COLI Mischief--and Fix

[J Simmons]

ER established DB SERPs for a few executives. It's top hat and unfunded. One of the benefits of the DB SERP is a death benefit equal to 4x annualized earnings in year executive dies while yet actively employed.

As a hedge against the SERP obligations, the ER purchases COLI policies on these executives. The ER is the owner and the named death beneficiary. The SERP benefits are not keyed in any way to the CVA or death benefits of the policy the ER holds on the life of that executive.

Unbeknownst to the Board of Directors, one of these executives contacts the insurer, signs on behalf of the ER, and effects a change of death beneficiary from ER to that executive's spouse. The executive did not have the corporate authority to do so for the ER, but the insurer nevertheless did this. At the time, the CVA is $180k.

The Board learns of this 6 months later and instructs the insurer to change the death beneficiary back to the ER. The CVA value is then $120k.

Would the amount taxable to the EE as economic benefit be just the 'pure term life' value of having death benefit coverage since, initially it appears, the rights to the CVA never transferred from the ER to the executive or spouse?

If it turns out any rights to the CVA had transferred, would we yet be able to treat the CVA as a non-event, tax speaking, under the idea that since the executive's changing the policy was not authorized, any rights that the insurance company recognized the executive or spouse to have to the CVA were held in a constructive trust for the benefit of the ER (and thus, the only taxable event being the value of the death benefit coverage being the only economic benefit the executive received)?

[Mark Whitelaw]

Yes ... treat the death benefit during that period as endorsement split dollar. No rights to cash were tranferred. Hence, you have what has been referred to in situations like this as "deemed split dollar".

But the executive was pursuing a common technique in COLI informally funded plans ... deliver the death benefits through tax-free insurance proceeds rather than taxable plan payments. Have the DB SERP pay $0 at death. Adopt an endorsement split dollar agreement to deliver the equivalent SERP DB's from the policy, balance of the DB proceeds to the employer for cost-recovery ... charge the executive the economic benefit annually.