Asymmetrical Information

Let me emphasize another sentence for you, one from the Chronicle article I originally cited:

"Camelot Music was also sued in the same case after former employees, including many part-time workers making close to mimumum wage, discovered they were insured for between $273,000 and $368,000 each. All are former employees, who left the company by 1998, and say they are rightful owners of the policies.

Are you honestly going to tell me that a part-time, minimum wage worker is worth between $273,000 and $368,000 to Camelot Music? If it costs them that much to replace such a worker, then I'd have to call into question their hiring and training programs.

That's the nature of my dispute with this. It's totally out of proportion.

I also said that "I don't have any problem accepting that companies have an insurable interest in top executives, inventers, critical people like that". I don't accept this for minimum wage workers. I mean, if the opportunity costs for losing such a worker are as high as you imply, then it seems to me that there'd be a strong incentive for the company to pay a higher wage as an enticement to keep the employees. Employees quit more frequently than they die, after all. The fact that employers don't pay a higher wage means that the cost of replacement is not prohibitive, which argues against the need for large life insurance policies on low level employees.

I remain unconvinced that COLIs on low-level employees are necessary.

Charles, despite my explicit words above, you seem to think I'm still defending COLI from an insurable interest point of view. How can I make it more clear? COLI has little to do with the costs of an employee dying. At most, you could say the economics of COLI would be affected by a departure from average mortality overall. For the 500th time, COLIs are driven by taxes, not risk transfer. So let's divorce the size of COLI death benefits from the discussion of employers' economic interest.

I simply (and completely) disagree with your assertion that "most employees don't contribute to the bottom line." There would be no reason to hire people if that were so.

I should have made it clearer, perhaps, that the economic interest employers have don't equal the amounts insured in COLI contracts. But that didn't seem necessary having said that COLI generally has nothing to do with the aforementioned economic interest. A true economic interest in retaining a low-level clerical employee would be more like a few thousand dollars, depending on the level of training required, the possibility of finding a better employee and the percieved expense of setting a precedent to other employees. Managers make this calculation every time someone quits.

There's a point that all of the commentary on these plans seems to be missing -- there's no insurance rationale for these plans, at least at large employers.

I insure my life because my death would be a severe financial blow to my family. The insurance company, on the other hand, puts many people together to pay premiums and collect benefits. When put together like this, death rates are highly predictable and easily covered by premiums, plus investment income, minus a cut for the company. The death of any particular person, from the company's point of view, is no big deal.

If I'm uninsured, every year I live, death has no financial effect on my family; the year I die it has a huge effect. If I am insured, I pay a premium I wouldn't otherwise pay every "non-death" year, but my family survives my death without catastrophic financial consequences.

A large employer is different. Among their tens of thousands of employees in any given year, some will die and most won't. They can ameliorate the cost of any particular death (leaving key personnel to one side) themselves without paying premiums to an insurance company to do they same thing for them. In fact, the insurance company will probably charge them in premiums about what it pays out every year (less its profit, plus part of its investment returns, but there's no reason to think that the insurance company is better at investing than, say, WalMart, or rather the investment banks hired by WalMart), since it now has an identifiable population large enough to subject to underwriting.

I don't see any good business case for taking out (or providing) insurance for non-catastrophic events that are, as a whole, predictable except that the premiums are deductable and the proceeds are tax-free. If the money spent on premiums was declared as income and then distributed to shareholders, each shareholder would end up with (very) roughly $0.50 cents on the dollar after corporate and individual taxes. For every dollar paid on the policies, the shareholders will end up with roughly $0.65. If the money is not distributed, the policy payments are treated as earnings and the company has a p/e ratio of 20, theoretically, at least, the shareholder has an unrealized gain of $20, if the money came back dollar for dollar.

In other words, the tax treatment is the only reason for doing this. If you were to look at the premiums versus the payouts, my guess is that you would find that the company and the insurer are dividing up the tax premium, some of it coming back to the company as proceeds of the policies and some of it sticking with the insurer as compensation for making all this possible.

