Over the past year, the idea that companies take life insurance policies out on their own employees (Corporate Owned Life Insurance or COLI) has received increased attention in the media.
Employee works for company -> Company buys life insurance policy for employee -> Company pays premiums -> Employee passes on -> Company collects on life insurance policy
The past few months, there has been increased coverage about what I affectionately refer to as "Life-Insurance Backed Securities or LIBS."
Life Insurance Policy Holder (in this case primarily Ill or Elderly) desire cash now, not upon death -> Company purchases policy at a discount giving former policy holder cash -> Company continues to pay premiums -> Person passes on -> Company collects on life insurance policy at full amount
So is there something wrong with this picture? If one puts on the lens of incentives, what can be seen? In both cases, the company gains the EARLIER the employee or person dies and can reach negative ROIs the LONGER the person lives. Since the return is essentially static in the numerator as defined by the policy the level of return is driven by the denominator and the primary variable driving variance in the denominator is the cumulative amount of the premiums. The longer the premiums are paid, the higher the denominator and the lower the ROI.
Originally, COLI plans were used to protect against the loss of key employees and senior executives in the case of death. This would allow a company to be insured against the opportunity costs associated with no longer having key personnel around. However, with time this also morphed into companies buying policies for the broader staff which became known as janitor or dead peasant insurance. The underlying reason for this morphing was not "insurance" per say but potentially for tax breaks and profit.
The government apparently realized the potential ethical and political issues with this and stepped in passing laws that limited COLI essentially trying to force them to be used again for the original purpose of insuring against the loss of key talent.
Now, the question of LIBS is coming to the forefront and one wonders whether this "innovation" may follow a similar path or be viewed as a predatory type of activity. For a good overview of the background and conversation around this type of securitization see this New York Times article. The article hints at the fact that in the void left by exotic securities spurring the financial crisis, these may just turn out to be more of the same: complex instruments that will be later reclassified in the "toxic" asset category.
My point is not portray corporations as greedy capitalist pigs, suggest companies will start adding hit men to their payrolls or sound the clarion call for more regulation. I simply want to highlight an interesting peculiarity in the intrinsic incentive structures linked to these life insurance instruments. If nothing else, it is great fodder for the Hollywood's anti-business conspiracy flick: joe plumber gets knocked off; his wife and 7 kids suffer in poverty; former employer pockets a boatload of cash; young beautiful lawyer tries to expose the conspiracy coining the term eCOLI where the "e" stands for "evil"; company hit man goes after the lawyer; turns out the lawyer's firm is actually involved and puts pressure on her to drop the case as well; she doesn't give in and after nearly being killed exposes the evil scheme; in the end the credits begin to role as the judge sends multiple executives and the hit man to jail as he awards the widow millions of dollars as bittersweet tears of unbelief, sadness and vengeance roll down her face as the court adjourns.
