Key Person Insurance Required by Your Bank Loan

Key person insurance required by bank loan documents is something many borrowers first see at closing. Lenders ask for it when the loss of one person could put loan repayment at risk. The business usually owns the policy, pays the premiums, and receives the death benefit. This page explains what the requirement means, what the proceeds can and cannot do, and how a coverage review works. NR CPAs & Business Advisors is a Miami CPA firm. Insurance is offered by a licensed agent, separately from the accounting practice.

What Key Person Insurance Is and Who It Is For

Key person insurance is a life insurance policy a business buys on an owner or employee whose work or loss would seriously hurt the company. The business is the owner and the beneficiary. The death benefit is paid to the business, not to the insured’s family, and the business decides how to use the money.

It often fits owners of small and mid-size companies, partnerships, and firms where one person holds key client, technical, or financial relationships. Owners who are also borrowers or guarantors often hear about it from a lender first.

Key person disability insurance is a different contract. It pays when the person cannot work because of illness or injury, not at death. It has its own waiting period, benefit terms, and exclusions, so it needs its own review.

The two main policy types are term life insurance and whole life insurance. These are generic policy types. A lender may accept either one, depending on the loan.

Why a Lender May Require It and What Banks Typically Ask For

A lender may require key person insurance to protect repayment if an important owner, officer, or guarantor dies. The lender wants a backup source of funds for the loan.

Loan documents often ask for:

• A coverage amount tied to the loan balance
• The lender named as assignee or loss payee
• Proof that the policy is in force at closing
• A review of the insurer’s financial standing

The exact requirement depends on the loan program, the lender, and how the business is structured. Read the insurance section of the loan commitment closely. Do not assume it matches the terms of someone else’s loan.

Florida law adds a step for business-owned coverage. A business has an insurable interest in the life, body, and health of its owners, directors, officers, partners, managers, or key employees, and of those of any affiliate or subsidiary of the business, if it obtains their written consent before the insurance is bought. A business, or any affiliate or subsidiary of the business, may not retaliate or take adverse action against a key employee or key person who does not consent to insurance on that person’s life. Florida law adds a limit for business-owned coverage. A person may insure another’s life only if the benefits are payable to that person or their personal representatives, or to someone with an insurable interest in that person when the contract is made. Fla. Stat. § 627.404 sets that rule.

SBA-backed loans have their own insurance conditions, set by the loan program and the lender. Bring the commitment letter to the coverage review so the lender’s wording can be read against the policy terms.

A collateral assignment pledges the policy to the lender as security. The assignment wording decides how the lender’s rights work. Compare those terms with the policy’s beneficiary and ownership lines, not just the loan summary.

What Key Person Insurance Covers and What the Proceeds Can Pay For

The policy pays a death benefit to the business, in the face amount stated in the policy. Payment follows the policy’s terms, limitations, and exclusions.

The business may choose to use the money for:

• Repaying or reducing the loan balance
• Covering lost revenue during a transition
• Funding the search and training for a replacement
• Settling a buy-sell obligation, if one exists

The proceeds do not pay off the loan automatically. The lender’s rights depend on the assignment language.

Tax treatment needs attention. The IRS says life insurance proceeds are generally excluded from gross income, but interest paid on proceeds held under an agreement to pay interest is taxable. IRS guidance on life insurance proceeds explains the general rule. Employer-owned policies follow special federal rules. Under the employer-owned life insurance rules, the amount excluded from gross income is limited to the premiums and other amounts the policyholder paid for the contract, subject to the exceptions those rules provide. See 26 U.S.C. § 101(j). Employer-owned life insurance contracts issued after the August 17, 2006 enactment date can also carry an annual filing duty for the applicable policyholder under 26 U.S.C. § 6039I.

Policy details matter too. Under Fla. Stat. § 627.455, a life policy must become incontestable after it has been in force during the insured’s lifetime for 2 years from its date of issue. The exceptions are nonpayment of premiums and, at the insurer’s option, provisions on disability benefits and provisions granting additional accidental death insurance. The coverage review checks exclusions and any age-based changes line by line.

Term or Whole Life: Choosing the Policy Type for a Loan Requirement

Term life insurance covers a set period, often matched to the loan’s length. Premiums and coverage terms depend on the policy, and some change at renewal or at stated ages.

Whole life insurance continues for life when premiums are paid as required. It includes cash value, which follows the policy’s terms.

Dividends on participating whole life are not guaranteed. In any illustration, guaranteed values and non-guaranteed values should appear on separate lines so you can tell them apart.

Funding speed matters too. A policy funded faster than the 7-pay test allows becomes a modified endowment contract. How loans and withdrawals from that contract are taxed depends on the policy and your personal circumstances, so review them with your tax advisor before you act. See 26 U.S.C. § 7702A.

A lender may accept either type. The choice affects the premium payment period, renewability, and what happens if the loan is repaid early. Compare each option in writing before anything is signed.

How the Coverage Review Works: Steps and Timeline

A coverage review starts with your loan document and ends with a written summary you can check against the lender’s wording. Here is the typical sequence.

1. Share the requirement. Send the loan commitment, the business structure, and the names of the people the lender is concerned about.
2. Identify the key person. We review that person’s role in revenue, client relationships, and operations. We write down why the lender asks for coverage.
3. Size the coverage. The amount is set against the loan balance, the business’s dependence on the person, and any buy-sell or succession terms. The method is explained in writing.
4. Compare insurer options. Licensed agent Nischay Rawal reviews insurer options, policy form numbers, premium payment periods, and any change in face amount or premium. Limitations and exclusions are explained in plain words.
5. Apply and underwrite. Health questions are required, and issue may depend on insurability.

Timing depends on the insurer and the lender’s deadline. Tell us the closing date at the start so the review can be planned around it.

Fees for the coverage review and any insurance placement are set out in writing before work begins.

Why NR CPAs and How the Firm Is Compensated

NR CPAs & Business Advisors is a Miami CPA firm. It serves families, professionals, and business owners across the United States, including Indian-American households and business owners. Our team reviews insurance purchases with a CPA’s view of tax and cash flow.

Insurance is offered by licensed agent Nischay Rawal, separately from the accounting practice. Any commission on insurance is disclosed in writing before the engagement.

Florida law sets the disclosure rule. A CPA firm engaged in the practice of public accounting that accepts a commission for the sale of a product or service to a client must disclose that fact to the client in writing, in accordance with rules adopted by the board. Fla. Stat. § 473.3205 covers this point. The engagement letter gives the full compensation details before work begins.

The firm offers no rebates or inducements. We look at how premiums, proceeds, and the business’s entity structure may interact with tax and cash flow. These are areas we review, not outcomes we promise.

Frequently Asked Questions