COLI Users: Time to Tune Up

Monitor COLI Like Any Other Corporate Investment Or Risk Unnecessary Loss

Few corporate investments are so significant yet receive so little scrutiny as corporate-owned life insurance (COLI). Few corporate investments disappoint so often. Why is this?

COLI was a popular investment strategy in the 1990s and into the 2000s. But the tipping point was reached 2007, when use of COLI to fund nonqualified executive benefit liabilities began a steady decline. Today’s management is still attempting to understand what their predecessors purchased many years ago.

On Decline

According to a 2011 Mullin/TBG study mutual funds outpaced COLI by more than 10 percentage points (52.6% vs. 42.1%). This trend was also confirmed by a 2013 report, A Three-Step Approach to Nonqualified Plan Financing prepared by CAPTRUST, indicating 44 percent of companies fund plans with life insurance compared to 55 percent with mutual funds. One percent of companies leave plans unfunded.


While at its core COLI is only life insurance, the subject of life insurance as a funding tool is quite complex, and its efficiencies are highly dependent on tax-laws and accounting advantages. Anecdotally, we know that companies find it difficult to understand the inherent costs in insurance policies; cost is not as transparent as with other corporate assets. Consequently, COLI investments are not managed as well as other corporate investments.

Hard-to-Get Information

Another thorn is the side of COLI users is how prickly it is to gather objective information about COLI programs: Brokers who sell the programs appear to hold the greatest knowledge yet they have an incentive to continue to sell more COLI, despite its decline in use.

Let’s back up a little and look at why companies informally fund their nonqualified (NQDC) plans to better understand why COLI is needed at all.

Informal Funding/Finance of Nonqualified Plans

The term “informal funding” describes the funding of a nonqualified benefit plan. You will also read the term informal financing. Informal funding represents the monies the sponsoring employer sets aside for the express purpose of satisfying obligations to participants who have elected to defer compensation; the contributions are usually the amounts deferred.

A nonqualified plan is an unfunded and unsecured contractual benefit obligation between a plan sponsor (employer) and participant (executive). In a nonqualified arrangement, when the participant defers income, the company (plan sponsor) records that amount as a liability on its balance sheet; this amount can get quite large over time.

To offset this liability, companies often choose to informally fund benefit obligations by setting assets aside. These assets provide the sponsor with liquidity to pay future benefits and some assurance to plan participants that they will receive their benefits. Assets used for this purpose are impacted by tax, accounting, financial statement, and expenses that are often the most costly aspect of operating a nonqualified plan. As you know, NQDC plans differ from qualified plans, which are formally funded.


In qualified plans, formal funding is required for 401(k plans) which must set aside contributions in a trust outside the reach of the company. These benefits are protected by ERISAS1 (Employer Retirement Income Security Act) and cannot be touched by the employer. Should the sponsoring employer become insolvent, creditors cannot make claims against monies in formally funded programs.

Nonqualified plans are informally funded when the plan sponsor decides to take some or all of the money deferred by the participant and invest it. This move helps to ensure that, when the time comes to pay out funds, those funds will be in place. The plan sponsor may invest in virtually any type of investment to accomplish this objective. The most common choices are mutual funds and COLI contracts owned by the sponsoring employer’s corporation.

Three Whys to Informally Fund NQDC Plans

There are three primary reasons why sponsoring employers elect to informally fund a nonqualified plan:

  • To provide a degree of benefit security to participants;
  • To match plan liabilities with a pool of assets; and
  • To mitigate P&L funding impact of the overall program

Like all financial instruments, there are advantages and disadvantages to COLI as a funding vehicle.

The following chart is a summary of the advantages and disadvantages of the three most popular funding options:

So, where do we go from here?

Advice on COLI

American corporations hold approximately $83 billion of cash value assets in COLI policies, a highly significant market. Typically, these companies seek out brokers and specialized firms to help evaluate their COLI assets. But the information is as hard to unearth as the body of Jimmy Hoffa. Providers are incentivized to sell you more COLI, not less. Full stop.

What’s more, broker incentives often recommend replacing existing policies with new contracts rather than restructure the current holdings. In most scenarios, the broker compares new policies with an existing portfolio, which is like comparing a gazelle to a zebra.

