Lender Requires Key Person Life Insurance? Start With the Loan Agreement

When a lender requires key person life insurance, it wants a backup source of repayment if a key owner or employee dies. The business usually owns the policy and is the beneficiary, so the money goes to the company, not the person’s family.

The exact duties come from the loan agreement. Read that document first, then work out what the policy must do. This page covers the lender’s concern, how the policy fits inside the business, the loan terms to check, and the tax and cash flow questions. It is written for business owners in Florida and across the United States, including Indian-American owners reviewing a lender’s paperwork.

Insurance is offered through Nischay Rawal, a licensed insurance agent, separately from the accounting practice of NR CPAs & Business Advisors in Miami, Florida.

Why a Lender Asks for Key Person Life Insurance

A lender asks for this coverage when loan repayment depends on a few people. If one of them dies, the business may lose the income or skills it needs to pay the debt.

Picture a company where one owner brings in the largest clients or runs daily operations. The lender sees that person as a risk to repayment. The lender may then ask the business to insure that person’s life and pay the company if the person dies.

Banks use this idea too.

Still, the lender’s rule lives in the loan agreement. General guides explain the idea, but the agreement sets the amount, the person, and the deadline. Follow the agreement, not a general rule of thumb.

What Key Person Life Insurance Is

Key person life insurance is a life insurance policy a business owns on someone whose work matters to the company. The business pays the premiums and receives the benefit if that person dies.

The Insurance Information Institute explains that key person life or disability insurance compensates a business for financial losses caused by a key employee’s death or disability. The purpose is the company’s financial loss, not the person’s family.

Florida law adds a consent rule. Under Fla. Stat. § 627.404, a business may insure a key person only if written consent is obtained from that person before the insurance is purchased; for this rule, a ‘key person’ is someone whose position or pay fits the definition in section 101(j)(2)(A)(ii) of the Internal Revenue Code. The business also may not retaliate against a key employee who refuses consent.

Personal life insurance works differently. A personal policy names family members as beneficiaries. In a key person policy, the business is usually both owner and beneficiary, and the insured person does not receive the benefit.

How the Policy Works Inside the Business

In most arrangements, the business owns the policy, pays the premiums, and is the beneficiary. The company receives the death benefit and uses it under the loan agreement and its own needs.

Taxes matter here. Under federal tax law, no deduction is allowed for premiums on a life insurance policy if the taxpayer is directly or indirectly a beneficiary under the policy. When the business is the beneficiary, its premiums are often not deductible. A cash flow forecast built on a deduction can be wrong.

Death benefits are treated differently. Under 26 U.S.C. § 101(a), life insurance proceeds paid because of the insured person’s death are generally left out of gross income, except as otherwise provided in other parts of section 101, including subsection (j) and the rules for policies transferred for valuable consideration. A CPA should check the policy and the business facts before relying on that rule.

The face amount is set by the lender’s agreement. Compare that amount with the loan balance and with the cash the business would need to keep running. Those numbers should match before the policy is issued.

Key Terms in a Loan Agreement to Check

Before you sign, check the required amount, the named key person, the owner and beneficiary, and any collateral assignment. Those four terms decide most of what the policy must do.

A collateral assignment pledges the policy’s rights to the lender as security. In plain words, the lender may be able to collect part of the death benefit to repay the loan. Ownership and control can change, so read that clause closely.

Look at the notice and maintenance terms too. Ask what happens if the policy lapses, is changed, or is replaced. Under Fla. Stat. § 627.453, every insurance contract must give at least a 30-day grace period to pay a premium after the first. A grace period gives time to pay. It does not cancel the premium.

What Happens If the Key Person Leaves or the Policy Changes

If the key person leaves the business, the loan agreement decides what happens to the requirement. Check that clause before assuming the policy can be stopped or moved.

Replacing a policy needs care. That tax rule does not decide whether the lender accepts the new policy. The lender’s approval and the new policy’s terms still matter.

Timing matters too. Under Fla. Stat. § 627.455, a policy must be incontestable after it has been in force during the insured’s lifetime for 2 years from its date of issue, except for nonpayment of premiums and, at the insurer’s option, as to provisions relative to benefits in event of disability and as to provisions which grant additional insurance specifically against death by accident or accidental means.

Issue depends on underwriting. The insurer may ask health questions, and whether it issues the policy depends on the insured person’s insurability. A lender’s deadline does not change that process.

Questions to Bring to a Coverage Review

Bring the loan agreement and the business’s cash flow numbers to a coverage review. Then ask the lender and the business these questions:

• How much coverage does the agreement require?
• Which person is named, and by when must the policy be in place?
• Who owns the policy, and who is the beneficiary?
• Does the condition last for the full loan term?
• What documents does the lender need, and in what form?
• What happens if the business later wants to change or replace the policy?

If an owner lives outside the United States or a key person is not a U.S. citizen, ownership and underwriting questions can differ. Raise those points early with the lender.

Insurance is offered by Nischay Rawal, a licensed insurance agent, separately from the accounting practice. The firm is paid a commission on the life insurance policies it sells to clients, and Fla. Stat. § 473.3205 requires the firm to disclose that fact to the client in a written disclosure made in accordance with rules adopted by the Florida Board of Accountancy.

Talk Through Your Loan Condition With Us

A coverage review can show what the policy must do before the lender’s deadline. That is the right time to bring the loan agreement and the questions above.

Quick answers

Can a lender require key person life insurance? A lender can include it as a loan condition, and the loan agreement sets the terms.

Are key person premiums tax deductible? Generally not when the business is the beneficiary, under federal tax law.

Does the key person have to agree? Yes. Florida requires written consent from the key person before the business buys the policy.

If a lender has asked your business to carry key person coverage, contact NR CPAs & Business Advisors to set up a coverage review.