A semiconductor device is made by mounting an insulating layer over a temporary substrate. A via is formed through the insulating layer. The via is filled with conductive material. A semiconductor die has a stress sensitive region. A dam is formed around the stress sensitive region. The semiconductor die is mounted to the conductive via. The dam creates a gap adjacent to the stress sensitive region. An encapsulant is deposited over the semiconductor die. The dam blocks the encapsulant from entering the gap. The temporary substrate is removed. A first interconnect structure is formed over the semiconductor die. The gap isolates the stress sensitive region from the first interconnect structure. A shielding layer or heat sink can be formed over the semiconductor die. A second interconnect structure can be formed over the semiconductor die opposite the first interconnect structure.