Tuesday, November 24, 2009

Dead Peasants Insurance – Fifteen Minutes that Came and Went

So there I was watching CSI: Miami, when one of the characters said that the life insurance policy his corporation owned on another character’s life was “Dead Peasants Insurance,” a term I had never heard before. I had, indeed, heard – and used the term “dead peasants” in connection with corporate-owned life insurance, but I had never heard this particular usage. Whereby, as they say, hangs a tale.

I used to work for a company that sold life insurance to corporations. One of our main products was what we called “Broad-based Corporate-Owned Life Insurance (COLI).” Less charitable observers called it “janitor insurance,” because the policies in question covered the lives of all employees from the CEO on down the payroll to, for example, the janitor. (It’s no accident, I suppose, that the deceased in last night’s CSI: Miami episode was, in fact, a janitor.)

Broad-based COLI programs were first and foremost tax-avoidance schemes. Life insurance proceeds are exempt from tax, but the tax advantage of broad-based COLI program did not arise from the tax-free windfall on an employee’s death. Rather, the advantage arose because the company could borrow the money to pay the premiums, deduct the interest it paid on the loans, and then receive a death benefit that effectively refunded the interest without tax. This particular gambit had always been permitted by the tax law, and was to some extent regulated and limited by then-existing law. But whether or not the tax benefits were valid, broad-based COLI worked best if the employees lived a long time. The death of an employee terminated his policy, leaving the employer with one less source of tax advantage. It was, therefore, in the interest of the employer that the employees live, not that they die.

There was no windfall when an insured employee died. A provision of the COLI plan allowed the insurer to raise future premiums to recoup any mortality losses, so the employer didn't get to
keep any money it made by reason of early deaths. In case of catastrophic loss, the recoupment mechanism would fail, and the employer would receive a net gain on the insurance. But the loss of that many lives would almost certainly cost the company more money than the insurance could cover, so that was hardly the object of the game. The insurance element of the plan was not a profit engine, and, pace Michael Moore et al., the employer had no reason at all to seek or wish for the early deaths of its employees.

The tax advantages accruing on account of an individual remaining insured explains why employers continued to carry insurance on former employees long after they could claim any insurable interest in their lives. It is these former employees that we, at our company only, and for internal purposes only, referred to as “dead peasants,” an allusion to Gogol’s Dead Souls, in which the main character seeks to buy the registered ownership of dead serfs from feudal owners so that he could secure a loan against their future outputs, something he could do because banks used outdated census rolls to underwrite such loans. Our clients were securing loans on life insurance on “employees” who no longer were employees, so the analogy to peasants who were, in a sense, no longer peasants seemed apt. It never occurred to us that the term “dead peasants” would be applied to dead employees, in part because we already had a different use for the term, and in part because, as described above, the plans we were selling were designed to work best if the “peasants” lived.

But the football of life takes some odd bounces. In 1999, the Tax Court labeled the broad-based COLI program at Winn-Dixie Stores – a program that we sold – as a sham and denied Winn-Dixie the deductions it had claimed on the ground that the program had no business purpose, in part because it was never expected to show a pre-tax profit. Buried in the record of the case was this memo that I wrote. Mike Myers, a lawyer who has made Broad-based COLI his meal ticket, links to the memo in his blog, adding that “the ‘dead peasants’ referenced in the memo were deceased Winn-Dixie employees whose deaths resulted in policy benefits to the company.” On this score, he’s just plain wrong. As I said, “dead peasants” was short-hand for former employees. But reporters – he cites a couple – seemed to have reached the conclusion Myers offers, and that, as they say, was that.

An interesting aside: the “section on dead peasants” mentioned in the memo would have addressed a quirk in the tax law that made certain limitations applicable to a policy if the insured “is” an employee. Since a former employee was no longer an employee, the limits arguably did not apply to a former employee, i.e., someone who no longer is an employee. It was soon after our investigation of this subject that President Clinton held forth on the meaning of the word “is” in connection with Ms. Lewinsky. Needless to say, we enjoyed that bit of tap-dancing immensely.

