that are subject to the alternative minimum tax include income from
death benefits and earnings from insurance when calculating the tax,
but they are not required to list the insurance-related values on the
alternative minimum tax form. Also, businesses that are required to
complete Schedule M-1, Reconciliation of Income (Loss) per Books with
Income per Return, as part of their Form 1120, U.S. Corporation Income
Tax Return, would report earnings on business-owned life insurance as
part of the income recorded on their books but not on the tax return.
However, according to IRS officials, these earnings might not be
identified as earnings from business-owned life insurance, as they are
often lumped together with other adjustments.[Footnote 22]
Federal revenue estimators have estimated that the current tax
treatment of earnings on the cash value of business-owned life
insurance results in over a billion dollars in forgone tax revenues
annually. In its "Estimates of Federal Tax Expenditures for Fiscal
Years 2004-2008," prepared for congressional use in analyzing the
federal budget, the Joint Committee on Taxation estimated that the
forgone tax revenues resulting from the tax treatment of investment
income on life insurance for corporations would total $7.3 billion for
2004 through 2008. Similarly, OMB, in its fiscal year 2005 budget
"Analytical Perspectives," reported Treasury's estimate of forgone tax
revenues resulting from the tax treatment of life insurance as $13
billion for 2004 through 2008. These estimates assumed policies would
be held until the insureds' deaths, making the current tax-deferred
earnings tax-free. The estimates did not reflect the forgone tax
revenues on the additional income from death benefit payments in excess
of the premiums paid and the accumulated tax-deferred earnings.
Officials involved in preparing these estimates said that, lacking
comprehensive data on the earnings on business-owned life insurance,
they developed their estimates using available data on life insurance
companies' investment income and assumptions about business-owned life
insurance's share of the total life insurance market.
State Insurance Regulators Have Not Collected Data on the Prevalence of
the Policies:
State insurance regulators, concerned with state requirements, rates,
and solvency issues, have collected extensive financial information
from insurers through NAIC's standardized financial reporting forms,
but not at the level of detail that would describe the prevalence of
business-owned life insurance policies. State insurance regulators use
insurers' financial statements to monitor individual companies'
solvency. According to the four state regulators we contacted and NAIC,
information on business-owned life insurance is not required or
necessary for regulating solvency.[Footnote 23] Insurers' financial
statements list the number of policies and premiums collected during
the reporting period, but the amounts are broken out only by individual
and group policies, not by whether businesses or individuals owned the
policies.
Businesses May Purchase Business-Owned Life Insurance for Various
Purposes but Generally Are Not Required to Use Policy Proceeds for
Those Purposes:
Under state laws that define insurable interest, businesses may
purchase life insurance for various purposes, including for business
continuation--that is, to ensure that a business can continue to
operate when a key employee or owner dies. Historically, insurable
interest reflected a family or business's dependency on an individual
and the risk of financial loss in the event of that individual's death.
Accordingly, a traditional use of business-owned life insurance is as
key-person insurance, which is intended to ensure recovery of losses--
such as a loss of earnings or added hiring costs--in the event of the
death of key employees. In addition, businesses may use business-owned
life insurance as part of "buy-sell arrangements" that allow the
surviving owners to use the death benefits to purchase a deceased
owner's share of the business from the estate or heirs.
In the 1980s and 1990s, several states expanded their definitions of
employers' insurable interest to permit purchases of broad-based
business-owned life insurance in connection with employee compensation
and benefit programs. Several of these states limit the aggregate
amount of insurance coverage on nonmanagement employees to an amount
commensurate with the business's employee benefit plan liabilities or
require that insured employees be eligible to receive employee
benefits. Information we obtained from officials of large banks and
from our analysis of a sample of public companies' Forms 10-K indicates
that firms have related their purchases of broad-based business-owned
life insurance to various types of employee benefit costs, including
health care for current or retired employees, life and disability
insurance for current or retired employees, workers' compensation,
qualified retirement plans--including defined benefit and defined
contribution plans, such as 401(k) plans--and nonqualified retirement
plans, such as supplemental executive retirement plans.[Footnote 24]
Consistent with this expanded use of business-owned life insurance,
NAIC has observed that many products sold by life insurers have evolved
to become primarily investment products. Also, consulting firms that
specialize in business-owned life insurance transactions, life
insurance brokers, and industry experts have emphasized the potential
use of broad-based business-owned life insurance as a profitable long-
term investment strategy to finance employee benefit costs and not
merely as protection against financial losses that a business would
incur in the event of the death of key persons.
According to bank regulators and life insurance industry
representatives, when purchasing life insurance, businesses generally
relate the amount of coverage they purchase on a group of employees to
the value of their projected employee benefit costs. For example, a
business might insure the lives of a group of employees such that the
present value of expected cash flows to be received from the policies
over time, net of premiums, would cover some portion or all of the
present value of the business's employee benefit expenses over the same
period of time.[Footnote 25] When calculating the expected future cash
flows from the insurance, businesses would not generally assume
policies will be surrendered if employees leave or retire because
surrendering the policies would result in taxation and possibly
surrender charges; rather, businesses would assume that they will hold
the policies until the insured employees die.
Because businesses may hold business-owned life insurance policies for
many years before receiving death benefit payments, businesses do not
necessarily receive the cash flows from business-owned life insurance
at the same time that they must pay their employee benefit expenses.
According to insurance industry representatives, when businesses use
the insurance in connection with health care benefits for retired
employees, the death benefit proceeds are well timed for reimbursing
the benefit costs, because retirees tend to incur their largest medical
expenses in the last months of their lives. However, we found examples
of businesses that said they used the insurance in connection with
current employee benefit costs, such as active employee health care. In
such cases, the timing of the death benefit payments would not
necessarily correspond to the timing of employee benefit expenses
because businesses must pay those expenses years before receiving death
benefits on most insured employees.
Regardless of a business's reported purpose for purchasing business-
owned life insurance, the business generally does not have an
obligation to restrict its use of the life insurance proceeds to these
purposes. Although the expected income from broad-based business-owned
life insurance policies over time might be commensurate with a
business's expected employee benefit costs at the time of the insurance
purchase, businesses are generally not required to use the proceeds
from the policies to pay for employee benefits. Unless the policies
were placed in a trust that restricted their use to employee benefit
payments, the life insurance policies would be part of the unrestricted
general assets of the business and, as such, could be used to pay any
obligations of the business.[Footnote 26]
Limited Data Show That Some Businesses Use Life Insurance in a Variety
of Ways:
Of the federal and state regulators we contacted, only OTS has required
the institutions it regulates to provide information that distinguishes
among the uses of business-owned life insurance. Through the end of
2003, OTS required the thrifts it supervises to report the value of
their key-person policies and the value of business-owned life
insurance policies purchased for other purposes as separate items, if
the amounts met the reporting threshold. Of the $3.3 billion cash
surrender value that 249 OTS-supervised thrifts reported owning as of
December 31, 2002, about $400 million was for key-person insurance and
$2.9 billion was for other business-owned life insurance. However,
these amounts may not be representative of the proportions of key-
person and other business-owned life insurance that these thrifts held.
OTS's disclosure threshold applied separately to each category, so that
OTS-supervised thrifts could have been required to report on only one
type of policy rather than the total value of their business-owned life
insurance holdings. Beginning in 2004, OTS eliminated its reporting
threshold so that all the thrifts it supervises are required to report
the value of both their key-person and other business-owned life
insurance policies. The new requirement will allow OTS to determine the
cash surrender value of all key-person and other business-owned life
insurance held by the institutions it supervises.
Although SEC did not specifically require them to do so, we found that
some businesses included information on how they intended to use
business-owned life insurance in the Forms 10-K they filed with SEC. We
reviewed the Forms 10-K of 100 randomly selected Fortune 1000 public
companies. Of these, 11 provided information on the intended use of
their business-owned life insurance policies. All 11 businesses
reported using these policies to provide deferred compensation or
benefits for executives; 1 also reported using them to provide
postretirement health care.[Footnote 27] For example, 1 of the 11
businesses reported having a supplemental executive retirement plan
financed by life insurance that had a cash surrender value of about $66
million as of December 31, 2002. The amount of insurance coverage was
designed to cover the full cost of the plan, which at that time was
estimated to have a present value of about $69 million. Another 1 of
the 11 businesses reported that it had purchased policies with a cash
surrender value of about $161 million as of February 28, 2003, with the
intention of using the policies' proceeds as a future financing source
for postretirement medical benefits, deferred compensation, and
supplemental retirement plan obligations aggregating $241.3 million.
However, the business noted that the life insurance assets did not
represent a committed financing source and that the business could
redesignate them for another purpose at any time.
Some large businesses have also provided survey responses suggesting
that some business-owned life insurance is used to finance executive
benefit plans. Clark Consulting has conducted annual executive benefits
surveys of Fortune 1000 corporations and reported on respondents' use
of business-owned life insurance to informally fund nonqualified
deferred compensation and supplemental executive retirement plans.
Businesses informally fund such plans by planning to have assets
available to pay for them, although the assets would not generally be
protected in bankruptcy.[Footnote 28] From its 2003 survey, which had a
22 percent response rate, Clark Consulting reported that 93 percent of
the respondents offered nonqualified deferred compensation plans, 69
percent of those with nonqualified deferred compensation plans
informally funded them, and 55 percent of those that informally funded
the plans used business-owned life insurance to do so.[Footnote 29]
Similarly, 71 percent of the respondents offered supplemental executive
retirement plans, 53 percent of those respondents informally funded the
plans, and 61 percent of those that informally funded the plans used
business-owned life insurance to do so. Because the survey did not use
a statistical sample of businesses and may be subject to other sources
of error such as nonresponse bias, respondents' answers cannot be
projected to all Fortune 1000 companies or to all businesses in the
United States.[Footnote 30] The statistics reported here are meant to
indicate only that some large businesses are using life insurance in a
variety of ways.
Regulators Have Applied Their Guidelines or Requirements and Have
Generally Not Had Significant Regulatory Concerns about Business-Owned
Life Insurance:
Banks and thrifts are required to follow federal regulatory guidelines
in purchasing business-owned life insurance. Officials from federal
bank regulators that had examined some institutions' purchases told us
that these purchases had not raised major supervisory concerns. SEC's
general disclosure requirements apply to business-owned life insurance;
the agency has not had specific investor-protection concerns about such
policies. The Internal Revenue Code includes statutory requirements,
and IRS has issued regulatory requirements related to the tax treatment
of the insurance. IRS officials told us that the agency was studying
potential concerns. States had differing laws concerning insurable
interest and consent requirements for business-owned life insurance.
The insurance regulators of the four states we contacted described
limited oversight of business-owned life insurance sales, and the four
state regulators and NAIC generally did not have concerns about the
policies.
Federal Bank Regulators Examined Some Institutions' Purchases of
Business-Owned Life Insurance and Have Not Had Major Supervisory
Concerns:
Federal bank regulators have issued guidelines for purchases of
business-owned life insurance that they have used in overseeing banks
and thrifts' holdings of such policies. The regulators' oversight,
consistent with their missions, includes assessing the safety and
soundness of supervised institutions, and regulatory officials said
that the agencies generally have not had major supervisory concerns
about banks and thrifts' business-owned life insurance holdings. They
said that while business-owned life insurance carries some risk,
policies that were purchased in accordance with their guidelines are
generally not a major threat to an institution's safety and soundness.
The regulators cited other types of activities--such as commercial real
estate, specialized, and subprime lending--as generally raising more
supervisory concerns than business-owned life insurance because of
increased risk or volatility.
OCC and OTS guidelines describe the permissible uses of business-owned
life insurance.[Footnote 31] According to Federal Reserve and FDIC
officials, their agencies generally follow OCC's guidelines. The OCC
and OTS guidelines state that banks and thrifts may purchase life
insurance only for reasons incidental to banking, including insuring
key persons and borrowers and purchasing insurance in connection with
employee compensation and benefit plans. The guidelines require that,
before purchasing policies, a bank or thrift's management conduct a
prepurchase analysis that, among other things, determines the need for
insurance and ensures that the amount of insurance purchased is not
excessive in relation to the estimated obligation or risk. For example,
the guidelines state that when purchasing life insurance on a group of
employees, the institution may compare the aggregate obligation to the
group (such as employee benefit costs) with the aggregate amount of
insurance purchased.
