Retirement Heist: how companies plunder and profit from the nest eggs of American workers

This was the first time Johnson had ever heard of the policy, and she was appalled. The bank had taken out a life insurance policy on her husband and now was going to keep the money. But she would have been even more outraged if she had known where the money would go.

In recent years, as the costs of salaries and benefits for executives have put huge IOUs on corporate books, companies have begun stuffing billions of dollars into new and existing life insurance contracts taken out on the lives of their employees. The insurance policies serve as pseudo pension funds for executives: companies deposit money into the contracts, which act like giant IRAs. Like an IRA, the money in the policies is allocated among investments and grows tax-free. When the employees die—no matter how long it’s been since they’ve left the company—the death benefit goes to the company tax-free. The primary goal, though, isn’t to harvest the death benefit but to reap tax benefits and to use the investment income to offset the cost of the executive obligations.

Technically, it’s illegal for companies to buy life insurance on workers as a tax dodge, but companies can buy it to finance “employee benefits.” This loophole was created in the 1990s when companies and life insurance lobbyists convinced lawmakers that they could use the insurance to pay for “retiree benefits.” What they didn’t tell Congress was that the retiree benefit they were referring to was executive deferred compensation.

This corporate-owned life insurance, or COLI for short, was initially nicknamed “janitors insurance,” because when companies first started taking out the coverage in the 1980s and early 1990s, the policies could cover almost anyone at a company, even the janitors. More recently, it has become known as “dead peasants insurance,” which is how an insurance consultant for Winn-Dixie Stores, who had apparently watched too many Monty Python movies, referred to it in some memos in the mid-1990s.

Although the companies receive the death benefits, it isn’t really the cash that the companies are looking for. The big money, and the big benefit they get, comes from keeping the money in the contracts. This is thanks to a cascade of tax breaks and accounting rules that enable these pseudo pension funds to generate income that boosts profits. It works like this. Let’s say a company owes its executives $1 billion in deferred compensation. Since the obligation is unfunded, the interest on the debt hurts the company’s earnings. Essentially, the executives, by deferring their pay, are making a loan to the company; the company owes them interest on the loan. The interest cost on the debt reduces the company’s income. Unlike regular pensions, executive pensions aren’t funded, so there are no investment returns to offset the cost of carrying the debt. And whereas other debt burdens, like retiree health benefits, can be—and often are—cut, companies rarely cut executive benefits.

Enter life insurance policies. The kind companies buy aren’t the simple ones that pay a death benefit, but “cash value” policies, like “whole life” and “universal life” contracts, which are investment accounts with a death benefit attached. Because the account is wrapped in an insurance policy, the investments within it accumulate untaxed. In other words, the life insurance contract is a stand-in for a tax-favored pension fund.

The life insurance contracts not only provide some of the same tax benefits as pension funds; they also provide the same accounting benefits. Investments in insurance policies not only grow tax-free, but their returns pump up company income. If the investments had a return of $100 million, the company could add the $100 million to its income that year, which would offset the interest cost on the executive obligations. This tax-free flow of investment income—like the income from investments in pension funds—offsets the interest cost of the executive obligations.

If the investments weren’t wrapped in an insurance policy, the company would have to sell the investments, then pay taxes on the gains, if it wanted to be able to report the income. Bottom line: Even though companies aren’t supposed to get tax breaks for funding executive deferred comp and pensions, they get essentially the same tax breaks—and accounting benefits—by taking out life insurance on workers.

TO DIE FOR

Though the investments are essentially locked up in the insurance policies, companies receive tax-free cash when employees and former employees die whether in car accidents, in plane crashes, or from illness. Even people who are murdered or accidentally killed at work produce death benefits for their employers.

Companies report the death benefits as income, though they usually refer to them by opaque terms. The St. Louis–based Panera Bread Company calls them “mortality dividends” and refers to a death benefit as a “mortality income receivable” in its filings.