I left the COLI business before the Winn-Dixie case was decided, and I never saw another reference to dead peasants until last night. I now find, on further Googling, that Michael Moore used the term in his farce “Capitalism: a Love Story.” He presents a family outraged by the notion that their loved one had been insured and that the company got paid the amount of the policy when he died. No mention is made of the fact that the company didn’t get to keep the money but had to give the cash back to the insurance company as an adjusted future premium on existing policies. That would’ve spoiled the mood, I suppose. Indeed, one of the reasons the tax case was so weak was that, at least to the satisfaction of the IRS and the courts, the “insurance” wasn’t really insurance. The plan failed its purpose precisely because its purpose was not to profit on the deaths of employees. But the fact remains that profiting from lives, not deaths, is what the plan was about.

So, if the subject of dead peasant insurance comes up at a cocktail party, you tell 'em that you know the guy credited with providing the sobriquet, however unintentionally. It's not Susan Boyle type fame, but it's a start.

5 comments:

  1. Larry- you're one up on me. I have never watched CSI: Miami.I'm still laughing from the last two episodes of Curb Your Enthusiasm.


    Interesting blog.

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  2. I get what you are saying about the tax advantage of employees living longer in that corporations continue to write off premiums paid, but do not the corporations collect when a dead peasant actually dies? A hundred grand might take some of the sting out from losing that policy premium write-off, wouldn't you say?

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  3. Jim -

    Thanks for the post.

    The company "collected" when an employee died, but the insurer immediately adjusted the following year's premiums to recoup the loss (unless it had already been recouped from premiums on employees who did not die).

    Moore et al. are complaining about the dastardly incentive that this insurance created, but it did not create that incentive. It created exactly the opposite incentive. Whether any given death was "profitable" is beside the point, because, aside from a Bhopal or 9/11 type disaster, it was not possible for there to be enough deaths for the aggregate mortality experience to be profitable, and only aggregate profit matters. As a result, the insurance element was a nuisance, the bubble gum in the pack of tax advantage baseball cards.

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  4. Jim -

    Let me add that your comment about how $100k would ease the sting would actually provide a justification for a real insurance element, if there were one. The loss of the tax play gave the employer an economic interest in the survival of the employee. After all, easing the sting is not a motive for getting stung. But easing the sting and then some?

    Insurable interest is an interesting existential notion. It's all about whether you'd really rather have the thing insured or the money, and such preferences are personal and fleeting. I heard Alfred Hitchcock tell a joke on TV, which I remember as follows: (Stephen King attributes a similar joke to Bing Crosby.)

    A man's son at the age of six or so
    was very sad when he learned that his dog was dying. To try to cheer him up - take some of the sting out, you might say - his father suggested they plan a funeral. "We'll find a nice box, line it with silk, and paint the outside black. We'll dig a hole in the back yard, invite the family, say a prayer and wish Spot a fond farewell and peace in Dog Heaven. Then we'll have a wake, with ice cream and cake..." The boy's eyes lit up at this last thought, and he said, with dark glee, "Let's...kill...it!" Did the boy have an insurable interest in his dog's life?

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  5. Georgann E. PutintsevMarch 31, 2011 at 4:07 AM

    I believe we've lost sight of real problems with this kind of 'white collar' crime. Who protects 'We The People' from such mis-adventures or blatant bambusseling of our government. It's bad enough that the vast majority of these 'dead peasant' companies rarely if ever pay their fair share in taxes. Now they get to get cheap credit and have "no-interest taxation" on their employees; of whom they fail to pay a decent wage or medical benefits a.k.a. Wal-Mart, Winn Dixie.
    If the SEC, IRS & the FBI took this more seriously, we would have had some of these top level people behind bars for GRAND THEFT and under so much scrutinity, public exposure & public ridicule. This needs to be investigated further, because alot of the companies involved like Enron or AT&T had top level CEO or BOD's come in and be allowed to run amuck. Ask yourself why & who instigated this? It is the fruit for the dismantling of AMERICA. At least now, we have a way of identifying some of the companies where the 6 degree of separation is not far from the tree of the top elite / corporate / government / new world order types who want to see the United States go down the drain. What better way then to rip its employee's off through unfair compensation to our WE THE PEOPLE unfair taxation. Its a Win/Win, where we always have to pay and THEY get away with 'white collar' criminal activity.
    Who put the Foxes in the Chicken Coop & who is responsible for Killing the Fox? This is even worse than GREED.
    We the People have got to enforce EQUAL LAWS here and Stop the Pillaging: derivatives, junk bonds, dead peasant insurance, bailouts, white collar scams that are so privilent in business & government today. The only people we can Trust is average We The People.

    ReplyDelete

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