Executive Summary
Corporately owned life insurance (COLI) has long been used by organizations to fund future liabilities, stabilize benefit programs, and manage long-term financial risks. Over the past several decades, the life insurance market has changed significantly as interest rates, product structures, and investment portfolios have evolved. These changes affect how companies evaluate, design, and maintain life insurance programs.
This paper explains how life insurance contracts work, why product design matters, and how shifts in interest rates have reshaped the corporate market. It also outlines the emergence of newer products such as universal life and index universal life, which give policyholders more flexibility and potentially stronger long-term performance.
Background: The Changing Corporate Life Insurance Market
1.1 Early Structure of the Market
For many years, COLI products were primarily backed by bond portfolios. Whole life insurance dominated the field, offering stable, bond-like returns. In the late twentieth century, bond portfolios could provide reliable yields, often making up more than 90% of an insurer’s general account holdings. These yields supported predictable premium requirements and long-term guarantees.
1.2 Declining Interest Rates and Market Impact
As interest rates fell in the early 2000s, returns on bond portfolios dropped. While whole life remained structurally sound, the investment portfolios underlying these contracts were no longer producing attractive results. For corporations seeking long-term funding vehicles, the gap between projected internal rates of return and actual performance grew wide enough that many older policies stopped meeting their original objectives.
How Life Insurance Contracts Are Built
A life insurance policy has three essential components:
- Risk component (death benefit)
- Cash reserve (the offset of the risk expense)
- Premium (the deposit that funds the first two components)
2.1 Risk Component: The Death Benefit
The death benefit is created the moment the contract is executed. The insurer charges a mortality cost each year based on actuarial tables that estimate the likelihood of death at each age. This cost increases as the insured ages.
2.2 Cash Reserve: Offsetting Rising Mortality Costs
Because mortality costs rise, a permanent policy needs a cash reserve. As this reserve grows, the insurer’s “amount at risk” declines. By reducing the amount at risk, the contract keeps long-term mortality costs manageable.
Without a cash reserve, the cost of coverage in later years would rise to levels that make it impractical to maintain the policy. This is why term insurance rarely results in a paid death claim and why permanent insurance requires a funding mechanism that grows over time.
2.3 Premium: The Contract Deposit
Premiums are deposits that fund both the mortality cost and the cash reserve. The required premium level depends heavily on the interest rate used in the policy design. Higher interest assumptions reduce required premiums; lower assumptions increase them.
During the high-rate era of the 1980s and early 1990s, guaranteed interest rates of 4% or more kept premium requirements low. As guaranteed rates fell to 1–2%, many older whole life contracts no longer received enough interest credit to maintain originally projected performance. Some contracts were not designed to accept additional deposits, leading to underfunding problems.
Market Shifts and Product Innovation
3.1 Emergence of Universal Life in the 1980s
Universal life (UL) introduced flexible premiums and adjustable interest crediting. When rates were high, UL appeared attractive because projected cash growth reduced premium needs. As interest rates declined, however, many UL policies underperformed. Policyholders often had to contribute additional money to prevent lapse.
Despite these issues, UL created a foundation for innovations that would reshape the industry.
3.2 Development of Index Universal Life
Index universal life (IUL) expanded on UL by tying interest crediting to market indices such as the S&P 500, while adding protective features:
- A 0% floor, preventing negative returns even if the index declines
- A cap on positive returns, limiting upside but providing stable long-term growth characteristics
Typical designs have included a 0% floor and caps near 12%. Historically, index-based crediting has outperformed bond-based crediting over long periods. This added return potential helps build the cash reserve needed to maintain policy stability through the insured’s lifetime.
Application: Using COLI to Fund Corporate Liabilities
Corporations use COLI for purposes such as:
- Funding non-qualified executive benefit plans
- Offsetting long-term benefit liabilities
- Enhancing balance-sheet stability
- Providing tax-advantaged growth for corporate assets
A well-designed COLI strategy aligns policy structure with future funding needs. Understanding the relationship between mortality cost, cash reserves, and interest rate assumptions is essential for long-term success.
Key Considerations for Corporations
5.1 Interest Rate Sensitivity
Premium adequacy and cash reserve development are directly tied to interest rates. Policies designed in a high-rate environment may require modification, additional funding, or replacement if interest crediting falls short of original projections.
5.2 Policy Flexibility
Products that allow flexible deposits or dynamic investment crediting are better suited to changing interest rate environments. UL and IUL contracts offer more adaptability than traditional whole life.
5.3 Investment Structure Behind the Contract
Performance depends on how the insurer invests. Bond-heavy portfolios behave differently from index-linked strategies. Corporations should understand:
- The expected return profile
- The safety mechanisms within the contract
- How index caps and floors work
- How cash reserves will grow over time
5.4 Long-Term Funding Reliability
The policy must maintain a stable cash reserve to support long-term liabilities. Poorly funded or inflexible contracts can jeopardize funding strategies.
Conclusion
As interest rates and financial markets continue to evolve, corporately owned life insurance remains a valuable tool for managing long-term corporate liabilities. The key is understanding how a life insurance contract works and matching the right product to the company’s objectives.
Traditional whole life offered predictable returns when bond yields were strong. Universal life added flexibility but struggled in low-rate environments. Index universal life introduced a way to capture equity-linked returns with downside protection, creating more stable long-term funding potential.
For corporations, selecting and managing life insurance products is not a one-time decision. It requires ongoing evaluation to ensure performance aligns with the company’s long-term financial needs.