Is Key Person Insurance Required by Law? Know Where You Stand

Generally, no. Key person insurance is usually a choice a business makes, not a legal mandate. The pressure to buy it usually comes from a contract.

The Short Answer: No General Law Requires Key Person Insurance

Whether a business buys key person insurance is a decision its owners make, but a business has an insurable interest in a key person only if consent is obtained in writing from that person before the insurance is purchased. In most situations, it is a business decision. Key person insurance is a policy the business owns and pays for. The business is the beneficiary, and the insured person is the one whose life is covered.

Because the rule is general, the answer can change for a particular deal. So, is key person insurance required by law for your business? Look at your own documents. A loan, a partnership agreement, or an investor’s paperwork can add a requirement that the general rule does not. Read every document you have signed or are being asked to sign, and look for insurance clauses.

What a Key Person Insurance Policy Pays For

The death benefit is paid to the business, not to the family of the person who died. That is the main difference from personal life insurance. The business decides how to use the money. It might cover lost profits, the cost of recruiting and training a replacement, or other costs of losing someone central to its work.

The Insurance Information Institute describes key person coverage as compensation to a business for financial losses caused by an employee’s death or disability.

Key person policies can be term or permanent. Term life insurance covers a set period. Whole life insurance covers the insured for life and includes a cash value feature. The insurer sets the benefit amounts and terms. The policy document controls what is covered, so read it before you rely on it.

Where the Requirement Really Comes From: Contracts and Lenders

The requirement usually comes from a contract. Common sources are a loan agreement, a partnership agreement, or a shareholder agreement. A lender may ask for key person coverage as a condition of a loan. That is a term of the loan, not a statute.

Owners often write insurance and buyout terms into their own agreements. Florida law lets those agreements work. Under Fla. Stat. § 607.0732, a shareholder agreement that meets the section is effective among the shareholders and the corporation. Under Fla. Stat. § 620.8701, when a partner leaves a partnership without the partnership being dissolved, the partnership must cause that partner’s interest to be purchased for a buyout price determined under the statute’s formula, not a set price. For LLCs, Fla. Stat. § 605.0105 says that, except as otherwise provided in subsections (3) and (4), the operating agreement governs relations among the members.

Buy-sell agreement insurance can provide the money for a purchase. The terms of an agreement between owners can set out whether the business will buy coverage. Check every loan, operating agreement, and investor document before you decide.

Who Qualifies as a Key Person in My Business

Common examples are an owner, a top salesperson, or a technical leader the business depends on. The loss should be real and measurable, not just possible.

Florida’s insurable interest statute, Fla. Stat. § 627.404, lists who a business may insure. A business entity can insure its owners, directors, officers, partners, managers, and key employees or key persons. It must get written consent from a key employee or key person before buying the policy. The insurable interest must exist when the contract is made. It does not have to exist after coverage starts.

Write down why each person was chosen. Review the list when roles or ownership change.

Who Cannot Be Covered Under Key Person Insurance

Florida law recognizes an insurable interest for an individual who is closely related by blood or by law to the person insured and in whom the individual has a substantial interest engendered by love and affection, and also for an individual who has an expectation of a substantial pecuniary advantage through the continued life, health, and safety of that person and a consequent substantial pecuniary loss by reason of that person’s death, injury, or disability (Fla. Stat. § 627.404). The insurable interest rule ties the right to insure to defined roles.

Consent matters too. Under the same statute, a contract on a person’s life generally requires that the insured person, if legally capable, applies for it or consents to it in writing before the contract is made. Fla. Stat. § 627.404 reads: “(5) A contract of insurance upon a person, other than a policy of prepaid funeral contract; group life insurance; or group or blanket accident, health, or disability insurance, may not be carried out unless, on or before the time of entering into such contract, the person insured, having legal capacity to contract, applies for or consents in writing to the contract and its terms, except that any person having an insurable interest in the life of a minor younger than 15 years of age or any person upon whom a minor younger than 15 years of age is dependent for support and maintenance may obtain a policy of insurance on the minor.” Group life insurance is one listed exception.

Insurers also review each applicant. Health history and age can affect whether a policy is issued and on what terms. If an age or sex was misstated, Fla. Stat. § 627.456 says the benefit is what the premium would have bought at the correct age or sex. An incontestability clause, under Fla. Stat. § 627.463, limits challenges to a policy’s validity. It does not stop an insurer from relying on exclusions. Read the exclusions before you count on the coverage.

Tax Treatment Basics for Business Owners

Premiums are generally not deductible when the business is the beneficiary. Under IRC § 264, no deduction is allowed for premiums on a life insurance policy if the taxpayer is directly or indirectly a beneficiary under it.

For employer-owned life insurance, which includes key person policies a business owns, IRC § 101(j) limits the exclusion to the premiums and other amounts the policyholder paid for the contract, unless that section’s requirements are met. One example is an amount received by reason of the death of an insured who has a certain status with respect to the policyholder, where the notice and consent requirements are met.

The tax code also uses a narrow definition of key person for certain rules. For purposes of the business entity insurable interest provision, Florida law defines a “key employee” or “key person” as an individual whose position or compensation is described in section 101(j)(2)(A)(ii) of the Internal Revenue Code of 1986 (Fla. Stat. § 627.404). The tax result depends on the facts, especially how the policy is owned and structured.

Premiums are a real cash cost. Plan the budget before the policy starts, not after.

Do I Have to Have Business Insurance at All?

Key person insurance is separate from other business coverages. Some other coverages may be required in some cases. Leases, contracts, and licenses can each set their own insurance terms.

Review those requirements on their own. Don’t assume a key person policy meets them. Don’t assume a lease requires key person coverage either.

Keep the question narrow. Key person insurance answers one question: what happens to the business if an important person dies or becomes disabled. It does not cover every business risk.

Next Steps After You Read the Documents

Check the legal requirements first, then the contracts. Then decide based on the business’s own risk. A lender may ask for coverage after an owner’s health changes. Or a family member may be handling a business that depends on one person. Either case calls for a calm look at the paperwork.

Insurance is offered by Nischay Rawal, a licensed insurance agent based in Miami. That work is separate from the accounting practice of NR CPAs & Business Advisors.

If you have a loan, partnership, or shareholder document in front of you, contact NR CPAs & Business Advisors to set up a coverage review.