Key Person (Key Men) Life Insurance
What is key person life insurance?
What is key person life insurance?
Key person life insurance is a policy the business owns and pays for on the life of an owner or employee whose death would damage the company, with the business as beneficiary. If that person dies while covered, the death benefit is paid to the company, not to the individual’s family. The business decides how to use it: to steady revenue, reassure lenders and investors, or fund the search for and training of a replacement. California adds a rule most other states do not have about who can be insured this way, and federal tax law adds a condition that has to be met before the policy is issued.
Schneiderman Insurance Agency places key person coverage for businesses across the Los Angeles area, and this page covers what we review with each of them.
Who can a California business insure with itself as beneficiary?
Owners, directors, and exempt employees, and not hourly staff. Under Insurance Code section 10110.4, a corporate-owned life insurance policy is void when the insured is a non-exempt employee. The section defines that policy as one bought by a California employer, naming the employer as beneficiary, on the life of a current or former employee. It declares holding one a violation of public policy. The section carves out exempt employees, defined by reference to Labor Code section 515 as administrative, executive, or professional employees. The insurable interest itself comes from section 10110.1, which gives an employer an insurable interest in any director, officer, or employee whose death might cause it financial loss. So the question before any key person application in California is not only whether the person is key, but whether they are exempt. A top salesperson paid hourly with overtime may be the most valuable person in the building and still not be insurable this way.
What federal tax condition applies, and when does it have to be met?
Before issue. A business-owned policy on an employee is employer-owned life insurance under Internal Revenue Code section 101(j). The general rule limits the tax-free death benefit to the premiums the business paid. The full exclusion is restored only if two conditions are met. The insured falls within the listed categories, such as a director, a highly compensated employee, or someone employed within the 12 months before death. And the written notice and consent requirements were met before the policy was issued. The consent has to be obtained first; it cannot be signed after issue and cannot be repaired after the insured dies. Separately, premiums on a policy where the business is the beneficiary are not deductible under section 264(a)(1), so key person coverage is funded with after-tax dollars. Your CPA confirms both against your own structure. We do not give tax advice.
The Insurance Code, Labor Code, and Internal Revenue Code provisions here are as published at the time of writing. They are amended from time to time, and the California Legislative Counsel and the Office of the Law Revision Counsel publish the current text.
How is the coverage amount set?
By what the loss would actually cost, not by a multiple of salary. The usual components are three. The revenue the person generates or protects during the period it would take to replace them. The cost of recruiting and training a successor. And any debt or investor covenant tied to that person staying involved. Lenders sometimes require key person coverage as a loan condition and set the amount themselves. The figure is reviewed at renewal, because the person who was key at founding may not be the person who is key five years on, and the reverse.
Term or permanent?
Term fits a key person exposure with a foreseeable end: a founder planning to step back, a loan with a maturity date, a growth phase that will pass. Permanent fits an exposure that runs as long as the business does. A permanent policy may build cash value the business can access, which we describe as a feature of the contract and not as an investment. Any loan against it reduces the death benefit until repaid.
What California protections apply to the policy?
The same ones as every individual life policy issued or delivered here. Incontestability after no more than two years in force under section 10113.5. A 60-day grace period under section 10113.71, and no lapse for nonpayment without 30 days’ mailed notice to the owner and to a named designee under section 10113.72. For a business-owned policy, name a second officer or the company’s attorney as designee, so the coverage does not lapse because one person was traveling when the notice arrived.
Who buys key person life insurance?
A founder or owner whose relationships or expertise drive much of the revenue. A technical lead, partner, or exempt senior salesperson who would be costly to replace. A business with loans or investors that depend on a specific person staying involved. Where the concern is buying out a deceased co-owner’s share rather than steadying the company, the structure that fits is buy-sell agreement life insurance, and the two often sit together.
How do we help with key person coverage?
We start by confirming the person is insurable this way in California, then frame a coverage amount tied to real replacement cost and request quotes. We coordinate with your CPA and attorney on the notice-and-consent sequence so the tax exclusion is preserved. The wider picture is on our life insurance page, and the business insurance page covers the rest of the company’s program.
Every business is different, and this page does not replace legal and tax advice. To start, request a quote below or call 818-322-4744.
