COLI as an Insurance Company Investment

Several years ago banks began holding life insurance in their portfolios (BOLI) because of its tax advantages.

Insurance companies are now holding COLI in their investment portfolios because it creates three distinct advantages.

These include: 1) favorable impact to risk-based capital, 2) favorable tax treatment, and 3) the ability to reposition balance sheet assets.

There are basically two types of COLI policies: general and separate account. A general account policy invests in the general assets of the underwriting insurance company. A general account policy credits a fixed rate of return to the policy owner based upon the overall portfolio rate of the insurance company. Current general account rates of return typically average between 3.0%-3.5% (August 2013). General account policies are subject to the claims of creditors in the event of bankruptcy.

A separate account policy is not subject to the claims of creditors and usually offers the policy owner 80-100 investment choices in a number of asset classes with several money managers. Generally any asset class that is currently held by an insurance company as an individual investment can be replicated in COLI.

The risk-based capital treatment afforded COLI depends on the rating agency and if the COLI is general or separate account. The NAIC and A.M. Best treat COLI in the same classification as a class 1 bond, regardless if it is separate or general account. It gets the same rating as the insurance company that issues the COLI. If, for example, COLI were issued by New York Life, it would receive the same AAA rating as New York Life. This is true even if the separate account is used and policy assets are invested in equities.

Standard and Poor's rates general account COLI most similar to an NAIC class 1 bond of 10-20 year duration. For separate account COLI, there is a "look through" to the actual investments that have been selected.

When investing in COLI, some insurance companies will elect to move their more highly rated (RBC) assets, generally equities, into COLI to more significantly change their risk-based capital, and tax, status. Others will seek to duplicate the current debt to equity ratio of their existing portfolio.

The tax treatment of COLI earnings, if any, is such that the earnings are not taxed unless the policy is surrendered. They are, however, recognized as income on the income statement and are accounted for in accordance with FAS 85-4.

COLI also affords the opportunity to favorably reposition assets on the balance sheet. There are classes of assets that are treated with more risk assessment than equities. These include any hedging investment strategies that are reflected on Schedule BA. Insurance companies usually prefer to keep their Schedule BA assets to a minimum. By moving Schedule BA assets to COLI they may be reclassified as "other admitted assets".

The legal justification for this type of COLI transaction, insuring a company's key people, is IRC Sec. 101(j), which was created in 2006 by the Pension Protection Act.

This material is intended for informational purposes only and should not be construed as legal advice and is not intended to replace the advice of a qualified attorney or tax advisor.