The guidelines require that the prepurchase analysis determine the
amount of insurance needed using "reasonable" financial and actuarial
assumptions, such as those for the time period or the discount rate
used to calculate the present value of expected employee benefit
costs.[Footnote 32] However, the guidelines do not specify parameters
for the assumptions, such as the discount rate or time period, to be
used in the prepurchase analysis--parameters that affect the amount of
insurance that can be purchased.[Footnote 33] OCC officials stated that
specifying such parameters would have little or no effect because banks
tend to purchase less insurance than they could justify based upon
their expected employee benefit expenses, regardless of the assumptions
used in prepurchase analyses. In addition to the requirements for
determining the need for insurance, the guidelines state that banks and
thrifts using business-owned life insurance for executive compensation
should ensure that total compensation is not excessive--that is,
unreasonable or disproportionate to the services performed, taking into
account factors such as the financial condition of the institution and
compensation practices at comparable institutions.
The OCC and OTS guidelines also require the bank or thrift's
prepurchase analysis to consider the risks associated with business-
owned life insurance and to maintain effective senior management and
board oversight of the purchases. In addition, the guidelines state
that a bank or thrift should consider the size of its purchase of
business-owned life insurance relative to the institution's capital and
diversify risks associated with the policies. The OCC and OTS
guidelines require banks and thrifts to document their decisions and
continue to monitor, on an ongoing basis, the financial condition of
the insurance companies that carry their policies. For example, the
guidelines state that institutions should review an insurance company's
ratings and conduct further independent financial analysis, with the
depth and frequency of such analysis determined by the relative size
and complexity of the transaction.
OCC officials explained that the agency's guidelines do not require
institutions to continue to compare their projected employee benefit
costs with the projected cash flows from the insurance after purchasing
the policies. However, purchases of additional insurance would require
a prepurchase analysis, so that institutions would be required to
update their comparisons at such times. Officials at three large banks
said that their banks had not compared the projected employee benefit
costs and projected insurance cash flows after purchasing the
insurance. Officials at a fourth large bank said their bank had updated
the comparison annually in conjunction with additional insurance
purchases in recent years.
Federal bank regulators told us that their risk-based examination
programs are designed to target aspects of banks and thrifts' purchases
of business-owned life insurance that would raise supervisory concerns
about institutions' safety and soundness. They specifically identified
the credit and liquidity risks associated with business-owned life
insurance as concerns that could warrant attention during an
examination. Credit risk arises from the potential failure of an
insurance carrier that might then be unable to pay death benefits or
return the cash surrender value of policies upon request. OCC and
Federal Reserve officials said they were less concerned about credit
risk when it was diversified--for example, when institutions held
policies with several highly rated insurers. Liquidity risk arises from
the long-term nature of life insurance and the cost to the bank or
thrift of surrendering policies.
OCC officials emphasized that other risks associated with business-
owned life insurance could also raise supervisory concerns,
particularly among institutions with relatively large holdings.
Specifically, OCC officials said that the potential risk to
institutions' reputations could be of concern as a result of negative
perceptions of their holding the policies. For example, the officials
noted that under California's new law, businesses must disclose to
insured employees the existence and face amount of insurance policies
purchased on their lives by the end of March 2004, which could
negatively affect the businesses' reputations if employees were unaware
that the policies existed. The officials also cited potential concerns
about transaction risk, which arises from an institution not fully
understanding or properly implementing a transaction. For example, if
an institution did not comply with applicable insurable interest laws
in purchasing a policy, it may not be able to collect the death
benefits on the policy.[Footnote 34] Finally, OCC and Federal Reserve
officials cited potential concerns about tax risk--the risk that
Congress could change the tax treatment of business-owned life
insurance. If any such changes were applied to previously purchased
policies, banks might not receive the returns on the policies that they
had expected, which could, in turn, raise supervisory concerns with
respect to certain institutions.[Footnote 35]
The federal bank regulators explained that they determined whether to
include business-owned life insurance in the scope of an examination
based not only on their preliminary assessment of the level of risk
associated with business-owned life insurance but also on the size of
an institution's holdings relative to capital. The regulators'
examination procedures, in general, direct examiners to identify
concentrations of credit--instances where the institution's exposure to
a creditor or, in some cases, a group of creditors (such as an
insurance company or companies from which the institution has purchased
policies) exceeds 25 percent of the regulator's measure of the
institution's capital. All of the regulators said that, if the cash
surrender value of a bank or thrift's policies exceeded this threshold,
they would consider whether further supervisory review of these
holdings was warranted. Such a review would help to ensure that the
institution was not unduly exposed to credit or liquidity risk and that
it was complying with the guidelines on business-owned life
insurance.[Footnote 36] OCC officials also said that the difficulty of
quantifying the reputation, transaction, and tax risks associated with
the policies underscored the importance of examiners considering
whether institutions had overly concentrated holdings of business-owned
life insurance.
As of December 31, 2002, 467 banks and thrifts reported business-owned
life insurance holdings in excess of 25 percent of their tier 1
capital.[Footnote 37] We asked the bank regulators to explain their
oversight of 58 institutions with the largest concentrations, all in
excess of 40 percent of tier 1 capital. Bank regulatory officials said
that their agencies were monitoring these institutions' levels of
holdings through reviews of quarterly financial reports and had
conducted reviews of the holdings as part of their examinations at many
of the institutions. Officials from each regulator told us their
agencies had concluded that major supervisory concerns did not exist
about the amount of insurance the institutions owned, although the
Federal Reserve and OCC had cited the need for some institutions to
improve their oversight or internal controls related to the policies.
Specifically, Federal Reserve officials said that the agency had
reviewed business-owned life insurance holdings as part of its
examinations of the nine Federal Reserve-supervised banks that we
identified (table 1). Federal Reserve officials said that the agency's
examinations did not raise concerns about the nine banks' total
holdings of business-owned life insurance. However, the officials said
that the Federal Reserve had made recommendations to four of the banks,
including that they conduct more diligent prepurchase analyses,
communicate more information to board members, enhance internal
controls, and conduct quarterly reviews of insurance carriers'
financial condition. Based on a review of examination summary reports,
FDIC officials said that FDIC had criticized the level of business-
owned life insurance at only 1 of the 32 FDIC-supervised institutions
we identified; the officials said that the summaries might only note
the results of a review of business-owned life insurance if examiners
identified problems, so it was unclear how many of the other
institutions' holdings had been reviewed. OCC officials told us that
OCC did not have safety and soundness concerns about the amount of
holdings at any of the 15 OCC-supervised banks we identified. The
officials distinguished between community banks (4 of the 15 we
identified) and large banks (11 of the 15 we identified), noting that
OCC's primary supervisory concern has been with the effectiveness of
community banks' ongoing oversight of their business-owned life
insurance.[Footnote 38] They said that OCC had reviewed the holdings of
at least three of the community banks we identified and had cited the
need for one of these banks to improve ongoing risk management of the
policies. In contrast, the OCC officials said that large banks
generally have sophisticated risk management systems and manage their
insurance investments well. Although the officials did not report how
many of the large banks' business-owned life insurance holdings had
been reviewed during examinations, they said that these banks sometimes
approach OCC examiners before making new insurance purchases and that,
in this respect, OCC monitors some banks' business-owned life insurance
programs on an ongoing basis. OTS officials told us that OTS had
examined both of the thrifts we identified and did not have supervisory
concerns about their current holdings or policy oversight.
Table 1: Banks and Thrifts with the Largest Concentrations of Business-
Owned Life Insurance as of December 31, 2002, and Issues Cited in
Regulators' Most Recent Examinations:
Regulator: The Federal Reserve;
Institutions with business-owned life insurance holdings greater
than 40 percent of tier 1 capital: 9;
Institutions whose most recent examination cited concerns or
made recommendations related to business-owned life insurance[A]: 4.
Regulator: FDIC[B];
Institutions with business-owned life insurance holdings greater
than 40 percent of tier 1 capital: 32;
Institutions whose most recent examination cited concerns or
made recommendations related to business-owned life insurance[A]: 1.
Regulator: OCC[B, C];
Institutions with business-owned life insurance holdings greater
than 40 percent of tier 1 capital: 15;
Institutions whose most recent examination cited concerns or
made recommendations related to business-owned life insurance[A]: 1.
Regulator: OTS;
Institutions with business-owned life insurance holdings greater
than 40 percent of tier 1 capital: 2;
Institutions whose most recent examination cited concerns or
made recommendations related to business-owned life insurance[A]: 0.
Regulator: Total;
Institutions with business-owned life insurance holdings greater
than 40 percent of tier 1 capital: 58;
Institutions whose most recent examination cited concerns or
made recommendations related to business-owned life insurance[A]: 6.
Sources: GAO analysis of FDIC and OTS data for the number of
institutions with largest concentrations and all four federal bank
regulators for the number of examinations that cited concerns.
[A] Examinations were conducted through September 2003, except that the
Federal Reserve examinations were conducted through November 2003.
[B] FDIC and OCC officials did not report whether all examinations had
included a review of business-owned life insurance holdings.
[C] Of the 15 OCC-supervised banks, 4 were community banks and 11 were
large banks. OCC generally defines community banks as banks with less
than $1 billion in total assets. OCC characterizes banks in its Large
Bank Supervision program as the largest and most complex national
(federally chartered) banks. One examination of a community bank cited
a concern related to business-owned life insurance. The number of large
bank examinations that cited concerns was not available.
[End of table]
SEC Has Applied Its Disclosure Requirements and Has Not Had Investor-
Protection Concerns about Business-Owned Life Insurance:
SEC officials said that the agency's regulations for public companies
do not specifically address business-owned life insurance; rather, SEC
has relied on its broadly applicable disclosure requirements to
identify any investor protection concerns. As discussed, SEC, whose
mission is to protect investors and maintain the integrity of the
securities markets, requires public companies to disclose material
financial and other information so that investors can make informed
decisions. SEC officials said that business-owned life insurance is
unlikely to be a material item. However, they added that the agency
would have an oversight concern if it became aware of a public
company's failure to disclose material purchases of or earnings from
business-owned life insurance or if problems developed in accounting
for these policies. For example, a senior SEC official said that SEC
might become aware of a failure to disclose material information if it
was examining a poorly performing business and found that its
management had not disclosed that the business was using business-owned
life insurance to sustain itself. SEC officials said that, to date, no
such problems have arisen, and the agency has not had investor-
protection concerns about public companies holding business-owned life
insurance.
IRS Has Issued Requirements for the Tax Treatment of Policies and Is
Studying Potential Concerns:
IRS, whose mission includes administering the tax law, had some
requirements related to the tax treatment of business-owned life
insurance. The Internal Revenue Code defines life insurance for tax
purposes, establishes its tax treatment, and limits the deductibility
of interest on loans taken against policies. In addition, in September
2003, IRS and Treasury issued final regulations on the tax treatment of
split-dollar life insurance policies--policies in which the employer
and employee generally share costs and benefits as part of an executive
compensation arrangement.[Footnote 39] Because none of IRS's prior
rulings regarding the taxation of split-dollar arrangements had
directly addressed the types of arrangements that have been widely used
in recent years, IRS and Treasury issued interim guidance in 2001 and
2002 that culminated in the final regulations. Under the final
regulations, corporations cannot provide tax-free compensation to
executives using split-dollar policies, and a business's premium
payments are treated as loans to an executive who owns the policy. If
the employer owns the policy, the regulations treat the executive's
interest in the policy's cash value and current life insurance
protection as taxable economic benefits to the executive.
