Key Person Life Insurance Wasn’t Built for Divorce, But It Should Account for One

The name gives it away. Key person life insurance is built to protect a business from losing someone to death, not to a marriage ending. Fair enough. But has anyone at your company ever asked what happens to that same coverage, and the business it protects, when the disruption comes from a courtroom instead of a funeral? The overlap between these two very different risks is bigger than most owners realize.

What the Policy Actually Covers

A key person life insurance policy is coverage that a business purchases on the life of an owner, executive, or other individual whose loss would meaningfully disrupt its operations. The company is typically the policy’s owner, premium payer, and beneficiary, and the payout is meant to replace lost revenue, fund the cost of recruiting a replacement, or provide breathing room during a rocky transition. Under Internal Revenue Code Section 101(a), death benefits are generally excluded from taxable income. Section 101(j), added by the Pension Protection Act of 2006, requires specific written notice and consent from the insured before the policy is even issued. Skip that paperwork, and a death benefit that was supposed to be tax-free can lose a meaningful share of its value to ordinary income tax.

The Overlap Nobody Plans For

If a key person’s ownership interest becomes entangled in a divorce, the business can face many of the same disruptions that key person life insurance was designed to guard against, just without a death involved. A forced buyout, a sudden shift in leadership focus, or a prolonged valuation dispute can destabilize operations in ways that feel remarkably similar to losing that person outright. Some owners now structure their planning around this overlap directly, using coverage or reserve funds not just for a death-related payout, but also to supply liquidity if a divorce forces an unplanned ownership transition.

Four Questions a Coordinated Plan Should Answer

Insurance on its own does not resolve what happens to an ownership stake in a divorce. That is where a buy-sell agreement typically comes in, working alongside the coverage rather than replacing it.

• Is divorce explicitly listed as a triggering event under the company’s buy-sell or shareholder agreement?
• Is existing key person or buy-sell insurance funding sufficient to cover a divorce-related buyout, not only a death-related one?
• How would the valuation formula already in place apply if a court needed to price a divorcing owner’s interest?
• Have the spouses of all owners acknowledged and consented to these provisions in writing?

Florida divides marital assets under Section 61.075 of the Florida Statutes, and a business interest acquired or grown during a marriage is frequently treated as, at least partially, marital property. Having the insurance funding and buyout structure settled before that question ever reaches a courtroom is often the difference between an orderly transition and a scramble for cash under pressure.

If your business carries key person life insurance coverage, it is worth finding out whether that same planning holds up against a divorce, not just a death. Our Miami business divorce attorneys at Hamilton O’Neill help business owners across South Florida coordinate insurance planning with buy-sell agreements. Contact us to talk through how your current coverage fits into the bigger picture.

Source:

flsenate.gov/Laws/Statutes/2023/61.075