Does a Business Have Insurable Interest in Key Employee Life Insurance?

Insurable interest is essentially the expectation of a financial benefit from the continued life of the proposed insured. The question in basic terms is, “Does the business expect to benefit financially from its relationship with the proposed insured?” Generally, a business has an insurable interest in the life of a key employee if the continued success of the business depends upon the special skills and talents of the key employee, and the policy is purchased to protect the business against loss in the event of the key employee’s death. The insurable interest is not unlimited though – it is limited to the loss which the business would sustain in the event of the death of the key employee (generally the maximum death benefit is 5 to 10 times the key employee’s compensation).

Generally, if a business has insurable interest in an individual when the policy is purchased, the issue is not again raised when the insured dies. However, the definition of insurable interest and its requirements is determined by state law. Practitioners must look to the law of the proposed insured’s domicile to determine if the business does in fact have an insurable interest. If there is no insurable interest, the IRS might claim that the proceeds are not paid by reason of the insured’s death but instead are paid from a wagering contract and therefore are taxable at ordinary income rates

Reproduced with permission.  Copyright The National Underwriter Co. Division of ALM

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