IRS officials said that the agency was studying some possible remaining
issues related to business-owned life insurance that is held by highly
leveraged financial institutions such as banks and thrifts. Various
sources have reported that the limitation on the deductibility of
policy loan interest adopted in 1996 curtailed new sales of leveraged
business-owned life insurance policies. However, IRS officials
expressed concern that this limitation had not eliminated the tax
arbitrage opportunities available through business-owned life
insurance and that, for this reason, highly leveraged financial
institutions such as banks and thrifts might be borrowing to indirectly
finance their policies. Borrowing to indirectly finance policies can
occur when businesses pay the premiums on life insurance policies by
increasing debt that is not directly linked to the policies and then
deducting the interest they pay on that debt from their taxable
income.[Footnote 40] Although the Internal Revenue Code limits the
amount of deductible interest that is linked directly to business-owned
life insurance, establishing such a link is difficult because
businesses may incur debt for many purposes. Borrowing to indirectly
finance policies presents a tax advantage to businesses because they
receive tax-deferred inside buildup from life insurance policies
indirectly financed with debt on which the interest expense is tax-
deductible.
In addition, IRS officials said that the agency is concerned that banks
may be using separate account policies to maintain excessive control
over investments, which is inconsistent with the Internal Revenue Code
treatment of life insurance. Internal Revenue Code provisions were
intended to ensure that the primary motivation in purchasing life
insurance would be the traditional economic protection provided by such
policies, while discouraging the use of tax-preferred life insurance as
primarily an investment vehicle. In separate account life insurance, an
asset account is maintained independently from the insurer's general
account. Compared with a general account policy, which offers either a
guaranteed rate of return or a rate that varies at the insurer's
discretion, a separate account policy permits the policy owner latitude
in the choice of investments, particularly equities.[Footnote 41]
Businesses may also purchase private placement policies, or separate
account policies that allow policyholders to negotiate key terms of the
policies--such as who will act as investment adviser--with the
insurance company. These policies also offer investment alternatives
that traditional separate account policies do not, including privately
traded investments in start-up businesses and private venture capital
funds. Based on IRS revenue rulings, the agency decides on a case-by-
case basis whether the purchaser of a policy has excessive control over
separate account assets. These revenue rulings have identified factors
to consider, such as whether the purchaser directs the account to make
a particular investment, sells or purchases assets in the account, or
communicates with the investment adviser about the selection or quality
of specific investments, and whether the account's investment
strategies are broad enough to prevent the purchaser from making
particular investment decisions by investing in a subaccount. IRS
officials said that the agency was studying its concerns about
indirectly financing policies through borrowing and about using
separate account policies at five banks that IRS had identified through
routine examinations. The officials said that IRS had not taken action
against any of these banks.
State Laws Differ, and Four States with Limited Oversight of Business-
Owned Life Insurance Have Not Had Significant Concerns:
Although NAIC has developed model legislative guidelines for business-
owned life insurance, the states are not required to follow them. NAIC
initially developed model guidelines for business-owned life insurance
in 1992 and revised them in 2002 (fig. 2). The 1992 guidelines
suggested that states consider including in their laws provisions that
recognize employers' insurable interest in employees, including
nonmanagement employees who could expect to receive benefits. The 2002
revision added a recommendation for states to consider requiring
employee consent to be insured and prohibiting employers from
retaliating against employees who refused to grant their consent.
However, states have passed a variety of laws regulating insurable
interest and consent requirements for business-owned life insurance
(see app. II).
Figure 2: NAIC Model Guidelines on Business-Owned Life Insurance,
December 2002 Revision:
[See PDF for image]
[End of figure]
While some states have followed NAIC's guidelines, state consent
requirements still differ. Since NAIC revised its guidelines in 2002,
several states have passed legislation requiring employers to obtain
employees' written consent before taking insurance on their lives
(others already had such requirements). Also, while some states have
consent provisions that specifically address business-owned life
insurance, in some states consent provisions apply to life insurance
policies in general. Compendiums of state laws prepared by NAIC and the
American Council of Life Insurers and our review of selected state
statutes indicated that, as of December 31, 2003, 35 states had laws
requiring written consent (either for life insurance in general or
specifically for business-owned life insurance), and another 4 states
had consent requirements that were satisfied if an employee did not
object to a notice of the employer's intent to purchase a policy.
However, at least 18 of these states exempted group life insurance
policies from consent requirements. Additionally, 1 state required
employers to notify employees when purchasing business-owned life
insurance, but did not require employee consent.
We spoke with insurance department officials from California, Illinois,
New York, and Texas. The insurable interest and consent provisions of
the four states differed, but all allowed some purchases of business-
owned life insurance and three required some form of consent; two
required the amount of coverage to be related to employee benefit costs
(table 2). The insurance department officials told us that they conduct
limited oversight to test compliance with their states' insurable
interest and consent laws. They said that their primary method of
addressing this issue was through policy form reviews, or assessments
of the proposed forms that insurers would provide to policyholders when
selling policies in their states. For example, New York insurance
department officials said that department officials review policy forms
for compliance with the state's requirements and that, for policies on
non-key employees, the form must describe insured employees' right to
discontinue the coverage on their lives and must note the statutory
limitations on the coverage amounts. Also, a submittal letter that
insurers must provide to the department along with the policy form must
explain how the insurer will verify that New York's insurable interest
requirements are satisfied and, for non-key employees, whether the
employer or the insurer will prepare the required employee consent
notices. In Illinois, insurance department officials said that they
review policy forms to ensure that the forms include the state's
statutory requirements related to business-owned life insurance, but
the forms need not detail procedures for obtaining consent or
determining appropriate amounts of coverage.
Table 2: State Insurable Interest and Consent Laws Applicable to
Business-Owned Life Insurance in Selected States as of December 31,
2003:
State: California;
Employer and employer-sponsored trusts' insurable interest in current
and former employees:
* An employer may insure the lives of directors and officers or
administrative, executive, or professional employees exempt from
California overtime compensation requirements;
* An employer-sponsored trust providing employee or retiree benefits
may insure the lives of those for whom benefits are to be provided;
Requirements for notifying or obtaining consent of insured employees:
* Employee written consent is required;
* Policies purchased on nonexempt employees prior to January 1, 2004,
will be void no later than January 1, 2010, unless the employer meets
certain exceptions, including disclosing in writing information about
such policies to insured employees.
State: Illinois;
Employer and employer-sponsored trusts' insurable interest in current
and former employees:
* An employer or employer- sponsored trust may insure the lives of
directors and officers and management, nonmanagement, and retired
employees;
* Coverage of nonmanagement and retired employees is limited to an
amount commensurate with the employer's projected unfunded employee
benefit plan liabilities for nonmanagement and retired employees;
Requirements for notifying or obtaining consent of insured employees:
* The consent requirement is satisfied if an employee does not reject
coverage within 30 days of receiving written notice of the coverage.
State: New York;
Employer and employer-sponsored trusts' insurable interest in current
and former employees:
* Employers may insure the lives of employees in whom the employer has
a lawful and substantial economic interest in having the life of the
insured person continue;
* Employers may insure the lives of employees or retirees who
participate in or are eligible to participate in an employee benefit
plan upon satisfaction of eligibility criteria. In such cases, the
total amount of coverage cannot exceed employee benefit costs incurred
since date of coverage plus projected future employee benefit costs;
Requirements for notifying or obtaining consent of insured employees:
For all employees:
* Employee notification and written consent are required;
For employees insured under the insurable interest provision related to
participation in an employee benefit plan:
* The notification must state that the insured can have coverage
discontinued at any time;
* When employment terminates, employees must receive notice that they
can have coverage discontinued. Notification is not required if the
employee has a right to receive benefits being financed by the
insurance coverage.
State: Texas;
Employer and employer-sponsored trusts' insurable interest in current
and former employees:
* Employers may purchase a group life policy to insure the lives of
officers, directors, employees, and retired employees in an amount
necessary to provide funds to offset liabilities related to fringe
benefits;
* An individual may consent in writing to the purchase of or
application for an individual or group life insurance policy and
designation of any entity as beneficiary of the policy or owner of the
policy;
Requirements for notifying or obtaining consent of insured employees:
* Employee consent is not required for policies purchased to offset
liabilities related to fringe benefits.[A];
* Any individual may consent to a business's purchase of and
designation as beneficiary of a policy on the individual's life.
Source: GAO analysis of state statutes.
[A] The Texas Department of Insurance noted that, notwithstanding the
statute's language, based on its legislative history, the department
has consistently maintained that employee consent is required.
[End of table]
NAIC staff said that state insurance regulators generally have the
authority to review policies currently in force for compliance with any
state requirements. But the officials from the four states we contacted
said that their departments had not routinely verified that employees
covered by the policies had consented to being insured or, where
applicable, tested whether coverage amounts were appropriate.[Footnote
42] An official from California's insurance department said that the
department did not routinely review business-owned life insurance
sales, but added that the department had recently received complaints
about at least one insurer and multiple employers. The official noted
that the department was investigating these complaints, including
reviewing documentation for the policies in question, and that any
policies that were found to violate state provisions could be voided.
Officials in Illinois, New York, and Texas said that a pattern of
consumer complaints about business-owned life insurance would cause
their departments to investigate the insurance sales during market
conduct examinations of insurers or refer the matter to their legal
division for an enforcement action.[Footnote 43] However, the officials
said that generally they had not received complaints about business-
owned life insurance. In addition, NAIC staff told us that the
organization maintains a national database of consumer complaints made
to state insurance regulators and that business-owned life insurance
had not been a significant source of complaints. As a result, NAIC had
not developed a separate category for tracking such complaints.
However, relying on complaints may not be an effective means of
identifying violations of state law related to business-owned life
insurance, because employees who are not aware of their state's
notification and consent requirements and whose employers have not
provided the required notification or obtained the required consent,
would not know that they have a basis for complaining to their state
insurance regulators.
More Comprehensive Data Could Be Useful to Congress; Costs Would Be
Incurred in Obtaining the Data:
More comprehensive data on the prevalence and use of business-owned
life insurance could be useful to Congress in assessing the potential
effects of legislative proposals that address the tax-favored treatment
of this insurance. Data would be most useful if reported separately for
business continuation and broad-based policies because legislative
proposals that would further limit the tax-favored treatment of
business-owned life insurance generally have treated the policies
differently--they have applied primarily to broad-based policies. Data
on business continuation versus broad-based insurance would be useful
in understanding the proportion of the total business-owned life
insurance market that might be affected by future legislative
proposals. Useful data that are not available include the amount of
tax-free income received from the death benefit payments on business
continuation and broad-based policies--data that could help Congress
better understand the potential effect of changes to the tax treatment
of these policies on tax revenues.[Footnote 44]
Other data on the prevalence and use of business-owned life insurance,
further broken down or identified by business continuation and broad-
based policies, might also be helpful to Congress in evaluating the
potential effects of legislative proposals on businesses, their
employees, and insurance companies. The cash surrender value of
business-owned life insurance policies could help assess whether the
value of assets invested in such policies is consistent with the
behavior that Congress wishes to encourage through tax preferences. The
annual premiums paid on new policies could be used to determine the
demand for business-owned life insurance and the potential effect of
proposed legislative changes on the market for business-owned life
insurance. The number of businesses that hold business-owned life
insurance policies could provide information on how many businesses
might be affected by proposed legislative changes. Additional
information on the size, type, and geographic location of businesses
holding the insurance could be used to characterize the businesses that
might be affected. Finally, although obtaining an unduplicated count of
the total number of people covered by business-owned life insurance
might be impractical, data on the number of each business's employees
insured under such policies could be used, for example, to determine
the average number or percentage of employees covered by businesses
that reported owning policies.[Footnote 45] Although more costly to
obtain, data collected over multiple periods could help identify trends
that might provide additional insights into the effects of legislative
proposals.
Businesses that hold business-owned life insurance or insurance
companies that sold the policies could provide the data for Congress's
use, but both types of entities would incur administrative costs in
extracting the required information from their records and summarizing
it. We did not discuss these costs with businesses, however, we expect
that they would maintain financial records and insurance policy
statements from which the required data could be extracted. Also, some
businesses already aggregate this information for use in completing
their income taxes or Forms 10-K filed with IRS and SEC, respectively,
suggesting that some businesses would not have difficulty providing the
data. Nonetheless, businesses might differ in their willingness to
voluntarily provide the data, depending at least in part on the cost
and their perception of the benefits of doing so. While we did not
independently determine the costs that insurers would incur in
collecting the data, officials from several insurance companies told us
that extensive effort would be required to identify policies as
business-owned life insurance, as opposed to policies in which a
business is the owner but not the beneficiary, and extract the data
that we identified as being useful for decision making. These officials
also told us that it would be difficult for them to distinguish between
business continuation and broad-based policies. Consistent with these
concerns, three life insurance industry trade associations recently
supported proposed legislation that would require businesses that hold
business-owned life insurance to report some information on their
policies to IRS. While businesses might be able to provide data on the
policies they own more easily than insurance companies could provide
information on the policies they have sold, requiring insurance
companies to report would substantially limit the number of reporting
entities. About 1,200 companies sell life insurance, according to NAIC,
while many more businesses purchase it.
The organization collecting, analyzing, and reporting the data would
also incur costs. SEC, Treasury, and NAIC are candidates for this role,
because each already collects financial information from businesses
that purchase business-owned life insurance, insurers, or both. One of
the agencies or NAIC could collect the data by modifying existing
reporting instruments, such as the SEC Form 10-K, applicable IRS tax
forms, or insurance company annual reporting forms. Alternatively, the
agencies or NAIC could collect the data through a survey. We did not
determine the resources that would be required for the agencies or NAIC
to modify their existing reporting instruments or conduct a survey.
Beyond the costs, other factors could be considered in selecting one of
these or another organization to lead the effort. Either SEC or
Treasury might be able to combine data on business-owned life insurance
with other data that businesses already report to them, such as
business size, type, or location. SEC currently collects information
only from publicly traded companies, whereas Treasury, through IRS,
requires all businesses, including life insurance companies, to file
tax returns. While taxpayer information is confidential and would not
be publicly available except in the aggregate, Congress would likely
need only aggregate information. Collecting business-owned life
insurance data through NAIC, a membership organization of chief state
insurance regulators, assumes the data would be collected from
insurance companies and would involve the organization's voluntary
cooperation.
Conclusions:
The use of life insurance, which receives tax-favored treatment, has
expanded from its traditional coverage of a family's principal wage
earners and a business's key employees to broad-based coverage of a
business's other employees. Although recent legislative proposals have
sought to limit the tax-favored treatment of business-owned life
insurance, comprehensive data on the prevalence and use of such
insurance have not been available for use in assessing the impact of
these proposed changes. Should Congress conclude that such data would
facilitate its ongoing deliberations on the appropriate tax treatment
of business-owned life insurance, decisions would be required on what
data are needed, who should provide the data (insurance buyers or
sellers), who should collect the data (SEC, Treasury, NAIC, or another
organization), how to collect the data (additional reporting or a
survey), what it would cost to collect the data, and whether the
benefits of collecting additional data warrant the cost of doing so.
Important data for understanding the tax and other implications of
changes in the tax-favored treatment of business-owned life insurance
would be the amount of tax-free income received from death benefit
payments, reported separately for business continuation and broad-based
policies. Additional data of value could include the cash surrender
value of policies, the annual dollar amount of premiums paid on new
policies, the number of businesses that hold business-owned life
insurance, the characteristics of businesses that own the policies, and
the number of employees insured under such policies.
Matter for Congressional Consideration:
If Congress decides that it needs more comprehensive data on the
prevalence and use of business-owned life insurance, such as the tax-
free income from death benefit payments and/or other select data
reported separately for business continuation and broad-based policies,
Congress could, among other alternatives, obtain the data by:
* assigning responsibility to SEC or Treasury to (1) require purchasers
of business-owned life insurance or insurers to report the data in
their financial statements or federal tax returns, respectively, or (2)
conduct a survey of the purchasers or insurers to obtain the data; or:
* encouraging NAIC to (1) require insurers to report the data in the
annual reports they file with NAIC or (2) conduct a survey of insurers
to obtain the data.
Agency Comments and Our Evaluation:
We received written comments on a draft of this report from Treasury,
IRS, SEC, and NAIC that are reprinted in appendixes III-VI,
respectively. Treasury commented that the report is well-researched and
informative, but together with SEC expressed reservations about the
matter for congressional consideration. Both agencies were reluctant to
have a potential role in collecting data on business-owned life
insurance, stating that having such a role would not be necessary to
fulfill their regulatory missions. NAIC did not express such
reservations, but said that it would like to evaluate the need for and
utility of the data and favored using a survey as an initial step in
the data gathering process. In addition, we received technical comments
from Treasury, the federal bank regulators, SEC, and NAIC that we
incorporated into the report where appropriate.
In addressing their concern about collecting the data described in our
matter for congressional consideration, SEC and Treasury commented that
because they do not need the data to fulfill their regulatory missions,
they do not believe it would be appropriate for them to collect the
data. Specifically, SEC expressed concern about collecting data for
purposes other than protecting investors. Similarly, Treasury expressed
concern about collecting information not directly needed to calculate
tax liabilities or enhance IRS's ability to audit tax returns. However,
as discussed in our report, Treasury provides OMB the estimate of
forgone tax revenues resulting from the tax treatment of life
insurance, and OMB reports this estimate in its budget documents. As we
also report, this estimate is not complete because it does not reflect
the forgone tax revenues on the additional income from death benefit
payments in excess of the premiums paid and the accumulated tax-
deferred earnings. Accordingly, Treasury might find that gathering
additional data would allow the agency to provide OMB with a more
complete and accurate estimate. NAIC reiterated that collecting the
data described in our matter for congressional consideration would go
beyond what is needed to support states' regulation of insurers'
solvency. But NAIC did not explicitly express reservations about being
charged with collecting the data should Congress request that it do so.
We recognized in the report that none of the potential candidates that
we identified for collecting additional data on business-owned life
insurance needs the data to fulfill its missions and that the data
would be used primarily for making tax policy decisions rather than for
providing regulatory oversight. As discussed in the report, if Congress
decides that it needs more comprehensive data on business-owned life
insurance, among its alternatives would be to turn to SEC, Treasury,
NAIC, or another entity to collect the data.
Addressing the issue of how to collect the data, Treasury commented
that it would be costly to design and distribute a survey, that
response rates might be low without a penalty for noncompliance, and
that Treasury would not be the best candidate to conduct a survey
because it is not a "statistical gathering agency." Regarding the
latter, Treasury said that a survey of insurance products could be
better performed by other organizations or agencies. As discussed in
the report, we agree that collecting the required data would involve an
investment of resources, whether it is done through a survey or via
existing reporting mechanisms. We also agree that obtaining an adequate
survey response rate presents a challenge. However, according to
professional literature, congressional action making the survey
mandatory should significantly improve the response rate.[Footnote 46]
Also, according to this literature, government surveys that have
employed response improvement methods continue to achieve acceptable
response rates. Additionally, the surveyed entities may be more likely
to respond if they believed that doing so would be in their interest.
For example, they might conclude that congressional action would be
more favorable to them if it was based on more complete data. Further,
although Treasury is not a statistical gathering agency, it has chosen
to conduct surveys to provide required information to Congress, as well
as for other purposes, such as to study the growth of investment in
foreign securities. Treasury has also contracted out surveys, as have
other federal agencies. NAIC also commented that collecting the data
could entail significant costs. NAIC said that it would like to
evaluate the need for and utility of collecting the data and suggested
that an initial study sampling the data described in our matter for
congressional consideration might be a cost-effective way to assess the
need for broader data collection. We agree that such a strategy could
be one way of approaching the data collection effort.
:
We are sending copies of this report to the Chairmen of the Senate
Committee on Finance, House Committee on Financial Services, Joint
Committee on Taxation, and other interested congressional committees.
We will send copies to the Chairman of the Board of Governors of the
Federal Reserve, Secretary of the Treasury, Chairman of FDIC,
Commissioner of Internal Revenue, Comptroller of the Currency, Director
of OMB, Director of OTS, Chairman of SEC, Executive Vice President of
NAIC, and other interested parties. We also will make copies available
to others upon request. In addition, the report will be available at no
charge on the GAO Web site at [Hyperlink, http: //www.gao.gov].
Signed by:
If you have any further questions, please call me at (202) 512-8678,
[Hyperlink, dagostinod@gao.gov], or Cecile Trop at (312) 220-7600,
[Hyperlink, tropc@gao.gov]. Additional GAO contacts and staff
acknowledgments are listed in appendix VII.
Signed by:
Davi M. D'Agostino:
Director, Financial Markets and Community Investment:
[End of section]
Appendixes:
[End of section]
Appendix I: Scope and Methodology:
To obtain information on the prevalence and use of business-owned life
insurance, we analyzed the quarterly financial reports--the Call Report
and Thrift Financial Report--that banks and thrifts filed with their
respective regulators. We obtained the data from the Federal Deposit
Insurance Corporation (FDIC), which compiles Call Report and Thrift
Financial Report data collected by the Board of Governors of the
Federal Reserve System (the Federal Reserve), FDIC, the Office of the
Comptroller of the Currency (OCC), and the Office of Thrift Supervision
(OTS). We also obtained additional Thrift Financial Report data from
OTS. Because regulators only began collecting the information in a
consistent format at the beginning of calendar year 2001, our analysis
covered the eight quarters ending March 31, 2001, through December 31,
2002. Although we did not independently verify the accuracy of the
data, we assessed its reliability by discussing the data system with
bank regulatory officials and examining the data for missing or
unreasonable values. We concluded that the data were reliable for
purposes of this report.
To obtain further information on the prevalence and use of business-
owned life insurance, we reviewed the most recent annual Form 10-K
financial reports that publicly traded companies had filed with the
Securities and Exchange Commission (SEC) between January 2002 and
September 2003. To identify information about insurance companies'
sales of such policies, we reviewed the Forms 10-K of 32 life insurance
companies that were among the 50 largest such companies ranked by
assets. We also searched for references on how businesses used such
policies in the Forms 10-K that a random sample of 100 Fortune 1000
public companies filed with SEC. Although the examples that we
identified were not necessarily representative of all businesses that
own these policies, they illustrated some uses of business-owned life
insurance. We also reviewed industry literature, including studies by
life insurance industry consultants and brokers, and interviewed
experts to identify other surveys related to business-owned life
insurance sales and use. We reviewed surveys conducted by CAST
Management Consultants, Inc. that estimated 2001 and 2002 business-
owned life insurance premiums and by Clark Consulting that reported on
businesses' use of business-owned life insurance in 2003. We did not
fully assess the quality of these surveys, but we determined that
despite some limitations, the surveys illustrated the amount of some
recent sales and some businesses' uses of business-owned life
insurance.
We also obtained information concerning the prevalence and use of
business-owned life insurance from officials of relevant federal
regulatory agencies: four federal bank regulators (the Federal Reserve,
FDIC, OCC, and OTS), SEC, and the Internal Revenue Service (IRS). In
addition, we reviewed the Joint Committee on Taxation's and the Office
of Management and Budget's reported estimates of forgone tax revenues
attributable to business-owned life insurance and obtained information
from officials of both entities about the development of these
estimates. We also obtained information about the prevalence and use of
business-owned life insurance from the National Association of
Insurance Commissioners (NAIC), two life insurance trade associations
(the American Council of Life Insurers and the Association for Advanced
Life Underwriting), and four large banks that held business-owned life
insurance.
In an effort to better describe the prevalence and use of business-
owned life insurance, we also considered the possibility of conducting
a survey of life insurance companies, but did not do so. Although
representatives of six life insurance companies cooperated in a survey
pretest, and American Council of Life Insurers representatives said
that they would encourage their members to participate in the survey
itself, the results of the pretest led us to conclude that we would not
be able to obtain sufficiently reliable data to warrant conducting the
survey. The insurance company representatives told us that their
companies do not have a business need to maintain the comprehensive
data on business-owned life insurance that we needed for the survey. We
did not verify the accuracy of these statements. Still, for the reasons
the insurance company representatives cited, we were uncertain whether
we would receive an acceptable response rate to a survey. Also,
insurance companies' requests for anonymity would have precluded us
from determining the percentage of total life insurance sales the
survey respondents represented.
