New rules have clarified the use of company-owned life insurance (COLI) and bank-owned life insurance (BOLI) to fund supplemental executive retirement plans (SERPs) and nonqualified deferred compensation plans. This makes these plans more attractive for attracting and retaining top talent. The rules set by Congress, the IRS, and other regulators address prior issues and reduce tax and legal uncertainties. As a result, more businesses and banks may offer these plans going forward.

1. The law of attraction: new rules regarding deferred
compensation plans may help attract young talent.
As baby boomers retire from executive posts in record numbers, corporations and banks face the
imperative of attracting and retaining top young talent to fill the void.
For years, Supplemental Executive Retirement Plans (SERPs) and deferred compensation plans have
been well-established tools in the high-stakes competition to bring in the best-qualified future
leaders.
Although the popularity of such plans has fluctuated in response to market conditions, media reports
and complex tax issues, a healthy segment of the Fortune 1000 and an ever-expanding number of
banks have them.
There are important new reasons for corporations--especially small and midsized businesses that
still don't offer SERPs or other nonqualified deferred compensation plans--to consider offering them
as lures for young talent.
Those firms that fail to act may find themselves in a recruiting battle for a critically important
executive with another company that offers--and touts--such plans.
New Ground Rules
Rules for SERPs and Nonqualified Deferred Compensation Plans (NDCPs), as well as the programs
most commonly used to finance them--company-owned life insurance (COLI) and bank-owned life
insurance (BOLI) plans--have been clarified by Congress, the Internal Revenue Service, the Financial
Accounting Standards Board and federal bank regulators. By reducing uncertainty about how a plan
should be structured and how its informal funding mechanism will be taxed, those new ground rules
make the plans more attractive than ever.
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Insurance carriers have lowered their number-of-lives limits for guaranteed issue underwriting,
making it easier for small groups to purchase the insurance. While insurers previously required a
minimum of 25 covered executives, guaranteed issue coverage is commonly available now for fewer
than 20 lives--making COLI a realistic option for a huge pool of small- and midsized businesses. In
fact, the U.S. Department of Labor found that the average number of participants in new COLI plans
was 17.
In addition, insurers have expanded greatly the number and breadth of variable investment options
available in COLI products. This makes it easier for companies to match their nonqualified benefit
plan obligations to those in their qualified plans.
In recent years, most Fortune 1000 companies have offered NDCPs, SERPs or both to their
executives. Various marketplace estimates suggest that most large companies participate. And COLI
investments have been a consistently popular option for informally funding NDCP and SERP
programs.
A series of articles published by The Wall Street Journal in 2002 revealed that COLI plans were

2. covering thousands of low-level employees without their knowledge. While those articles didn't
significantly dampen interest in more mainstream COLI, they did spur state and congressional
initiatives to set new standards.
Those legislative efforts culminated in the federal COLI Best Practices Act of 2006. Congress set
limits on which employees could be covered under a COLI policy, and required that covered
employees give their written consent to being covered.
Employers must comply with the provisions of the act to receive favorable tax treatment.
The measure, introduced by U.S. Rep. Thomas Reynolds (R-N.Y.) had
https://www.facebook.com/law.of.attraction.page bipartisan support in Congress and enjoyed
widespread backing from the insurance industry. Most players already were following the majority
of these "best practices," and the new law merely leveled the playing field for competitors.
Tax Implications
Companies have turned to COLI because they may provide a higher after-tax yield than some other
financial products and investments. With COLI, companies pay the premiums and own the cash
value of the policies. Typically, companies also are the sole beneficiaries of the policies.
And COLI policies generate http://www.huffingtonpost.com/news/law-of-attraction/ reportable
income for the company as their cash values grow beyond premiums paid. In addition, death benefits
are generally tax-free, as long as the policies are structured in accordance with IRS guidelines and
the COLI Best Practices Act.
Those regulations, under IRC section 409A, were published April 10, 2007, and employers have until
the end of 2008 to amend their plans to conform to the new requirements. Additionally, the agency
recently issued sweeping new rules for deferred compensation
http://www.law-of-attraction-info.com/whatisloa.html plans, including SERPs.
While one insurance industry commentator characterized many of the provisions as "more liberal"
than earlier rules, the potential penalty for failing to comply with them can be "harsh and
expensive."
Even so, the fact that rules are spelled out in detail gives corporations a clearer road map for
structuring plans. It also removes, or at least reduces, the chance that the IRS will take them into
court.
The Financial Accounting Standards Board also weighed in with guidance on accounting for deferred
compensation and certain life insurance contracts. FASB's Emerging Issues Task Force has issued
EITF 06-04, dealing with split-dollar life insurance arrangements, and EITF 06-05, which covers
accounting for cash surrender values.
While Congress, the IRS and FASB have clarified rules for COLI, the Office of the Comptroller of the
Currency has provided its own detailed guidance for banks that have BOLI programs. The OCC,
which regulates nationally chartered banks, said in its Bulletin 200456 that BOLI can "serve a
number of appropriate business purposes." Among other potential benefits, "BOLI can provide
attractive tax-equivalent yields to help offset the rising cost of providing employee benefits."
The OCC coupled that endorsement with strong cautions to banks to conduct "a thorough

3. prepurchase analysis" and to establish "a sound risk control framework."
It noted that OCC bank examiners would evaluate the effectiveness law of attraction works of the
prepurchase analysis and the control framework, and "assess the appropriateness of internal limits,
with particular emphasis on the limit for aggregate cash surrender value of BOLI."
The net effect of OCC 2004-56 has been a surge of interest by banks in using BOLI to fund their
SERPs, NDCPs and other employee benefit obligations.
BOLI assets held by banks and bank holding companies have been estimated to exceed $100 billion,
and BOLI sales have continued to show strength in 2007, with many of the nation's 8,000 community
banks joining in. That's no surprise, given that the need to attract and retain talent is especially
acute in the small-community bank market.
As authorities have clarified the rules for COLI and BOLI, and confirmed their tax advantages and
usefulness in the marketplace, insurance providers have expanded the range of products they offer.
By reducing the number of executives needed for a plan, and by providing a rich variety of
investment options, they have increased the appeal of COLI and BOLI as a means to informally fund
deferred compensation benefit plans.
The policies "informally" fund the plans in the sense that they are general assets of the company and
need not be segregated specifically for such funding.
Investment options allow COLI and BOLI returns to be tailored to meet a range of future corporate
liabilities, including expenses for medical plans and qualified and nonqualifled benefit plans.
The reforms of the COLI Best Practices Act, in particular, specifically address the key points of
public criticism so employees no longer need to view COLI and BOLI with suspicion.
Employees must give their written consent to being insured. Typically, the employee does not
receive any benefits under the terms of the life insurance policy. But a corporation or bank may
assign a portion of the death benefit--say, $10,O00--to the employee as an incentive to consent to
coverage.
Even when no such arrangement is established (as is usually the case), the employee should feel
more secure that the company can meet its obligations under the benefit programs being funded,
and that the financial soundness of the company is enhanced.
* The Situation: Executive retirement plans can provide employers with a competitive recruiting
advantage.
* What Changed: New rules facilitate the use of company-owned and bank-owned life insurance to
fund the plans.
* Looking Ahead: More businesses and banks may want to establish such plans, creating more
business for benefits advisers.
Contributor Andrew Sforzini is vice president of Prudential Benefit Funding, a unit of The Prudential
Insurance Company of America. He may be reached at andrew.sforzini@prudential.com.
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