Key Person Life Insurance: What Happens When the Claim Is Denied?
Key person life insurance is designed to shield businesses from the financial devastation that may occur when a vital individual unexpectedly dies or becomes incapacitated. This type of life insurance, also referred to as “key man insurance," is not immune to the same scrutiny, exclusions, and contestability issues that plague individual policies. Businesses relying on a key person policy for survival may find themselves in a precarious legal and financial position if the insurer refuses to pay.
Understanding the fine print of these policies and preparing for a possible claim denial is critical. If your company is banking on a payout from a key person policy, it’s essential to know what can go wrong—and how to respond when it does.
What Is Key Person Insurance and Why It Matters
Key person insurance is a life or disability policy taken out by a business on the life of a crucial employee, owner, or executive. The business pays the premiums and is also the beneficiary. These policies are meant to cover financial losses that could result from the death or long-term disability of the person whose vision, skill, or leadership is integral to company success.
The coverage may be used for:
Loss of profits due to leadership voids
Hiring and training replacements
Settling debts or investor obligations
Stabilizing the business while it reorganizes or restructures
For example, a software startup whose valuation depends on its CTO’s proprietary algorithms may collapse if that individual unexpectedly passes. A key person life policy might seem like a solution—but not if the claim is denied.
What Key Person Insurance Typically Covers
Key person insurance can vary significantly in structure, but most policies address the following scenarios:
Death of the insured: A payout is made if the key individual dies during the policy term.
Critical illness or disability: Some policies offer benefits if the individual becomes permanently disabled or critically ill.
Temporary incapacity: Short-term disruptions may trigger limited coverage depending on policy terms.
It is crucial to understand exactly what your policy covers and what it excludes. Many denials stem from alleged non-disclosure, policy exclusions, or insurer interpretations of incapacity that do not match medical realities.
Why Are Key Person Insurance Claims Denied?
While marketed as business protection, key person insurance claims are not immune to aggressive denial tactics by insurers. Common reasons for denied or delayed claims include:
Alleged misrepresentation: The insurer may claim the key person failed to disclose health conditions, tobacco use, or high-risk hobbies—even if the employer completed the application.
Contestability period disputes: If the death occurred within two years of the policy’s start date, insurers often launch investigations to void the policy.
Policy exclusions: Suicide, acts of war, or certain high-risk activities may be excluded, and the insurer may interpret the cause of death to fall within these categories.
Disputes over the insured's role: Some insurers challenge whether the person truly qualifies as “key,” particularly if the business has multiple decision-makers or stakeholders.
Ownership and beneficiary conflicts: If the business structure is unclear or there were changes in leadership, disputes over who has the right to the payout can arise.
Businesses are often caught off guard when insurers prioritize profits over payouts, especially in times of crisis when resources are stretched thin. A denial not only delays recovery efforts—it can jeopardize the survival of the company.
Frequently Asked Questions About Denied Key Person Life Insurance Claims
Can a business challenge a denied key person life insurance claim?
Yes, businesses can and should challenge denials, especially if the insurer acted unfairly, relied on vague policy language, or made incorrect assumptions about the insured’s health or role.
What if the key person didn’t personally fill out the application?
Insurers may still try to hold the business accountable for inaccuracies, but if the insured did not complete the application or was unaware of its contents, the denial may be challenged.
Does the contestability period apply to key person policies?
Yes, most key person life policies have a two-year contestability period during which the insurer can investigate and void the policy for alleged misstatements.
What happens if the insurer claims the person wasn’t ‘key’ enough?
This tactic is more common than many businesses realize. Insurers may argue the person wasn’t indispensable. Documentation showing the individual’s impact on revenue, operations, or strategy can counter this claim.
How often are key person life insurance claims denied?
While data is limited, denial rates tend to spike during financial downturns or in industries with high-risk classifications. Insurers often look for ways to protect their bottom line, especially when large sums are involved.
Is key person insurance governed by ERISA?
Generally no. Most key person policies are considered corporate-owned and not part of an employee benefit plan, so they fall outside of ERISA—but legal counsel should always verify.
Can a denied claim be reversed without litigation?
Sometimes, yes. A well-crafted appeal, legal demand letter, or internal dispute resolution process may result in reversal—particularly if the insurer knows litigation is imminent.
What if there is a disagreement among business partners about the claim?
Disputes can arise if one partner controls the policy but others have a financial stake. In these cases, legal intervention is often required to resolve ownership and payout conflicts.
Can a payout be delayed even if the claim is eventually approved?
Absolutely. Many businesses face devastating cash flow problems while waiting for insurers to approve or process a claim—even if it’s ultimately paid.
Should a company get legal advice before filing a claim?
Yes. Having an attorney involved from the outset helps prevent mistakes and ensures that your business is positioned to challenge any denial from day one.
What if the death involved questionable circumstances?
If the death of the key person is under investigation or involves complications like suicide, insurers may delay or deny the claim. Legal advocacy is critical in these sensitive scenarios.
Does state law affect key person insurance claims?
Yes. Each state has its own laws on contract interpretation, bad faith insurance practices, and time limits for filing disputes. A local attorney can guide you through jurisdiction-specific challenges.
Can an insurer rescind a key person policy after death?
They may try, especially during the contestability window, by alleging misrepresentation. Legal action may be needed to defend against rescission attempts.
What if the insured’s cause of death was excluded under the policy?
This is one of the most common denial reasons. Whether the exclusion applies is a legal question that should be evaluated carefully, especially if the language is ambiguous.
Are businesses entitled to punitive damages if the insurer acted in bad faith?
In many states, yes. If an insurer’s conduct was especially egregious, courts may award punitive damages in addition to the full policy benefit.
How long does a key person insurance dispute take to resolve?
It depends. Some cases settle in weeks, while others may take months or years, particularly if litigation is required. An experienced attorney can help accelerate the process.
Should key person policies be reviewed regularly?
Yes, especially after leadership changes, funding rounds, or expansions. Regular reviews reduce the likelihood of claim complications later.
Can a bank require a business to have key person insurance?
Yes. Lenders often require this coverage for loans, and they may be named as beneficiaries to protect the loan in case of the key person’s death.
Is it better to have multiple people insured under one policy?
It depends on the structure of your business. Multiple policies may offer more flexibility and reduce disputes over who qualifies as “key.”
What if the insurer delays communication during the claims process?
Delay is a common tactic. It’s often a red flag that the insurer is preparing to deny the claim. Legal pressure can force timely responses and accountability.
Common Traps in Key Person Policies
Businesses must be proactive in structuring and maintaining their key person policies to avoid later disputes. Common issues that increase the likelihood of a denied claim include:
Unclear documentation of the insured’s role and value to the company
Failure to update policies following leadership changes, restructures, or role shifts
Outdated financial justifications used to calculate the insured amount
Lack of internal review of policy language and exclusions
Many companies treat key person coverage as a “set it and forget it” investment—until a crisis hits. Avoiding common traps is one way to reduce the chance of a denial, but legal representation is the most effective path to recovering a denied claim when that day comes.
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