To describe federal and state regulatory requirements for and oversight
of business-owned life insurance, we met with officials of federal and
state agencies that have regulatory authority related to business-owned
life insurance to discuss their requirements and oversight activities
and reviewed agency documentation and applicable federal and state
laws. Specifically, we discussed requirements and oversight with
officials at each of the four federal bank regulators and reviewed
their guidelines, regulations, and reporting forms and instructions. We
also discussed these topics with officials at SEC and IRS and reviewed
their regulations, reporting requirements, and applicable sections of
the Internal Revenue Code. We also interviewed NAIC staff to gain a
perspective on state approaches to regulating business-owned life
insurance and to discuss the organization's model guidelines for state
laws concerning such policies. To understand more about how states
oversee compliance with their statutes, we obtained information from
officials of insurance departments in California, Illinois, New York,
and Texas. We selected these states because they represented different
geographical regions of the United States and had differing insurable
interest and consent provisions for business-owned life insurance; we
did not select states whose provisions did not specifically address
business-owned life insurance because we concluded that their insurance
departments would not have specific oversight activities or
requirements for business-owned life insurance. We did not conduct a
comprehensive evaluation of the quality of federal and state
regulators' oversight activities. For example, we did not review
records from federal examinations of banks and thrifts or state
examinations of insurers. In addition, although we did not review every
state statute that could affect business-owned life insurance, we
reviewed each state's statutes that related specifically to business-
owned life insurance. Further, to better understand differences in
state laws concerning insurable interest and consent requirements for
business-owned life insurance, we analyzed compendiums of state
statutes from NAIC and the American Council of Life Insurers.
To address the potential usefulness of and costs associated with
obtaining more comprehensive data on business-owned life insurance, we
reviewed state and federal legislative proposals for changing the tax
treatment of business-owned life insurance or addressing other public
policy issues related to this insurance and determined the types of
data that could be useful in considering these kinds of proposals. We
also assessed the extent to which the information we obtained on the
prevalence and use of business-owned life insurance provided a
comprehensive basis for decision making. In addition, we reviewed IRS,
SEC, and NAIC's reporting forms and instructions to understand what
role these organizations or Treasury might play if Congress wanted them
to collect, analyze, and report more comprehensive information on
business-owned life insurance. We also discussed with representatives
of six insurance companies the challenges insurers might face in
providing data, including what data they would be able to readily
provide and what data would be difficult to provide. Finally, we
discussed challenges that might be faced in collecting the data with
Treasury (including IRS), SEC, and NAIC representatives.
We conducted our work between February 2003 and December 2003,
primarily in Washington, D.C., in accordance with generally accepted
government auditing standards.
[End of section]
Appendix II: State Insurable Interest and Consent Provisions:
Table 3 provides information on state insurable interest and
notification and consent provisions applicable to purchases of
business-owned life insurance by employers or employer-sponsored
trusts.
Table 3: State Insurable Interest and Consent Laws Applicable to
Business-Owned Life Insurance as of December 31, 2003:
State: Alabama;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* A corporation or employer- sponsored trust established for the sole
benefit of the corporation may insure the lives of directors, officers,
employees, or any other person whose death might cause financial loss
to the corporation;
* An employer-sponsored trust established to provide employee benefits
may insure the lives of employees, retirees, or their dependents or
beneficiaries for whom the benefits are to be provided;
Requirements for notifying or obtaining consent of insured employees:
* Consent of insured is required, but the requirement is not specific
to business- owned policies and excludes group life insurance.
State: Alaska;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* For people not closely related, an insurable interest includes a
lawful and substantial economic interest in having the life of the
insured person continue;
Requirements for notifying or obtaining consent of insured employees:
* Written consent of insured is required, but the requirement is not
specific to business-owned policies and excludes group life insurance.
State: Arizona;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* For people not closely related, an insurable interest includes a
lawful and substantial economic interest in having the life of the
insured person continue;
Requirements for notifying or obtaining consent of insured employees:
* Consent of insured is required, but the requirement is not specific
to business-owned policies and excludes group life insurance.
State: Arkansas;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* An employer or trust providing employee benefits may insure the lives
of key employees and employees for whom employee benefits are to be
provided;
* Coverage of non-key and nonmanagement employees must be reasonably
related to the benefits provided to the employee;
* Insurance purchased to finance pension and welfare benefit plans is
only allowed on the lives of employees who have a reasonable
expectation of receiving such benefits at the time their lives are
first insured;
Requirements for notifying or obtaining consent of insured employees:
* Employee written consent is required.
State: California;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* An employer may insure the lives of directors and officers or
administrative, executive, or professional employees exempt from
California overtime compensation requirements;
* An employer-sponsored trust providing employee or retiree benefits
may insure the lives of those for whom benefits are to be provided;
Requirements for notifying or obtaining consent of insured employees:
* Employee written consent is required;
* Policies purchased on nonexempt employees prior to January 1, 2004,
will be void no later than January 1, 2010, unless the employer meets
certain exceptions, including disclosing in writing information about
such policies to insured employees.
State: Colorado;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* No statutory definition of employer or employer-sponsored-trust
insurable interest exists;
Requirements for notifying or obtaining consent of insured employees:
* No statutory consent requirement exists.
State: Connecticut;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* No statutory definition of employer or employer-sponsored-trust
insurable interest exists;
* The trustee of any voluntary employee benefits association may insure
the lives of employees or retired employees to provide benefits to
those employees;
Requirements for notifying or obtaining consent of insured employees:
* No statutory consent requirement exists.
State: Delaware;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* An employer providing benefits to some or all employees or their
dependents or beneficiaries may insure the life of any employee;
* An employer-sponsored trust established substantially for the
employer or for the benefit of employees or their dependents or
beneficiaries may insure the lives of such employees;
Requirements for notifying or obtaining consent of insured employees:
* Employee notification or consent is not required if the employer is
located in Delaware and has at least 50 employees.
State: Florida;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* No statutory definition of employer or employer-sponsored-trust
insurable interest exists;
Requirements for notifying or obtaining consent of insured employees:
* No statutory consent requirement exists.
State: Georgia;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* A corporation may insure the lives of directors, officers, employees,
or any other person whose death might cause financial loss to the
corporation;
* An employer- sponsored trust providing benefits to employees,
retirees, or their dependents or beneficiaries may insure the lives of
employees for whom such benefits are to be provided;
Requirements for notifying or obtaining consent of insured employees:
* Employee written consent is required.
State: Hawaii;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* For people not closely related, an insurable interest includes a
lawful and substantial economic interest in having the life of the
insured person continue;
Requirements for notifying or obtaining consent of insured employees:
* Written consent of insured is required, but the requirement is not
specific to business-owned policies and excludes group life insurance.
State: Idaho;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* For people not closely related, an insurable interest includes a
lawful and substantial economic interest in having the life of the
insured person continue;
Requirements for notifying or obtaining consent of insured employees:
* Written consent of insured is required, but the requirement is not
specific to business-owned policies and excludes group life insurance.
State: Illinois;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* An employer or employer- sponsored trust may insure the lives of
directors and officers and management, nonmanagement, and retired
employees;
* Coverage of nonmanagement and retired employees is limited to an
amount commensurate with the employer's projected unfunded employee
benefit plan liabilities for nonmanagement and retired employees;
Requirements for notifying or obtaining consent of insured employees:
* The consent requirement is satisfied if an employee does not reject
coverage within 30 days of receiving written notice of the coverage.
State: Indiana;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* An employer or employer- sponsored trust may insure the lives of
employees for whom they provide employee benefits;
Requirements for notifying or obtaining consent of insured employees:
* The consent requirement is satisfied if an employee does not reject
coverage within 30 days of receiving notice of the coverage.
State: Iowa;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* An employee or employer-sponsored trust may insure the lives of
employees, retirees, officers, managers, directors, owners,
shareholders, and members;
* Coverage of nonmanagement and non-key employees must be reasonably
related to the benefits provided to the employees;
Requirements for notifying or obtaining consent of insured employees:
* Employee written consent is required.
State: Kansas;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* An employer or employer- sponsored trust for the benefit of employees
may insure the lives of directors, employees, or retirees;
* Coverage of nonmanagement and retired employees is limited to an
amount commensurate with the aggregate projected liabilities under all
employee welfare benefit plans;
Requirements for notifying or obtaining consent of insured employees:
* The consent requirement is satisfied if an employee does not reject
coverage within 30 days of receiving notice of the coverage.
State: Kentucky;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* A corporation that provides active or retired employees with
retirement or other benefits, or a trust established by the corporation
for its sole benefit, may insure the lives of active or retired
employees who are covered by the retirement or other benefit plan;
Requirements for notifying or obtaining consent of insured employees:
* Written consent of insured is required, but the requirement is not
specific to business-owned policies and excludes group life insurance.
State: Louisiana;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* For people not closely related, an insurable interest includes a
lawful and substantial economic interest in having the life of the
insured person continue;
Requirements for notifying or obtaining consent of insured employees:
* Written consent of insured is required, but the requirement is not
specific to business-owned policies and excludes group life insurance.
State: Maine;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* A corporation or trust may insure the lives of employees, former
employees, and retirees for the purpose of funding pre-and
postretirement benefits, provided that the insured employees are
selected by objective standards and that the proceeds are used for the
sole purpose of funding the benefit programs covering at least a broad
class of employees;
Requirements for notifying or obtaining consent of insured employees:
* Employee written consent is required.
State: Maryland;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* A private or public corporation or a trust established by such a
corporation for the benefit of employees may insure the lives of key
employees;
* A public corporation or a trust established by such a corporation may
insure the lives of non-key employees who have been employed at least
12 consecutive months, provided the amount of coverage on non-key
employees is commensurate with employer-provided benefits;
Requirements for notifying or obtaining consent of insured employees:
* In general, consent of insured is required, but the requirement is
not specific to business-owned policies and excludes group life
insurance;
* Non-key employees of public corporations must consent in writing to
be insured.
State: Massachusetts;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* A corporation or employer-sponsored trust established for the sole
benefit of the corporation may insure the lives of directors, officers,
employees, or any other person whose death might cause financial loss
to the corporation;
* An employer-sponsored trust established to provide employee benefits
may insure the lives of employees or retirees for whom the benefits are
to be provided;
Requirements for notifying or obtaining consent of insured employees:
* Written consent of insured is required, but the requirement is not
specific to business-owned policies and excludes group life insurance.
State: Michigan;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* An employer or a trust maintained for the purpose of providing for
the cost of benefits under an employee benefit plan may insure the
lives of directors, officers, and managers and nonmanagement and
retired employees;
* Coverage of nonmanagement and retired employees is limited to an
amount commensurate with the employer's projected unfunded employee
benefit plan liabilities for nonmanagement and retired employees;
Requirements for notifying or obtaining consent of insured employees:
* For business-owned life insurance purchased by an employer, employee
written consent is required;
* For business-owned life insurance purchased by a trust maintained for
the purpose of providing for the cost of benefits, written notice is
required, and the trust may purchase insurance only if the employee
does not object in writing to the coverage.
State: Minnesota;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* A corporation or employer- sponsored trust providing benefits to
employees may insure the lives of employees for whom the benefits are
to be provided;
Requirements for notifying or obtaining consent of insured employees:
* Employee written consent is required.
State: Mississippi;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* A corporation or trust may insure someone's life if the corporation
or trust has a lawful and substantial economic interest in having the
life of the insured person continue;
Requirements for notifying or obtaining consent of insured employees:
* Written consent of insured is required, but the requirement is not
specific to business-owned policies and excludes group life insurance.
State: Missouri;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* An employer or employer- sponsored trust for the benefit of employees
may insure the lives of directors, employees, or retirees;
* Coverage of nonmanagement and retired employees is limited to an
amount of aggregate projected death benefits commensurate with the
aggregate projected liabilities to employees under all employee welfare
benefit plans;
Requirements for notifying or obtaining consent of insured employees:
* Written notice is required, and the insurance may be purchased only
if the employee does not object in writing within 30 days of the notice
of coverage.
State: Montana;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* For people not closely related, an insurable interest includes a
lawful and substantial economic interest in having the life of the
insured person continue;
Requirements for notifying or obtaining consent of insured employees:
* Written consent of insured is required, but the requirement is not
specific to business-owned policies and excludes group life insurance.
State: Nebraska;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* For people not closely related, an insurable interest exists when,
because of a pecuniary relationship, the beneficiary expects some
benefit in having the life of the insured person continue;
Requirements for notifying or obtaining consent of insured employees:
* Written consent of insured is required, but the requirement is not
specific to business-owned policies and excludes group life insurance.
State: Nevada;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* For people not closely related, an insurable interest includes a
lawful and substantial economic interest in having the life of the
insured person continue;
Requirements for notifying or obtaining consent of insured employees:
* Written consent of insured is required, but the requirement is not
specific to business-owned policies and excludes group life insurance.
State: New Hampshire;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* A business may insure a person's life if the business expects
pecuniary benefit or advantage in having the life of the insured person
continue;
Requirements for notifying or obtaining consent of insured employees:
* Written consent of insured is required, but the requirement is not
specific to business-owned policies.
State: New Jersey;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* A corporation may insure the lives of directors, officers, or
employees whose death might cause financial loss to the corporation;
* A trust established and fully funded by a corporation to provide
benefits to employees may insure the lives of employees for whom such
benefits are to be provided;
Requirements for notifying or obtaining consent of insured employees:
* No statutory consent requirement exists.
State: New Mexico;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* For people not closely related, an insurable interest includes a
lawful and substantial economic interest in having the life of the
insured person continue;
Requirements for notifying or obtaining consent of insured employees:
* Written consent of insured is required, but the requirement is not
specific to business-owned policies and excludes group life insurance.
State: New York;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* Employers may insure the lives of employees in which the employer has
a lawful and substantial economic interest in having the life of the
insured person continue;
* Employers may insure the lives of employees or retirees who
participate in or are eligible to participate in an employee benefit
plan upon satisfaction of eligibility criteria. In such cases, the
total amount of coverage cannot exceed employee benefit costs incurred
since date of coverage plus projected future employee benefit costs;
Requirements for notifying or obtaining consent of insured employees:
For all employees: ;
* Employee notification and written consent are required;
For employees insured under the insurable interest provision related to
participation in an employee benefit plan: ;
* The notification must state that the insured can have coverage
discontinued at any time;
* When employment terminates, employees must receive notice that they
can have coverage discontinued. Notification is not required if the
employee has a right to receive benefits being financed by the
insurance coverage.
State: North Carolina;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* An employer or business trust may insure the life of any employee;
* A trust to provide pension benefits may insure the life of any person
covered by the pension plan;
Requirements for notifying or obtaining consent of insured employees:
* No statutory consent requirement exists.
State: North Dakota;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* A corporation or employer- sponsored trust providing employee
benefits may insure the lives of employees for whom the benefits are to
be provided;
Requirements for notifying or obtaining consent of insured employees:
* Employee written consent is required.
State: Ohio;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* An employer or employer-sponsored trust for the benefit of employees
may insure the lives of directors, employees, or retirees;
* Coverage of nonmanagement and retired employees is limited to an
amount of aggregate projected death benefits commensurate with the
aggregate projected liabilities to employees under all employee benefit
plans;
Requirements for notifying or obtaining consent of insured employees:
* Written notice and employee written consent are required.
State: Oklahoma;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* An employer or employer- sponsored trust for the benefit of employees
may insure the lives of directors, employees, or retirees;
* Coverage of nonmanagement and retired employees is limited to an
amount agreed to by the employee or, in the absence of an agreement, an
amount of aggregate projected death benefits commensurate with the
aggregate projected liabilities to employees under all employee welfare
benefit plans;
Requirements for notifying or obtaining consent of insured employees:
* Written notice and employee written consent are required;
* Unless otherwise agreed, the employer must offer to sell the policy
to the employee upon termination of employment.
State: Oregon;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* No statutory definition of employer or employer-sponsored-trust
insurable interest exists;
Requirements for notifying or obtaining consent of insured employees:
* Written consent of insured is required, but the requirement is not
specific to business-owned policies and excludes group life insurance.
State: Pennsylvania;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* A corporation or a trust established to provide benefits to a
corporation's officers, directors, principals, partners, and employees
may insure the lives of such people;
Requirements for notifying or obtaining consent of insured employees:
* Written notification and written consent of insured are required.
State: Rhode Island;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* An employer or employer- sponsored trust may insure the lives of key
employees;
* An employer or employer-sponsored trust may insure the lives of other
employees, former employees, and retirees for the sole purpose of
funding the cost of preretirement and postretirement benefits;
* The amount of coverage on non-key employees is limited to an amount
commensurate with employer-provided benefits to those employees;
Requirements for notifying or obtaining consent of insured employees:
* Consent of insured is required for policies benefiting tax-exempt
charitable organizations, but the requirement does not address business-
owned policies.
State: South Carolina;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* No statutory definition of employer or employer-sponsored-trust
insurable interest exists;
Requirements for notifying or obtaining consent of insured employees:
* No statutory consent requirement exists.
State: South Dakota;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* For people not closely related, an insurable interest includes a
lawful and substantial economic interest in having the life of the
insured person continue;
Requirements for notifying or obtaining consent of insured employees:
* Written consent of insured is required, but the requirement is not
specific to business-owned policies and excludes group life insurance.
State: Tennessee;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* No statutory definition of employer or employer-sponsored-trust
insurable interest exists;
Requirements for notifying or obtaining consent of insured employees:
* No statutory consent requirement exists.
State: Texas;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* Employers may purchase a group life insurance policy to insure the
lives of officers, directors, employees, and retired employees in an
amount necessary to provide funds to offset liabilities related to
fringe benefits;
* An individual may consent in writing to the purchase of or
application for an individual or group life insurance policy and
designation of any entity as the beneficiary of the policy or owner of
the policy;
Requirements for notifying or obtaining consent of insured employees:
* Employee consent is not required for policies purchased to offset
liabilities related to fringe benefits.[A];
* Any individual may consent to a business's purchase of and
designation as beneficiary of a policy on the individual's life.
State: Utah;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* An employer or employer-sponsored- trust may insure the lives of
directors, officers, managers, nonmanagement employees, and retirees;
* Coverage for nonmanagement and retired employees is limited to an
amount commensurate with the employer's unfunded employee benefit
liabilities;
Requirements for notifying or obtaining consent of insured employees:
* Employee written consent is required.
State: Vermont;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* No statutory definition of employer or employer-sponsored-trust
insurable interest exists;
Requirements for notifying or obtaining consent of insured employees:
* No statutory consent requirement exists.
State: Virginia;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* A corporate employer or employee benefit trust may insure the lives
of key employees and other employees who have been employed for 12
consecutive months;
* Coverage on non-key employees is limited to an amount commensurate
with employer-provided benefits to these employees;
Requirements for notifying or obtaining consent of insured employees:
* Written notice is required.
State: Washington;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* For people not closely related, an insurable interest includes a
lawful and substantial economic interest in having the life of the
insured person continue;
Requirements for notifying or obtaining consent of insured employees:
* Written consent of insured is required, but the requirement is not
specific to business-owned policies and excludes group life insurance.
State: West Virginia;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* For people not closely related, an insurable interest includes a
lawful and substantial economic interest in having the life of the
insured person continue;
Requirements for notifying or obtaining consent of insured employees:
* Written consent of insured is required, but the requirement is not
specific to business-owned policies and excludes group life insurance.
State: Wisconsin;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* No statutory definition of employer or employer-sponsored-trust
insurable interest exists;
Requirements for notifying or obtaining consent of insured employees:
* Written consent of insured is required, but the requirement is not
specific to business-owned policies.
State: Wyoming;
Employer and employer-sponsored trusts‘ insurable interest in
current and former employees:
* For people not closely related, an insurable interest includes a
lawful and substantial economic interest in having the life of the
insured person continue;
Requirements for notifying or obtaining consent of insured employees:
* Written consent of insured is required, but the requirement is not
specific to business-owned policies and excludes group life insurance.
Source: GAO analysis of state statutes.
[A] The Texas Department of Insurance noted that, notwithstanding the
statute's language, based on its legislative history, the department
has consistently maintained that employee consent is required.
[End of table]
[End of section]
Appendix III: Comments from the Department of the Treasury:
DEPARTMENT OF THE TREASURY
WASHINGTON, D.C. 20220:
APR 23 2004:
Ms. Davi M. D'Agostino:
Director, Financial Markets and Community Investment
U.S. General Accounting Office:
441 G Street, NW, Room 2440B
Washington, DC 20548:
Dear Ms. D'Agostino:
Because the policy issues concerned with business-owned life insurance
are tax-related issues, Secretary Snow has asked that I provide
Treasury's comments with regard to the GAO draft report, "Business-
Owned Life Insurance: More Data Could Be Useful in Making Decisions
About Its Tax Treatment.":
The draft report is well-researched and informative. It provides useful
descriptions concerning the prevalence and use of business-owned life
insurance, current regulatory requirements regarding such insurance,
and the potential usefulness of more comprehensive data on the
ownership and scope of these products. Our comments are limited to a
clarification of the current tax treatment of interest as it relates to
business-owned life insurance and to a few remarks relevant to the
possible collection of additional data by the Internal Revenue Service.
On the whole, the report accurately describes the tax treatment of
business-owned life insurance and of interest on loans used to finance
such insurance. However, the report leaves the impression that interest
that is not linked directly to business-owned life insurance is almost
always deductible.
"Borrowing to indirectly finance policies presents a tax advantage to
businesses because they receive tax-deferred inside buildup from life
insurance policies indirectly financed with debt on which the interest
expense is tax-deductible." (p. 30).
This is not entirely correct. Subsection (f) of section 264 of the
Internal Revenue Code generally allocates a portion of the interest
expense of a business to its unborrowed policy cash values. Thus, in
general, if unborrowed policy cash values comprise x percent of the
assets of a business, then x percent of interest is held to be
nondeductible. However, this provision does not apply to policies that
cover the life of any person that owns at least 20 percent of the stock
or voting power of a corporation or 20 percent of the capital or
profits of a noncorporate business. It also does not apply to contracts
that cover the life of a person who is an officer, director, or
employee of the business at the time he or she is first covered by the
contract. Thus, this rule does not apply with respect to most contracts
considered in your report, but does apply to contracts covering
insureds who are not employees, such as customers, borrowers, or
lenders of the business. The provision also is limited to corporations
and partnerships; it does not apply to sole proprietorships.
The report suggests that additional data on business-owned life
insurance could be collected on applicable IRS forms (p. 38). We are
somewhat apprehensive with regard to this suggestion, and are concerned
with imposing additional reporting burdens on taxpayers when the
information collected does not have direct usefulness in the
calculation of tax liability or in enhancing the ability of the IRS to
audit tax returns. The types of information being discussed (e.g., the
purpose underlying the purchase of policies, the amounts of income not
subject to tax, policy cash surrender values, annual premiums paid) do
not appear to support these reasons for reporting information on tax
returns. Therefore, we do not believe the collection of such
information, whether administratively or as the result of a
Congressional requirement, to be useful or advisable.
We also have doubts as to the efficacy of the report's suggestion that
a survey, or surveys, could be employed by Treasury to gather the
desired information (p. 38). Well-constructed surveys can be costly to
design and distribute, and can be a burden on respondents. Past
experience indicates that, without a penalty for noncompliance, there
would be a low response rate to such a survey, and that such a response
rate would cast suspicions on the results as being non-representative
of the totality of business-owned life insurance. Furthennore, except
as a derivative of its function as tax collector, Treasury is not a
statistical gathering agency. We believe a survey of insurance products
could be better performed by other organizations or agencies.
Please do not hesitate to contact us if you have further questions.
Sincerely yours,
Signed by:
Gregory P. Jenner:
Acting Assistant Secretary (Tax Policy):
The Department of the Treasury (Treasury) commented on our matter for
congressional consideration, which suggested that, among other
alternatives, Congress could assign responsibility to Treasury for
collecting data on business-owned life insurance. We discuss these
comments in the Agency Comments and Our Evaluation section of this
report. We also modified the report based on the technical comments
that Treasury provided, as appropriate. In addition, discussed below is
GAO's detailed response to another comment from Treasury's April 23,
2004, letter.