Exactly. So what? It's hard to see any policy justification for the tax treatment of COLI/BOLI, but it's hard to see policy justifications for lots of other tax rules, too. The law being as it is, why shouldn't profit-maximizing corporations take advantage of it? And why should employees care if their employers have made investments in the form of life insurance policies on them and other employees? The garbage in the press about whether employees benefit from these policies is silly. Employers pay for the policies, employers get the benefits, and employees really have no need to know or reason to care (until a plaintiff's lawyer or reporter starts asking, "Gee, doesn't this really bother you?").

All right, I admit that I was focusing on the insurance angle. Your definition of an insurable interest as an economic interest is not what I consider to be an insurable interest. If we consider COLIs strictly from a tax viewpoint, then yes, there's nothing particularly surprising or scurrilous about them.

I should have been more clear when I said that "most employees make zero direct difference to a company's bottom line". What I meant was that the sudden departure of a given employee generally has no effect on a company's bottom line. I've seen plenty of skilled people quit and get fired, and my company has gone on as before. That again ties to the size of the payout of the COLI, and we seem to agree that the payout is out of proportion to the employee's replacement value, so I'll move on.

There's still the matter of whether or not there is a justification for the existence of COLIs. Dave Lonborg makes a good point, but I don't think we should be surprised that people answer "Yes" to that plaintiff's lawyer. I can't say I'd like the idea of a COLI on me. Whether that's a sufficient reason to make COLIs illegal is admittedly another question.

Here's what should be my last words on this:

http://offthekuff.blogspot.com/2002_05_05_offthekuff_archive.html#76282093

Just a note that MHD and I were arguing different things, a recommendation to check out his response and the comments, and a clarification of my statement about employees' effect on bottom lines. Thanks for the feedback!

Gentleman;

I probably should wade back to the start of all the cross talk before I chime in - but I won't! It occurs to me that a valid reason for objecting to these policies is that I (as an employee, or an OSHA inspector) don't want to see the company benefitting unreasonably from my death. OK, there are key-man issues, and re-trainiing issues, and so on but I would want to believe that if I die in what may be a work related incident, on net my employer will be a loser. Otherwise, the incentives start to go backwards.

I am reminded of the story in "Liar's Poker" by Michael Lewis. The young investment bank salesmen was leaving the trading floor to catch a flight for a client meeting out of town. The grizzled trader calls over "Hey, kid, you're flying to Chicago? Here's twenty bucks. Buy some flight insurance on yourself and put it in my name - I'm feeling lucky."

Thought you would want to know.

Regards,

Tom Maguire

You're thinking of COLI awards like term insurance, where the premium is only the mortality costs and therefore dwarfed by the death benefit. The point of COLI is to sock assets away into the policy, not so much take them out, even in the form of death benefits. The death of one or two workers, relative to the premium forked in, is not material. You realize an investment return on COLI not a disproportionate risk transfer return. Also, the companies put as many employees as possible into the policy.

In sum, you can't individualize what is, by nature, a generalized position. The death of a few employees does not make a material difference to the return on a COLI product. Remember, think INVESTMENT, not INSURANCE.

Well, Yeah, yeah , I get that it is a tax scam. But in terms of corporate incentives, I was reacting to the $300,000 policies on clerks in the mailroom. But in terms of shareholder incentives to promote employee safety, I suppose I can argue the other side as well. Back in the old days, the people who sold you boiler insurance also inspected the hell out of your boiler. In fact, you can find the Underwriter's Laboratory seal on all sorts of products today. The person buying insurance is also, in effect, hiring someone to monitor his performance and giving that monitor a financial stake in the outcome.

In the context of employee safety, this would mean that the insurance underwriter will stalk the factory floors looking for hazards to be sure that an actuarially high number of $300,000 men don't get knocked off. These outside monitors might actually bring useful expertise. A company with a miserable plant safety record would not find this product available. Of course, relatively safe firms such as banks would have no problem.

But I expect these issue are minor relative to the tax advantages.

Regards,

Tom Maguire

Comments are Closed.