Tillman COLI Advisory

June 2005

10th Circuit Rejects Insurable Interest In Lives Of Low Level Employees And Authorizes Employees To Recover Policy Proceeds

Corporations holding assets in corporate-owned life insurance programs (“COLI”) again face greater risk to those assets as a result of the recent decision, Tillman v. Camelot Music, Inc., 2005 U.S. App. Lexis 8261 (10th Cir. May 11, 2005).  The Tillman decision is identical in all material respects to the 5th Circuit’s earlier opinion in Mayo v. Hartford Life Ins. Co., 354 F.3d 400 (5th Cir. 2004).  In both cases, the courts:  (1) rejected uniform governing law for COLI programs; (2) rejected the corporation’s ability to insure the lives of low level employees; and, (3) provided a remedy to these employees to recover the COLI program’s insurance proceeds.   The Tillman decision also carries additional significance because the court construed a model insurable interest statute that has been adopted in a significant number of states. 

COLI is a general term used to describe life insurance purchased by employers to insure the lives of corporate employees.  COLI programs act like any life insurance, except that death proceeds of the policies are payable to the corporation.  For decades, employers have used COLI to hedge against the loss of key executives, provide deferred compensation to employees, and facilitate corporate control as an estate planning device.  Like nearly all life insurance, COLI proceeds also are not included in gross income for federal tax purposes.  Thus, many employers over the last two decades began using COLI programs to fund employee benefit programs.

In order to effect the individual insurance contracts that comprise a COLI program, an employer must establish that it has a valid insurable interest in each employee’s life.  The criteria necessary to establish this insurable interest varies from state-to-state according to the level of employee whom may be insured, employee consent, and the purpose for which death proceeds may be used.  Unfortunately, the insurers and brokers who marketed COLI programs throughout the 1990’s largely ignored these individual state requirements, often relying upon a trust to hold the COLI program in a jurisdiction with favorable insurable interest laws.  These trusts uniformly have been rejected by the courts.  As a result, many corporations now hold COLI assets which are at substantial risk because the employers never established an insurable interest before taking the insurance.

As a result of the Tillman and Mayo decisions, employers with COLI programs should expect that the insurable interest issue will be governed by the state law where each insured employee lived or worked.  Many states provide that a corporation may not insure low level employees.  In those states that adopted the model statute at issue in Tillman, the estates of employees whose lives were insured may recover the death benefits paid under the COLI policies—even though the corporation paid all policy premiums and despite any legitimate purpose by the corporation to use these proceeds to fund employee benefit plans.

Frost Brown Todd has significant experience advising our clients with regard to COLI programs.  Our attorneys have stayed ahead of trends in COLI insurance by advising our clients concerning the tax implications of the programs, performing pre-purchase analyses, and developing risk controls in response to the latest wave of insurable interest lawsuits.  We presently maintain a database of state insurable interest precedents ranging from prerequisite employment responsibilities, employee consent, and other limitations applied by the various states in connection with these programs.  We provide ongoing advice to a number of clients regarding these and other COLI issues.

We would be happy to meet with you and discuss these or other developments in the areas of COLI insurance programs that may affect your own assets.  Please contact Greg Mitchell gmitchell@fbtlaw.com (Lexington), Jeff Teeters jteeters@fbtlaw.com (Cincinnati) or David Walulik dwalulik@fbtlaw.com (Cincinnati) if we may assist you in this regard.

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