GAO Comments:
1. Treasury commented that the report leaves the impression that
interest not linked directly to business-owned life insurance is almost
always deductible, noting that the Internal Revenue Code generally
allocates a portion of the interest expense of a business to its
unborrowed policy cash values. However, Treasury also noted that this
provision does not apply to contracts that cover the life of a person
who is an officer, director, or employee of the business. Our report
addresses business-owned life insurance as permanent insurance that an
employer purchases on the lives of employees, with the business as the
beneficiary. Because the provision cited by Treasury does not apply to
this type of insurance, we do not discuss it in the report.
[End of section]
Appendix IV: Comments from the Internal Revenue Service:
DEPARTMENT OF THE TREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224:
COMMISSIONER:
April 22, 2004:
Ms. Davi M. D'Agostino:
Director, Financial Markets and Community Investment
United States General Accounting Office:
Washington, DC 20548:
Dear Ms. D'Agostino,
Thank you for allowing us to review and comment on your draft report
titled "Business-Owned Life Insurance: More Data Could Be Useful in
Making Decisions About Its Tax Treatment." Although your comprehensive
report does not contain audit recommendations, it does accurately
account for the factors that influence the IRS' audits of businesses
that own life insurance.
The IRS' efforts regarding business-owned life insurance have centered
on broad-based Corporate-Owned Life Insurance (COLT) and have
culminated in the favorable resolution, by litigation or settlement, of
the vast majority of cases. The government successfully leveraged its
litigation victories in major cases through Announcement 2002-96, which
offered taxpayers a final opportunity to settle their cases on terms
highly favorable to the government. Most taxpayers accepted the
settlement and, as a result, just a small number of broad-based post-
1985 COLT cases remain unresolved.
The IRS has also conducted in-depth audits of taxpayers with certain
pre-1986 abusive COLT plans. One such case is currently in Appeals
jurisdiction and another one was recently docketed for trial in the
U.S. District Court for the District of Minnesota. The government
expects to vigorously defend its position in that case.
Audit activity regarding Bank-Owned Life Insurance (BOLT) is currently
confined to a small number of cases judged to represent a typical
cross-section of BOLI products and taxpayers. The results of our review
will determine the need for any additional action.
During our exit conference with GAO, the Large andMid-Size Business
(LMSB) Division and the LMSB Division Counsel provided detailed
comments on your Statement of Facts for the Business-Owned Life
Insurance review. If you have any questions, please contact John
Petrella, Director, Heavy Manufacturing and Transportation Industry at
(732) 452-8102.
Sincerely,
Signed for:
Mark W. Everson:
[End of section]
Appendix V: Comments from the Securities and Exchange Commission:
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549:
DIVISION OF CORPORATION FINANCE:
April 13, 2004:
Davi M. D'Agostino:
Director, Financial Markets and Community Investment
441 G Street, NW:
Washington, DC 20548:
Dear Ms. D'Agostino:
Thank you for the opportunity to review and comment on the General
Accounting Office's draft report regarding Business-Owned Life
Insurance. While the GAO does not recommend executive action, it does
suggest how to proceed should Congress decide that it needs more
comprehensive data on business-owned life insurance. We appreciate the
opportunity to comment on these suggestions.
The GAO concludes that should Congress decide it needs more data on
business-owned life insurance, it could have the SEC, the Department of
Treasury or the National Association of Insurance commissioners collect
the data from businesses or insurance companies. I would like to make
two very important points in response to this conclusion. First, the
SEC's mission in requiring filings by public companies is to provide
investors with information that is material to investment and voting
decisions. With this in mind, we are concerned that the collection of
data by the SEC for purposes other than the protection of investors may
not be appropriate and may establish an unfortunate precedent for other
information collections that could clutter the material information
that investors seek and expect from the filings companies make with the
SEC. Second, please note that the efficacy of such an information
collection program through SEC filings would be constrained by the
federal securities law's limitations on those companies that are
required to file information with the SEC.
Thank you again for this opportunity to provide comments to the GAO as
it prepares its final draft of the report.
Sincerely,
Signed by:
Alan L. Beller,
Director:
The Securities and Exchange Commission (SEC) commented on our matter
for congressional consideration, which suggested that, among other
alternatives, Congress could assign responsibility to SEC for
collecting data on business-owned life insurance. We discuss these
comments in the Agency Comments and Our Evaluation section of this
report. We also modified the report based on the technical comments
that SEC provided, as appropriate. In addition, discussed below is
GAO's detailed response to another comment from SEC's April 13, 2004,
letter.
GAO Comments:
1. SEC commented that the efficacy of an information collection program
through SEC filings would be constrained by the federal securities
law's limitations on those companies that are required to file
information with SEC. Our report recognizes on page 36 that SEC only
collects data from public companies. As Congress evaluates the need for
additional data, it might determine that data from a subset of all
companies would provide adequate information.
[End of section]
Appendix VI: Comments from the National Association of Insurance
Commissioners:
NAIC:
National Association of Insurance Commissioners:
Executive Headquarters:
2301 McGee Street
Suite 800
Kansas City, MO
64108-2662
Ms. Davi M. D'Agostino:
Director, Financial Markets and Community Investment:
U.S. General Accounting Office
441 G Street, NW Washington, DC 20548:
Dear Ms. D'Agostino:
Thank you for the opportunity to provide you with feedback on the GAO's
draft report entitled, Business-Owned Life Insurance: More Data Could
Be Useful in Making Decisions About Its Tax Treatment. The NAIC
appreciates the opportunity to respond to your findings in this report.
We also appreciate the opportunity to have assisted during the
development of the report by meeting with the GAO to provide background
information.
The NAIC has been interested in this issue for some time and has also
reviewed the subject. During 2002, the NAIC appointed a working group,
chaired by Commissioner Jim Poolman of North Dakota, to review the
NAIC's earlier guidance and to recommend an appropriate state response.
The NAIC's COLI Working Group reviewed the model guidelines mentioned
in your report and recommended an additional provision that requires
written affirmative consent prior to purchase of coverage on an
employee. The changes to the model guidelines also acknowledged that
coverage might continue after the person was no longer employed by that
company and prohibited the employer from retaliating in any way against
an employee who chose not to give that consent. The working group also
considered requiring notification of the employee's spouse and
including a provision that would require employers to make notification
to all existing employees where coverage was already in place. These
provisions were not ultimately included because of the negative effect
they would have on employers in relation to the benefit that would be
provided.
As mentioned in the report, the majority of states do define insurable
interest in such a way as to allow employers to purchase life insurance
coverage on some, if not all, employees. Many states also require
getting consent prior to that purchase. The report also notes that in
many cases the coverage is purchased specifically to
fund employee benefits and some state laws require that the policies be
segregated into a trust for that purpose. Page 5 of your report may
mislead readers by specifying that four insurance regulators have
issued guidelines applicable to business-owned life insurance. Readers
may assume that the report is referring to the four states interviewed,
or may be confused by the wording to believe that only four states have
such requirements. A reading of the chart contained in Appendix II will
clarify that, in fact, most states have guidelines.
The report correctly states that insurance regulators have collected
little data on business-owned life insurance because concerns about
abuse or misuse of the policies have not been previously forthcoming.
The GAO suggests that the NAIC might be a source of information about
the extent of business-owned life insurance by adding the reporting of
that information to the annual statement that insurers are required to
file with the NAIC. As you are aware, the NAIC collects a large amount
of data from the insurance industry, a large portion of which is
included in the annual and quarterly financial filings submitted to the
states to support solvency regulation. The current statutory filing
requirements do not require the level of detail for business-owned life
insurance, or any other specialty line of business, contemplated by the
GAO in this report. We believe that what the GAO is suggesting by the
collection of more detailed information on business-owned life
insurance goes beyond that needed to support solvency regulation. We
agree there may be a significant cost associated with the collection of
this data, both from the reporting entity and collecting organization
standpoint; however, the NAIC would like to better understand the type
of information to be collected to further evaluate the need for and
utility of this information. Perhaps instead of an ongoing data
collection effort, a study sampling this data may be more cost
effective in assessing the larger need for ongoing data collection.
Thank you again for the opportunity to respond to the findings in your
report. We hope these comment are helpful and that you will contact us
if we can be of further assistance.
Sincerely,
Signed by:
Ernst N. Csiszar:
NAIC President:
Director, South Carolina Department of Insurance:
The National Association of Insurance Commissioners (NAIC) commented on
our matter for congressional consideration, which suggested that, among
other alternatives, Congress could encourage NAIC to collect data on
business-owned life insurance. We discuss these comments in the Agency
Comments and Our Evaluation section of this report. We also modified
the report based on the technical comments that NAIC provided, as
appropriate. In addition, discussed below is GAO's detailed response to
another comment from NAIC's April 19, 2004, letter.
GAO Comments:
1. NAIC commented that a statement on page 5 of our draft report may
lead readers to believe that only four states have issued guidelines
applicable to business-owned life insurance. We modified that statement
to clarify that we are referring only to the four states we contacted.
Although many other states have issued guidelines and requirements that
are applicable to business-owned life insurance, we only discussed
regulatory oversight of such policies with officials from the four
states that we contacted.
[End of section]
Appendix VII: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Davi M. D'Agostino, (202) 512-8678 Cecile Trop, (312) 220-7600:
Staff Acknowledgments:
In addition to those individuals named above, Joseph Applebaum, Emily
Chalmers, Rachel DeMarcus, Daniel Meyer, Marc Molino, Carl Ramirez, and
Julianne Stephens made key contributions to this report.
(250121):
FOOTNOTES
[1] Unlike term life insurance, permanent life insurance lasts for the
life of the insured and accumulates cash value as it provides coverage.
Businesses may purchase term life insurance on their employees; this
report does not address such purchases.
[2] This report focuses on businesses that own insurance on the lives
of their employees. As such, it does not address charitable
organizations that purchase insurance on the lives of their members or
donors and businesses that purchase insurance on the lives of their
creditors.
[3] Various types of plans and accounts exist that provide some tax
preferences for funding employee benefits. These plans and accounts are
subject to limitations that generally do not apply to business-owned
life insurance.
[4] U. S. General Accounting Office, Business-Owned Life Insurance:
Preliminary Observations on Uses, Prevalence, and Regulatory Oversight,
GAO-04-191T (Washington, D.C.: Oct. 23, 2003).
[5] The Federal Reserve regulates state-chartered banks that are
members of the Federal Reserve System, their foreign branches and
subsidiaries, and bank holding companies and their nonbank and foreign
subsidiaries. FDIC regulates state-chartered banks that are not members
of the Federal Reserve System and federally insured, state-chartered
state savings banks. OCC regulates nationally chartered banks and
federal branches and agencies of foreign banks. OTS regulates state and
federally chartered savings associations and savings and loan holding
companies. In this report, we refer to savings banks and savings
associations as thrifts.
[6] NAIC is a membership organization of chief state insurance
regulators that helps promote coordination among the states.
[7] "Banks and thrifts" or "institutions," as referred to in this
report, are the commercial bank and thrift institutions regulated by
the Federal Reserve, FDIC, OCC, and OTS. However, the report does not
cover bank and thrift holding companies and foreign banks with domestic
branches.
[8] Bank regulators' guidelines impose additional restrictions on
allowable life insurance purchases for banks.
[9] In New York, employees insured under broad-based plans may request
that coverage on their lives be discontinued at any time.
[10] With a business-established trust, trust-owned life insurance is
similar to corporate-owned or bank-owned life insurance. The business
generally controls the trust that holds the policies--for example, a
trust may maintain assets to fund nonqualified employee benefits.
[11] IRC §72(e)(1).
[12] In general, the alternative minimum tax is based on a
corporation's regular taxable income adjusted for certain tax
preference income items, such as exclusions, deductions, and credits.
The amount due is the amount by which the tax computed under this
system exceeds a corporation's regular tax.
