Key Person Insurance When Your LLC Membership Changes

Key person insurance for multi-owner LLC owners works best when the policy and the operating agreement agree. When a member joins, leaves or sells an interest, both documents may need attention. This page answers the common questions about who is insured, who owns the policy and who gets paid.

What Key Person Insurance Does in a Multi-Owner LLC

Key person life insurance pays a business if an important person dies, which can help it cover a financial loss. The Insurance Information Institute explains that this coverage compensates a business for losses caused by a key employee’s death or disability.

In a one-owner company, the key person is often clear. In a multi-owner LLC, several members may matter. One may run operations, another may bring in clients, and a third may manage the books. Each one could be a candidate for coverage.

Many LLCs buy coverage on more than one member. Each insured person should have a clear business reason for the policy. That reason is the core of the insurable interest rule covered below.

The policy usually pays the company or a named beneficiary. It does not automatically pay any member personally. The insurer that issues the policy sets its own forms and underwriting rules, so the policy document controls the details.

Who Owns the Policy and Who Receives the Benefit

The policy owner controls the contract. The beneficiary receives the death benefit. Most multi-owner LLCs use one of three setups.

• The company owns the policy and is the beneficiary. The company controls changes and collects the proceeds.
• The company owns the policy and names someone else. A named person or entity receives the proceeds only if the benefits are payable to the insured or his or her personal representatives, or to a person who had an insurable interest in the insured when the contract was made. This setup needs a clear written reason.
• A member owns a policy on another member. The owner controls the policy, but the business reason for the coverage still has to be clear.

Owner choice matters. The owner can usually change the beneficiary. On a policy with cash value, the owner may also be able to borrow against it or surrender it. Fla. Stat. § 627.458 states that its policy loan rules do not apply to term policies.

The operating agreement should name the same owner and beneficiary as the policy. Under Fla. Stat. § 605.0105, except as otherwise provided in subsections (3) and (4), the operating agreement governs relations among the members and between the members and the company. Beneficiary changes go through the insurer’s forms. An internal LLC resolution alone does not change the insurer’s records.

When a New Member Joins the LLC

A new member can be insured only when the company has an insurable interest and the person consents in writing first. Fla. Stat. § 627.404 lets a business entity, including an LLC, insure its owners and key persons. The consent must come in writing before the insurance is bought.

The same statute bars retaliation. The company may not take adverse action against a key employee or key person who refuses consent.

Insurable interest is judged when the contract is made. The statute says the interest need not exist after coverage begins. Adding a person later may still require the insurer’s underwriting.

A fully underwritten policy asks health questions. Issue may depend on insurability. A new member’s ownership share may also change how the company wants to split coverage among insured people. That split is a business decision to make before the application.

When a Member Leaves, Retires or Sells Their Interest

When a member leaves, the policy does not change on its own. The company must act through the insurer and the operating agreement. Florida LLC law sets the starting point.

A transfer of a membership interest is permissible. Fla. Stat. § 605.0502 also says a transfer that breaks an operating agreement restriction is ineffective against anyone who had knowledge or notice of that restriction at the time of the transfer.

Florida law sets out what happens after a member is dissociated. After dissociation, the member’s interest is owned only as a transferee. Dissociation does not wipe out debts the member owed while a member, under Fla. Stat. § 605.0603.

A buy-sell agreement sets the price and terms of a buyout. A key person policy may help fund that purchase. Read the two documents together with the policy’s owner and insured names. The buyout may leave the policy pointing at people who no longer own the company.

If someone recommends surrendering a policy with cash value, Florida law requires written information first. Fla. Stat. § 627.4553 lists items such as surrender charges, possible tax consequences and any forfeited death benefit. Confirm each transfer or surrender step with the insurer before acting. Do not assume a change is automatic.

Premiums, Records and the Company’s Books

The payer of premiums should match the owner in the company’s records. If the company pays premiums on a policy a member owns, the books should show why. Mismatched payers and owners make records hard to follow later.

Our CPA team looks at cash flow and business records as part of the firm’s accounting work. Insurance is offered by the licensed agent, separately from the accounting practice.

Federal tax treatment is not automatic. 26 U.S.C. § 101(a) generally excludes amounts paid because of the insured’s death from income. Federal tax treatment of life insurance has exceptions, and how they apply depends on the facts of each case, so a coverage review with our team can help you understand how they may affect your situation. The IRS says whether life insurance proceeds are taxable depends on the facts. Contact NR CPAs & Business Advisors to discuss how premiums and proceeds may apply to your entity in a coverage review.

Questions to Answer in the Operating Agreement

Your operating agreement should cover every membership event that can change coverage. Those events include adding a member, a member leaving, the death or disability of a member, a sale of a percentage interest, and a change in management role.

For the policy, the agreement should state the owner, the beneficiary and the premium payer. It should also explain how insured people are added or removed. That includes the written consent needed before a new insured person is covered.

A person who becomes a member is bound by the operating agreement. Under Fla. Stat. § 605.0106, that person is deemed to assent to it. Fla. Stat. § 605.0106 provides that a person who becomes a member of a limited liability company is deemed to assent to, is bound by, and may enforce the operating agreement, regardless of whether the member executes the operating agreement.

Changes made without updating the policy can leave coverage that no longer matches who the company depends on. Bring the current operating agreement and the policy schedule to your review. Together, they show where the two documents disagree.

Florida LLCs and Local Coverage Questions

Florida LLCs follow Florida’s LLC and insurance statutes. Review the operating agreement and the policy under those rules. Our insurance work covers Florida business owners in Miami, Fort Lauderdale, West Palm Beach, Orlando, Tampa and Jacksonville.

Florida law requires an insurance agent to be licensed and appointed before acting as one. Florida law requires that a person be currently licensed by the department and appointed before acting as an insurance agent or advertising as one. Nischay Rawal acts as a licensed insurance agent in Florida.

Florida’s insurance rules apply to the policy. The insurer’s own terms control the details of your coverage.

Request a Coverage Review for Your LLC

A coverage review is a useful next step when a member is joining, leaving or selling an interest. Those changes can leave the policy out of step with the operating agreement.

If you are adding a partner, losing one, or buying out a member, ask us to check the policy against your operating agreement. Contact NR CPAs & Business Advisors to request a coverage review with Nischay Rawal, a licensed insurance agent in Florida. Bring the operating agreement and your current policy schedule.

Insurance is offered by the licensed agent, separately from the accounting practice.

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