Insurable Interest and a Business-Owned Policy
Mason, 58, owns 60% of an LLC; Rivera, 35, owns 40% and is in good health. Mason wants the LLC to buy a $2 million life policy on Rivera, with the LLC as owner and beneficiary. The LLC would pay the premiums. The operating agreement has no buy-sell provision. Rivera has not been asked to sign a consent form, and his wife objects, saying the policy is 'a bet on his life.' Mason says the LLC clearly has insurable interest because Rivera is a key employee.
1. Analyze whether the LLC has an insurable interest in Rivera and whether Rivera's consent is required.
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Insurable interest is tested at policy inception. A business can have an insurable interest in a key person if the business would suffer a real economic loss from that person's death. Rivera's role as a 40% owner and key employee can support some coverage.
But the amount must be reasonable. A $2 million policy on a 35-year-old co-owner needs a documented economic justification, such as lost profits, replacement costs, or a buy-sell obligation. Here there is no buy-sell agreement, so the LLC's loss is harder to quantify.
Rivera's consent is also critical. Without consent, the arrangement looks like investor-initiated or stranger-originated life insurance, which creates contestability, tax, and regulatory risk. The wife's objection does not by itself determine insurable interest, but it is a warning sign that the file lacks the insured's knowing consent.
2. What happens if Rivera sells his interest and leaves the LLC two years after issue?
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The policy does not automatically become invalid merely because the relationship later ends. Insurable interest is generally required when the policy is issued, not continuously thereafter.
The LLC can keep the policy if it was valid at inception, but it should review:
- Whether the LLC still has an economic interest in Rivera's life.
- Whether the policy is now a company asset with transfer-for-value and tax consequences.
- Whether the beneficiary designation still makes sense.
- Whether any sale or transfer of the policy would violate transfer-for-value rules or state law.
If the policy was questionable at inception because the amount was excessive or consent was missing, the later departure makes the file even weaker. The correct time to fix the problem is at application, not after the insured leaves.
3. How could Mason restructure the arrangement to reduce legal and ethical risk?
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Mason should:
- Put a written buy-sell or key-person plan in place that quantifies the LLC's economic loss.
- Obtain Rivera's signed consent and acknowledgment of the coverage amount and ownership.
- Limit the death benefit to a defensible amount based on the agreement or a reasonable key-person calculation.
- Document who pays premiums, who owns the policy, and who receives proceeds.
- Consider whether entity-owned coverage or cross-purchase coverage better fits the business structure.
This converts a loosely justified policy into a documented business arrangement with a clear insurable-interest rationale and informed consent.