Most insurance companies will not pay new commissions on internal replacements or re-structuring of existing policies, so brokers illustrate other carriers to show vast improvement, based on illustrations chock full of assumptions. Most insurance companies, if given the half a chance, will clamor to “optimize” your existing COLI policies rather than see flee to another carrier.

What policy owners don’t see is new commissions, premium taxes and loads on the replacements; they are often hidden behind “enhancement riders” designed to spread the upfront loads over a seven to ten year period. The new policy provides enhanced cash values during this period, however, to receive the enhancement; the policy owner must surrender the contracts and possibly pay taxes on gains.

Hold Onto Existing COLI

The policies you currently hold have already been through the upfront sales charges, premium taxes and loads, so why exchange them for new contracts only to begin again to pay these loads?

In my opinion, COLI is a “buy and hold” informal funding strategy for companies. Your existing COLI can be a good asset to hold long term, to use in concert with other assets to informally fund your plan’s cash flows over the short term.

For those companies who are high tax payers, and willing and able to fund benefit liabilities out of their current cash flows and hold the asset (COLI policies) to the insured executive’s death, COLI is a viable asset. However, holding the best, optimally designed contracts is important. Because plan dynamics change, it is also important to make sure the policies are reviewed periodically and right sized.

In my next post, I want to share with you a process for financial modeling an optimal funding strategy that gives you a solid framework to grab better control of your COLI assets, as well as analyze other assets like mutual funds, ETFs and Total Return Swaps. Many of these assets are easier to administer, present full transparency, and match up with deferred compensation distributions.

To end this alert, please consider working with an independent advisor, one who does not sell COLI policies, one who can clarify your view of the entire cost structure, and show you how to optimize the policies you already own.

See you on the upside, Bill


1. The Employee Retirement Income Security Act of 1974 (ERISA) is a federal law that sets minimum standards for most voluntarily established pension and health plans in private industry to provide protection for individuals in these plans.

RIAs Take Center Stage to Spotlight Nonqualified Plans: How to Avoid Tripping Over Funding Challenges

RIAs are rapidly becoming the ideal catalysts for nonqualified plans due to their inherent fiduciary responsibility to act in the client’s best interest, their fee-based only compensation, and their standards of transparency. As they move into nonqualified plans as a natural expansion of their market outreach, it’s time for a heads-up. The intent of this article is to inform RIAs of current challenges in funding nonqualified deferred compensation (NQDC) plans.

The prevalence of nonqualified plans for executive benefits continues to grow, driven forward by increases in federal and state taxes, a rise in corporate profits, and the restoration of executive bonuses.

Because of these changes, plan participants are paying closer attention to their nonqualified deferred compensation (NQDC) plans, and the proactive companies, serving as plan sponsors, are busy reviewing their NQDC plans for their efficacy and overall financial efficiency.

With IRC § 409A well in place, it is now easier to structure a NQDC plan for maximum flexibility, especially for short-term deferrals to retirement payments over the life of the executive. Companies can now use prototype documents to offer features at best practices standards. What’s more, simplified plan administration is readily available because many of the major 401(k) administrators and payroll services now offer a streamlined processing experience for plan sponsors and participants.


While it may not seem obvious, RIAs who already take care of qualified plans are the cost-effective answer to sponsors wanting to adopt nonqualified plans. Five solid reasons why this is true: 1) 401(k) administrators can offer a full-service administration package at a fraction of the cost;

2) Most plan designs provide the opportunity for highly-compensated employees to defer in excess of the 401(k) contributions, and because a built-in platform already exists for 401(k) plan enrollment and communications, it is simpler to add a NQDCplan for both sponsors and their RIAs;

3) As mentioned earlier, with the advent of IRC § 409A, RIAs have access to well-drafted prototype plan documents not available in the past;

4) Another excellent reason to place NQDCs with RIAs is their immediate access to institutional platforms for the purchase of mutual funds and exchange-traded funds (ETFs). ETFs can be purchased by the company without tax on the earnings until the asset is sold. And mutual funds can be managed in a tax-effective manner.

5) The RIAs are hardwired to offer high-caliber investment advice, which can be put to work for NQDC sponsors and their participants to the benefit of the relationship well into retirement.


