Key Person Life Insurance Has Lapsed. What Should Your Business Do Next?

If key person life insurance lapses, first confirm the policy’s status with the insurer in writing. Then check the grace period and reinstatement terms in the contract before you pay, borrow, or replace anything. This guide, written from a CPA firm’s view, covers those steps in order.

What a Lapse Means for a Key Person Life Insurance Policy

A lapse means the policy has ended because a premium went unpaid. Coverage is no longer in force unless the policy is restored.

A key person policy is owned by the business and insures someone the company depends on. The Insurance Information Institute explains that a key employee is someone whose loss would cause financial harm to a business. Key person life insurance is meant to compensate the business for those losses. So a lapse affects the company’s plans and balance sheet, not only the insured’s family.

A lapse often starts with a payment that someone assumed was going out automatically. It may also be a bookkeeper who finds the notice before the owners do.

A lapse is not always final. Whether the policy can come back depends on its terms and on timing. The steps below help you gather facts before anyone decides anything.

Confirm the Policy Status and Find the Grace Period

Start with the policy contract, the latest statement, and every premium notice from the insurer. The contract is the source for the answers, not a general summary.

Check four things. Note the premium due date. Find the grace period stated in the contract. Confirm the insurer, policy number, owner, and insured. Then see whether the insurer sent a lapse notice. Matching the names matters, because you need to contact the right company about the right policy.

Florida law includes rules about when a life insurance policy may lapse for nonpayment. Every insurance contract must give the insured a grace period of not less than 30 days to pay any premium after the first. The policy stays in force during that grace period (Fla. Stat. § 627.453). The insurer may charge interest on the late premium, but not more than 8 percent per year for the days of grace that pass before payment.

Notice rules can apply too. Under Florida law, a life insurance contract issued or delivered in Florida on or after October 1, 1997, covering a natural person 64 years of age or older and in force for at least 1 year may not be lapsed for nonpayment of premium unless, after the grace period, the insurer has mailed a notice of impending lapse to the policyowner and to a specified secondary addressee, if one has been designated, at least 21 days before the lapse takes effect, subject to the exceptions set out in the statute (Fla. Stat. § 627.4555). Premiums paid monthly or more often, collected by a licensed agent or paid by automatic bank or card payment, fall outside that rule.

Finally, ask the insurer in writing for the current status. Ask for the exact amount needed to bring the policy current, with any past-due premium and charges listed separately.

Reinstatement Options and What Insurers Usually Ask For

Reinstatement means restoring a lapsed policy to in-force status. Contracts set a window for it and usually require payment of back premiums with interest. Compare the words in your own contract, since terms differ by policy form and by insurer.

Expect questions about the insured’s health. The insurer may require health information or updated underwriting before it reinstates coverage. Approval is not assured, and the insured’s current health can change the answer.

If the policy has cash value, a policy loan may be part of the picture. Florida law says a life policy with a cash surrender value must include a provision that, while no premium is in default, the insurer will advance a policy loan on proper assignment or pledge of the policy as security, but the policy must also reserve the insurer’s right to defer granting a loan, other than one for paying a premium to the insurer, for 6 months after you apply (Fla. Stat. § 627.458). Fla. Stat. § 627.458 reads: “The loan value of the policy shall be at least equal to the cash surrender value at the end of the then-current policy year, except that the insurer may deduct, either from such loan value or from the proceeds of the loan, any existing indebtedness not already deducted in determining such cash surrender value, including any interest then accrued but not due, any unpaid balance of the premium for the current policy year, and interest on the loan to the end of the current policy year.” If unpaid loan interest and other debt equal or exceed the loan value, the policy can terminate. That happens only after at least 30 days’ notice is mailed. That section does not apply to term policies or to term insurance benefits provided by riders or supplemental policy provisions.

Before you pay back premiums, compare the amount and timing with the business’s cash position. A rushed payment can strain the same cash the company needs for payroll and other obligations.

Business, Tax, and Cash Value Effects to Review With Your CPA

Start with the business side. A key person policy often ties into a buyout plan, a company loan, or a succession plan. Check the death benefit, any loan balance, and any buy-sell funding against the lapse and reinstatement facts.

On federal tax, one limit is specific. Whether premiums are deductible depends on the facts of the policy and the business, so ask your CPA to review the treatment.

Whole life policies can build cash value. An unpaid policy loan reduces the amount the insurer pays at death, so the loan balance belongs on your review list.

Have your CPA record the lapse, any reinstatement, and any payments on the company’s books, and confirm how they are reported. Keep copies of every notice and every payment confirmation.

Avoid Rushed Replacement and Misleading Comparisons

A replacement policy is not a quick fix. A new application means new underwriting, new premiums, and possibly new exclusions. A new policy also starts its own two-year incontestability period from its issue date (Fla. Stat. § 627.455).

Replacing a policy, or using its cash value to buy another, is a replacement. Florida law makes it unfair or deceptive to knowingly misrepresent a policy’s benefits, advantages, conditions, or terms (Fla. Stat. § 626.9541). Insist that both policies be shown in full.

If an agent recommends surrendering a policy with cash value and not using the proceeds for another policy, the agent must first give written information. That information includes, but is not limited to, any estimated surrender charge, the loss of any minimum interest rate guarantees, possible tax consequences, and any forfeited death benefit (Fla. Stat. § 627.4553). A lapse is a different event, and those surrender rules do not cover it.

Do not judge a policy by its monthly premium alone. Ask for the full terms of both policies, including benefits, exclusions, and costs. The NAIC Life Insurance Buyer’s Guide covers comparing policies and costs, and the questions to ask before buying.

Write down the facts and options before you sign any new application.

Next Step: Bring the Facts to a Coverage Review

A lapse notice often lands in the middle of payroll, closing, and other business demands. The person handling it may be a partner, a bookkeeper, or a family member who never set up the policy. That can make the notice harder to follow.

Have these ready: the contract, the latest statement, the lapse notice, the premium history, any buy-sell or loan agreement, and the names of the business owners.

Insurance is offered through the firm’s licensed insurance agent, Nischay Rawal, separately from the accounting practice.

Common Questions