[13] Under the first of the two alternative tests to qualify as life
insurance for tax purposes under Internal Revenue Code section 7702,
the cash value of a policy cannot at any time exceed the net single
premium that would have to be paid to fund the future benefits under
the contract. This test is designed to exclude contracts with an
investment orientation from the definition of life insurance. Under the
second test, the cumulative premiums paid cannot exceed a limitation,
computed at the time the policy is issued, and the ratio of the death
benefit to the cash value of the policy can never fall below specified
percentages. These tests are designed to restrict treatment as a life
insurance contract to those contracts where policyholders make
traditional levels of investment through premiums and to contracts that
do not allow excessive amounts of cash value to build up in regard to
the life insurance risk.
[14] The Tax Reform Act of 1986 disallowed interest deductions for
interest on a loan in excess of $50,000 with respect to policies on the
life of an officer, employee, or person financially interested in the
business. This provision did not apply to policies purchased on or
before June 20, 1986. The Health Insurance Portability and
Accountability Act of 1996 provided that no deduction is allowed for
interest on any indebtedness with respect to policies on any individual
who is or has been an officer or employee or financially interested in
any business carried on by the employer, regardless of the amount of
debt with respect to policies covering the individual. An exception was
provided for key persons where the indebtedness does not exceed
$50,000. A key person was defined as an officer or 20-percent owner.
The 1996 legislation applied generally to interest paid or accrued
after October 13, 1995, with a phase in period. The legislation
generally did not apply to policies purchased on or before June 20,
1986.
[15] The 1996 legislation also amended the Internal Revenue Code
section 264 to limit the number of policies on key persons for which
interest remained deductible to the greater of (1) 5 individuals or (2)
the lesser of 5 percent of the total number of officers and employees
of the business, or 20 individuals.
[16] In addition to the 1986 and 1996 legislation addressing leveraged
business-owned life insurance policies, IRS and the Department of
Justice prevailed in three cases involving the deductibility of loan
interest related to such policies. These plans covered over 55,000
employees. The courts found that the leveraged plans lacked economic
substance, making the interest deduction unallowable. See In re C.M.
Holdings, Inc., 301 F.3d 96 (3rd Cir. 2002); Am. Elec. Power v. United
States, 326 F.3d 737 (6th Cir. 2003), reh. denied, 338 F.3d 534 (6th
Cir. 2003), cert. denied, 72 U.S.L.W. 3446 (Jan. 12, 2004); Winn Dixie
Stores v. Commissioner, 254 F.3d 1313 (11th Cir. 2001), cert. denied,
535 U.S. 986 (2002). The taxpayer prevailed in a fourth case. See Dow
Chemical Co. v. United States, 250 F Supp. 2d 748 (E.D. Mich. 2003),
modified, 278 F. Supp. 2d 844 (E. D. Mich. 2003).
[17] The data do not include bank holding companies or foreign banks
with domestic branches. The Federal Reserve started collecting data on
business-owned life insurance from bank holding companies in 2003, but
the data were not available at the time of our analysis. The reporting
form for foreign banks with domestic branches did not have a
standardized reporting category for business-owned life insurance.
[18] The Federal Reserve, FDIC, and OCC require an institution to
report the tax-deferred earnings on life insurance if the amount
exceeds 1 percent of the sum of the institution's total interest and
noninterest income. OTS requires an institution to report adjustments
to the cash surrender value of life insurance if the amount is one of
the two largest items comprising the "other noninterest income" item,
which includes net income from leased property and real estate held for
investment, adjustments to prior periods, and other items.
[19] According to the Financial Accounting Standards Board and other
auditing guidance, the determination of what information should be
disclosed as material in financial statements is a matter of
professional judgment. Materiality involves both quantitative and
qualitative considerations. Even though quantitatively immaterial,
certain types of misstatements could have a material impact or warrant
disclosure in the financial statements for qualitative reasons. The
omission or misstatement of an item in a financial report is material
if, in the light of surrounding circumstances, the magnitude of the
item is such that it is probable that the judgment of a reasonable
person relying upon the report would have been changed or influenced by
the inclusion or correction of the item.
[20] "CAST 2002 COLI Marketplace Review and Assessment," CAST
Management Consultants, Inc. (July 2003). "CAST 2001 Bank-Owned Life
Insurance Market Survey - Final," CAST Management Consultants, Inc.
(April 2002).
[21] Cynthia Crosson, "Capturing COLI/BOLI," Best's Review, vol. 100,
no. 9 (2000).
[22] A proposed IRS form, Schedule M-3, Net Income (Loss)
Reconciliation for Corporations with Total Assets of $10 Million or
More, would expand the current Schedule M-1 for certain corporate
taxpayers and include specific reporting on life insurance proceeds and
corporate-owned life insurance premiums.
[23] New York state insurance regulators said that while they did not
collect detailed information on the prevalence or use of business-owned
life insurance, information about insurers that have a high volume of
business-owned life insurance sales would be useful to them in
conducting market conduct examinations in which examiners visit an
insurance company to evaluate its practices and procedures, such as for
selling and underwriting insurance policies.
[24] Qualified retirement plans receive special tax treatment under
present law and must meet requirements of the Internal Revenue Code. In
order to be tax-qualified, private pension plans must satisfy a number
of requirements, including minimum requirements on coverage and
benefits, including requirements on who is covered by plans and how
plans must provide benefits. A defined benefit plan is a qualified plan
that promises a participant monthly payments at retirement, usually
based on the participant's salary and years of covered service. A
defined contribution plan, such as a 401(k) plan, is a qualified plan
in which the employer, the employee, or both contribute to the
employee's account under the plan, and the employee ultimately receives
the balance of the account, which is based on contributions plus or
minus investment gains or losses. Nonqualified retirement plans are not
subject to many of the requirements of qualified plans and do not
receive the same tax treatment as qualified plans. Further, in contrast
to qualified retirement plans, assets intended to finance nonqualified
plans are not typically beyond the reach of a business's creditors in
bankruptcy proceedings.
[25] Present value is the value today of amounts to be paid or received
at a later date, taking into account the time value of money--that is,
a dollar today is worth more than a dollar in the future, because the
dollar today can be invested and earn interest.
[26] Life insurance held in certain trusts may be subject to creditors'
claims in bankruptcy.
[27] SEC requires companies to disclose information related to the
compensation of top officers. Therefore, the fact that companies most
frequently disclosed the use of business-owned life insurance in
connection with executive compensation does not mean that this is
necessarily the most common use of such policies.
[28] Businesses could informally fund nonqualified deferred
compensation and supplemental executive retirement plans by placing
assets in a trust that would restrict their use.
[29] "Executive Benefits: A Survey of Current Trends, 2003 Results,"
Clark Consulting (2003). Clark Consulting changed its name from Clark/
Bardes Consulting in 2003. Clark/Bardes published the results of
similar surveys from prior years, but comparisons among the surveys
cannot be used to infer trends, because the design of the survey may
have changed from year to year. We did not assess the quality of this
survey's methodology or the accuracy of its findings.
[30] Nonresponse bias results when potential providers of data do not
respond; it can be introduced when respondents as a group differ from
nonrespondents on some measured characteristic and consequently are
likely to differ in their responses.
[31] Department of the Treasury, OCC, "Bulletin 2000-23" (July 20,
2000). Department of the Treasury, OTS, "Regulatory Bulletin RB 32-26"
(July 31, 2002). These bulletins rescinded previous guidelines. OCC
officials said that the agency drafted revised guidance and circulated
it to the other regulators for review in January 2004; the officials
did not know when the revised guidance would be issued.
[32] The discount rate is the assumed interest rate used in a present
value calculation, reflecting how much could be earned from investing
today's dollars.
[33] In general, assuming a lower discount rate or including additional
years when calculating expected employee benefit costs would increase
the present value of the costs, which could in turn increase the amount
of insurance that could be purchased.
[34] OCC officials cited a court decision concerning Wal-Mart Stores,
Inc. as an illustration of transaction risk, see Mayo v. Hartford Life
Ins. Co., 220 F. Supp. 2d 714 and 794 (S.D. Tex. 2002), aff'd, 354 F.
3d 400 (5th Cir. 2004). In 2002, a federal district court in Texas
found that Wal-Mart did not have an insurable interest in employees'
lives under Texas law, given the nature of the policies taken out on
each of 350,000 Wal-Mart employees, and that under Texas law, Wal-Mart
could not collect on the death benefits paid under policies covering
deceased employees. Although the policies had been held by a trust in
Georgia, the court found that Texas insurable interest law applied.
[35] In addition to the risks identified above, the OCC and OTS
guidelines identify other types of risk, such as interest rate risk,
price risk, and compliance risk, that institutions should consider when
purchasing business-owned life insurance.
[36] Since July 2002, OTS has required thrifts to request its
permission before investing more than 25 percent of total capital in
business-owned life insurance policies. OTS officials said that the
agency had declined the three requests it had received as of September
2003 because it was not convinced the thrifts needed the additional
insurance. The other bank regulators did not have such a requirement.
[37] Tier 1 capital is a measure of the equity cushion that banks have
available to absorb loss, including credit losses from their holdings
of business-owned life insurance. The ratio of cash surrender value to
tier 1 capital is used as a proxy to measure potential risk
concentrations including credit risk (the risk of counterparty default)
arising from a bank's business-owned life insurance holdings.
[38] OCC generally defines community banks as banks with less than $1
billion in total assets. OCC characterizes banks in its Large Bank
Supervision program as the largest and most complex national (federally
chartered) banks.
[39] "Split-Dollar Life Insurance Arrangements," IRS, Department of the
Treasury, 68 Fed. Reg. 54336 (Sept. 17, 2003).
[40] Congressional Budget Office, Budget Options (Washington, D.C.:
March 2003). Congressional Research Service, The Library of Congress,
Corporate-Owned Life Insurance: Tax Issues (Washington, D.C.: updated
June 26, 2003). Congressional Research Service, The Library of
Congress, Taxation of Life Insurance Products: Background and Issues
(Washington, D.C.: July 18, 2003).
[41] OCC and OTS guidelines on business-owned life insurance limit
banks and thrifts' equity holdings in separate accounts.
[42] The Texas Department of Insurance suggested that no readily
available, cost-effective alternatives exist to test for compliance
with business-owned life insurance consent requirements.
[43] New York insurance department officials said that other factors
might also cause the department to investigate an insurer. For example,
they said that the department would investigate, as part of its market
conduct examinations, insurers that sell a significant amount of
business-owned life insurance. Officials said that, although the
insurance department has not systematically collected data on the
amount of business-owned life insurance companies have sold, they might
ask a company about the extent of such sales during a pre-examination
meeting to help the department target its market conduct examination.
[44] The total amount of tax-free income that a business receives from
a policy is the death benefit payment less premiums paid. A business
would have recognized some of this payment as tax-deferred earnings
throughout the life of the policy. However, as discussed, these
earnings do not become tax-free unless the policy is held until the
death of the insured.
[45] Obtaining an unduplicated count of the total number of employees
covered by business-owned life insurance could be impractical because
businesses can continue to hold policies on employees who have left
their employment and, therefore, more than one business can have
policies on the same person.
[46] Several studies have found that mandatory reporting has a positive
effect on survey response rates. S. Cole, G. Kusch, C.E. Hoy, and J.
Berry, "Studies of Nonresponse in Industrial Surveys" (paper presented
at the International Conference on Establishment Surveys, Buffalo, NY,
June 1993). D. Dillman, E. Singer, J. Clark, and J. Treat, "Effects of
Benefits Appeals, Mandatory Appeals, and Variations in Statements of
Confidentiality on Completion Rates for Census Questionnaires," Public
Opinion Quarterly, vol. 60, no. 3 (1996). C. Paxson, D. Dillman, and J.
Tarnai, "Improving Response to Business Mail Surveys," in Business
Survey Methods, eds. B. G. Cox et al. (New York, NY: Wiley, 1995), 303-
316. E. O'Brien, "Respondent Role As A Factor In Establishment Survey
Response," in Proceedings of the Second International Conference on
Establishment Surveys, ed. American Statistical Association
(Alexandria, VA: 2000), 1462-1467.
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