Exponential growth has taken place in the RIA sector over the past few years, underscoring their influence in financial services. In a 2013 RIA Benchmarking Study by Schwab Advisor Services, the largest of its kind with exclusive focus on RIAs, results revealed “that the median firm in the study ended 2012 with $572 million in AUM, an increase of 13.3 percent over the previous year, while revenues grew by 7.1 percent to $3.4 million in 2012. Based on the study findings, by the end of 2014 about one-third of advisor firms will have doubled in size over the previous five-year period.” But does size really matter?

According to the Schwab survey, “quality client service and an emphasis on relationships remain key drivers for client retention and of overall RIA growth and success.

When you look at market share, RIAs eclipse traditional full-service brokerage models by 2 to 1 in terms of growth, cites research firm Aite Group LLC in an August 2013 Investment News article.


With the rise in RIA influence, we expect to see more RIAs enter the nonqualified space. But they well may stub their toes on the issue of how to effectively fund NQDC without using corporate-owned life insurance (COLI), the standard approach in the past. Take comfort.


Given legal changes and renewed interest in NQDCs, now is the time for companies to zero in on funding arrangements. And, in my opinion, the RIA is an ideal partner to help a sponsor ensure plan performance reaches full potential.

According to a number of major studies, the use of COLI, once the favored funding vehicle, has been declining since 2009. Clark Consulting indicated that out of the 61 percent of companies setting aside assets to fund nonqualified plans, 45 percent used mutual funds—up from 37 percent in 2007; 61 percent used COLI, down from 72 percent.

In 2011 Mullin/TBG, now owned by Prudential Insurance Company, indicated that the prevalence of funding NQDC liabilities declined for the second consecutive year to 58.7 percent from 64.6 percent in 2010. This decline was well below the height of COLI funding of 71.4 percent reached in 2009. Further, the Mullin/TBG study stated mutual funds outpaced COLI by more than 10 percentage points (52.6% vs. 42.1%), certainly triggered by the arrival of


As a brief aside, corporate sponsors choose to informally fund the majority of NQDC plans for three primary reasons:

  • To provide a degree of benefit security to participants;
  • To match plan liabilities with a pool of assets; and
  • To mitigate P&L funding impact of the overall program


Heavier focus on transparency of qualified plans put pressure on COLI funding because retirement and compensation committees were determined to understand the expense load of these arrangements. What’s more, evolution of the nonqualified field sped up as companies consolidated vendors, shifting nonqualified plans to their 401(k) provider’s platform, triggering more reexamination of NQDCs.

As change unfolded, there has been a logical shift to alternative investments— mutual funds, ETFs, Total Return Swaps (TRS), annuities, company stock and managed accounts. Of course, this makes perfect sense as mutual funds now enjoy favorable accounting treatment, further adding to the simplicity of managing a portfolio.

FAS 159 (Fair Value Option for Financial Assets and Financial Liabilities) opened up an opportunity for sponsoring employers who wish to informally fund their NQDC plans to account for certain financial instruments such as mutual funds at fair market value and report in earnings the unrealized gains and losses on securities for which the company has elected the fair value option.

FAS 159 is especially attractive to defined contribution plans where participants allocate their deferrals and account balances among a menu of notional funds. By using FAS 159, sponsoring employers can hedge their income statement exposure to certain kinds of benefit cost volatility. These facts present strong arguments for key changes in funding.


Few corporate investments are so significant yet receive so little scrutiny as COLI. Worse yet, few corporate investments have disappointed so many. Let’s review why:

  • Management struggles to understand what predecessors purchased years ago.
  • Life insurance presents certain complexities, dependent on tax laws and accounting advantages.
  • Little or no transparency in insurance policy costs, unlike other corporate assets.
  • Insurance companies hold broad discretion to change, without notice, expenses and loads for existing programs.
  • COLI investments are not managed as well as other corporate investments.
  • Confusion and distrust arise when brokers earn incentives to recommend replacing existing policies with new contracts, instead of restructuring current holdings.
  • Securing objective information on COLI programs is almost impossible.
  • Sellers of COLI programs hold knowledge of COLI workings close to the vest.
  • COLI providers continue to sell more COLI, despite its decline in its use, because it pays to do so.

Let’s look at the menu of funding vehicles used over the past decade:

Now, let’s compare the advantages and disadvantages of the three most popular funding options: