NQDC Benefit Tied to COLI Cash Value

[EBECatty]

I'm trying to figure out the best way to word this arrangement. The underlying concept is pretty straightforward and I have seen it done many times: The employer has a COLI policy (which it owns, pays all premiums on, and is the beneficiary of) that accrues cash value. The employer enters a separate deferred compensation agreement with the employee saying if you work until age 65, the employer will pay the employee compensation equal to the cash value of the policy on the date the employee turns 65.

Generally the deferred compensation plan (like all plans) will say the employee has rights no greater than an unsecured creditor, the employer is not required to set aside any assets, etc. Obviously the language is in there to keep the plan unfunded for tax and ERISA purposes, but the deferred compensation plan never acknowledges what will happen if, for example, the employer defaults on premiums, surrenders the policy, draws down policy loans, etc. So the employee could reach age 65 and become entitled to benefits, but the employer could have let the policy lapse years before. There is nothing else stating the dollar amount of the benefit. (I know the agreement can set a fixed dollar amount projected to be covered by the cash value, but they want to pay the cash value, no more, no less.)

What's the solution here? Put a restriction on the policy saying the employer cannot surrender, withdraw cash value, or take loans? I think this would be fine as long as it didn't create any rights enforceable by the employee. What if the employer fails to pay premiums and the cash value cannot support the premiums, causing surrender of the policy? Draft the deferred compensation benefit to equal the cash value at age 65 plus any withdrawals or outstanding loans? That still doesn't solve surrender. Take the employer's word? Anything else enforceable by the employee or shielding the policy from the employer's creditors would upset the tax/ERISA status.

Thoughts?

 

[Mark Whitelaw]

You bring up great risks.  I would add the employer making poor fund choices if a variable policy.

One option I've seen is the benefit tied to the as-sold illustration used to sell the benefit to the executive and policy to the employer.  That way the participant is insulated from all those risks and the monkey is on the employer's back to properly fund the policy.

[EBECatty]

Bad investments is another good point; thanks. I'm still not seeing any bulletproof solutions, but appreciate the input.

[Peter Gulia]

To meet a concern about using a life insurance contract as a measure of the executive's deferred-compensation right without providing anything that could interfere with the employer's sole and exclusive ownership of its property, I've seen language that refers to the greater of the measuring life insurance contract's actual value or the value the contract would have if the employer had promptly paid over to the insurer each premium equal to each deferral amount and had not taken any surrender under, or loan against, the contract.

Understand that I've seen language of this kind, but have not used it in any plan or agreement about which I advised a client.  There are practical, and legal, difficulties with such a provision.

[EBECatty]

Appreciate the input. It sounds like the moral of the story is there's no perfect solution.

[Louis Richey]

I have always taken a very conservative position on doing these types of designs because of the potential ERISA issues with too close a tie to a specific single COLI (or any specific asset for that matter).  I recommend consideration of a generic employer account balance plan design based upon the value of a "package of potential assets held in connection with the plan in the company's general asset reserve" on the date of distribution.  The package listed in the doc may include certificates of deposit, stocks, bonds,  COLI contracts, annuities, etc. with the value for COLI contracts usually being the cash value the day before death, with the net policy death benefit (or some portion of it) going out under a separate endorsement split dollar arrangement.  In any event you will need to decide how a death situation will be handled while still under the plan. Of course, all the sponsor may ever have is one COLI behind the plan but in this framework the COLI is not directly identified and only plan "book-keeping" account values  will be reported the participant..  Additionally, this approach leaves the company free to utilize other company acquired and owned assets deemed desirable to place behind the plan to become part of the participant's phantom balance due under the plan.  You can find more discussion on this in BNA Portfolio 386 4th "Insurance as Compensation".