CBA Publications >> CBA Regulatory Compliance Bulletin >> Vol 2003 No.17
December 17, 2003

Vol 2003 No. 17 December 17, 2003

New Limits on Corporate Owned Life Insurance

A new California law, AB 226, prohibits insurers from issuing life insurance policies to California employers against the lives of their current or former non-exempt employees, that is, employees who are subject to the state's overtime rules. Under Labor Code Section 515 and related regulations, employees who work in executive, administrative, or professional capacities are exempt from state overtime laws. The bill also makes it a violation of public policy for a California employer to purchase or hold such a corporate-owned life insurance policy, except as specifically permitted.

Corporate-owned life insurance (COLI), including policies purchased by banks (commonly referred to as bank-owned life insurance or BOLI), are widely used investment vehicles for businesses because the death benefits and the investment gains that accrue as the policies build cash value are both tax-free. COLI is also an important means for employers to fund employee benefits.

The California legislature believes many businesses purchase COLI policies for questionable purposes, and sought originally to ban COLI outright. It adopted the view of supporters of the bill, including the California Labor Federation, that policy proceeds should be used solely to support employee benefits. Any other use is illegitimate and, at any rate, should not be supported with tax advantages. The legislature pointed to a Wall Street Journal article that suggests businesses did not necessarily use the death benefits only to fund employee benefits.

Under AB 226, the following transition rules apply to COLI policies that insure the lives of existing and former nonexempt employees who are California residents (policies insuring the lives of exempt employees are not affected by the new law):

• a policy purchased on or after January 1, 2004 is void.

• a policy purchased before January 1, 2004 that is not fully paid up becomes void five years after the date of the next premium payment date, but no later than January 1, 2010, and no premium payments may be made after January 1, 2004.

• a policy that is fully paid prior to January 1, 2004 remains in effect without limitation as long as the employer, within 90 days after January 1, 2004, discloses in writing to the insured nonexempt employee all of the following:

• the existence of the COLI policy on the life of the employee

• the identity of the insurer under the policy

• the benefit amount, unless the full amount of the benefit is used to defray the costs of nonexempt employee benefits.

• how benefits paid under the policy would be used

• the name of the beneficiary under the policy.

Note that if the policy benefits are used for the payment of nonexempt employee benefits, the disclosure need not be individualized, and can be delivered as a form disclosure. Note further, however, the individualized disclosure may be avoided only if the "full amount" of policy benefits are allocated to non-exempt employee benefits.

As to an insured former employee, the employer may provide the disclosure by mail to the former employee's last known address.

Among the issues that this bill raises is the need for businesses to ensure that their employees who are covered by COLI policies are properly designated as exempt from the overtime laws. The definitions of executive, administrative, and professional employees are fluid at best and employers, including banks, have been re-assessing their employee classifications in recent years for other reasons. AB 226 introduces new complications to re-classifications made after January 1. For example, premium payments made after January 1 on a policy covering a re-classified employee (from exempt to non-exempt) could immediately void that policy. Businesses should also consider the potential tax consequences of prematurely surrendering COLI policies that are made void by AB 226 by 2010.

If you have any questions on AB 226, you may contact CBA's lead lobbyist on the bill, James Clark, at 916-441-7377 x 209.