Employer has insurable interest in employees.

• Author: O'Driscoll, David

Prior to 1980, A established a group life insurance program for its employees, which allowed a participating employee, including retired employees, a death benefit. A later realized that its liability to its employees under these plans was greater than it could fund. It then decided to purchase insurance (P policies) that would cover the projected liability and allow for premium payments that A could sustain. Thus, A purchased whole life policies on its employees' lives, naming A as the beneficiary. Undisputedly, all of the employees insured under the new plans consented in writing to be part of the plans.

Because the P policies were whole life insurance policies, A was allowed to borrow up to the amount of a policy's cash value during the insured employee's life. If the insured employee died before the loan was repaid, the loan amount and any accrued interest was deducted from the death benefits paid to A. The projected interest expense deductions on the loans would reduce A's taxes by approximately $1.72 billion.

Insurable Interest Requirement

The Service asserts that A lacked an insurable interest in the lives of the 2,435 employees insured under the P policies. As a result, it contends that the policies were void as against public policy and did not create genuine indebtedness and, thus, A is not entitled to an interest deduction under Sec. 163.

State law: The parties agree that Colorado law governs the question whether A has an insurable interest in the employees covered by the P policies. Although Colorado courts have not had the occasion to decide precisely this question, the government urges this court to apply other jurisdictions' decisions that have prohibited employers from obtaining life insurance on their employees, citing Mayo v. Hartford Life Ins. Co., 354 F3d 400 (5th Cir. 2004); Tillman v. Camelot Music, Inc., 408 F3d 1300 (10th Cir. 2005); and distinguishing Dow Chem. Co., 250 FSupp2d 748 (DC MI 2003).

Purpose: The purpose of the insurable interest requirement is to ensure that a policy does not fall into the forbidden class of "wager contracts," taken out by people who are wholly unrelated to the insured and thus who have a "direct interest in [the insured's] early termination" (Warnock v. Davis, 104 US 775 (1881)). In Warnock, the Supreme Court further defined an insurable interest as "arising from the relations of the party obtaining the insurance, either as creditor of or surety for the assured, or from the ties of...