Protect the Business Your Family and Investors Depend On

If you are looking into key person insurance for investors, start with one fact: the policy pays the company, not the family. That payment can give a business a funded way to handle the loss of a founder or leader. This page explains how the policy works and what a CPA-led coverage review looks at.

What key person insurance is and who it is for

Key person insurance is life insurance that a business buys on a person whose death would cause it financial loss. The Insurance Information Institute describes this coverage as a way to compensate a business for losses caused by the death or disability of a key employee.

Three parties are usually involved:

• The company, which owns the policy and is the beneficiary.
• The insured, the founder or leader whose life is covered.
• The insurer, which issues the policy.

This coverage often fits companies with venture or private equity backers, bank lenders, or co-owners who rely on one person’s skills, relationships or licenses.

Insurance is offered by Nischay Rawal, acting as a licensed insurance agent, separately from the accounting practice. Florida law says no one may act as an insurance agent unless licensed and appointed, under Fla. Stat. § 626.112. Under Fla. Stat. § 626.112, no person may be, act as, or advertise or hold himself or herself out to be an insurance agent unless he or she is currently licensed by the department and appointed by an appropriate appointing entity or person. The insurance described on this page comes from a licensed insurance agent and is kept separate from the accounting work of NR CPAs & Business Advisors, a CPA firm based in Miami.

What a key person policy covers

A key person policy pays a death benefit to the business, and the business decides how to use it. The money goes to the company, not to the insured’s family. A company might use the payment to:

• Replace lost revenue during a transition
• Pay for the search and training of a successor
• Meet debt payments or loan terms
• Support working capital while the company adjusts

The face amount is the death benefit the policy pays. A common mistake is picking a round number instead of tying the amount to documented figures. Those figures include revenue linked to that person, outstanding debt and the expected cost of finding a replacement.

Exclusions, limitations and renewability depend on the policy form and the insurer. The coverage review covers these before any application.

How it supports investor confidence after a founder’s death

Key person insurance for investors gives a funded answer to one question: what happens to the company if a founder dies? A founder’s death can disrupt operations, customer relationships, strategy and the timeline for returning capital. Investors and lenders may ask how the company would handle that risk.

A policy is one item in that answer. It does not decide how any investor or lender will respond.

Co-owners sometimes agree in advance how a departing owner’s share will be bought. A policy can help fund a buy-sell purchase when the agreement is built for that use.

Before buying, check the investor and lender agreements. They set the coverage amount, beneficiary and ownership structure the company must provide. Those requirements vary from deal to deal.

How the process works, step by step

The process moves from documenting the risk to a coverage review, an application, underwriting and ongoing review.

1. Document the dependence. List the revenue, relationships, licenses and investor or lender requirements tied to the person.
2. Hold a coverage review. The agent and CPA discuss the company’s need, whether term or whole life fits, and who will own and fund the policy.
3. Complete the application. Health questions are required, and issue may depend on insurability.
4. Underwriting. The insurer reviews the application and issues the policy or makes an offer. Timing varies with the insurer’s process and the insured’s health history.
5. Ongoing review. Revisit the coverage amount when financing, ownership or investor terms change.

Term life insurance covers a set period. Whole life insurance is permanent coverage. The NAIC Life Insurance Buyer’s Guide explains term versus permanent life insurance and what to ask before buying.

Tax and cash flow points a CPA reviews

Under federal law, a death benefit is generally excluded from gross income, but exceptions can change the result. The general rule and its exceptions appear in 26 U.S.C. § 101. Those rules for employer-owned policies include written notice to the employee that the company intends to insure his or her life.

Section 101(j) limits the income exclusion for employer-owned life insurance contracts unless the notice and consent requirements are met and an exception applies. Under 26 U.S.C. § 6039I, an employer that owns one or more employer-owned life insurance contracts issued after that section was enacted must file an information return for each year such contracts are owned. The return reports the number of employees at the end of the year, the number of those employees insured under the contracts, the total insurance in force, the policyholder’s name, address, taxpayer identification number and type of business, and that the policyholder has a valid consent for each insured employee or, if not all consents were obtained, the number of insured employees for whom consent was not obtained.

Under 26 U.S.C. § 264, interest paid on debt connected with a life insurance policy you own on an individual’s life is generally not deductible. A narrow exception applies only to a key person, defined as an officer or 20-percent owner, with a cap on how many individuals may be treated as key persons. It covers interest only to the extent the aggregate debt on policies covering that individual does not exceed $50,000, and it is further limited by an interest rate cap.

On the cash flow side, a CPA reviews premiums against the company’s budget and other obligations. The CPA also checks how premiums are treated on the company’s books.

The firm is a CPA firm. Its insurance work is offered by its licensed agent, separately from the accounting practice. If the firm accepts a commission for the sale of a product or service to you, Fla. Stat. § 473.3205 requires the firm to disclose that fact to you in writing, in accordance with rules adopted by the Florida Board of Accountancy. See Fla. Stat. § 473.3205.

Who may not qualify and what affects the cost

A person may not qualify if the insurer’s underwriting finds that health, age or other factors fall outside its requirements.

One legal point comes first. Under Fla. Stat. § 627.404(1), an insurance contract on another person’s life may pay benefits only to the insured, to the insured’s personal representatives, or to a person having an insurable interest in the insured when the contract is made. See Fla. Stat. § 627.404. See Fla. Stat. § 627.404.

The main cost drivers are the insured’s age, health history, the coverage amount, the policy type and the policy’s features. This page does not quote premiums. The insurer, the underwriting and the facts of the company all shape the figure, and the coverage review is where those details get reviewed.

If the insured leaves the company, review ownership and beneficiary with the agent.

Frequently asked questions