Insurable interest

Insurable interest exists when an insured person derives a financial or other kind of benefit from the continuous existence of the insured object. A person has an insurable interest in something when loss-of or damage-to that thing would cause the person to suffer a financial loss or other kind of loss.

For example, if the house you own is damaged by fire, the value of your house has been reduced, and whether you pay to have the house rebuilt or sell it at a reduced price, you have suffered a financial loss resulting from the fire. By contrast, if your neighbor's house, which you do not own, is damaged by fire, you may feel sympathy for your neighbor and you may be emotionally upset, but you have not suffered a financial loss from the fire. You have an insurable interest in your own house, but in this example you do not have an insurable interest in your neighbor's house.

Historical background

The basic principle of insurance is to protect against loss rather than create an opportunity for speculative gain. Early use of insurance as a form of gambling (life insurance on the lives of kings, for example) led to the banning of life insurance in France, Holland and Sweden during the 16th and 17th centuries.^[1]

A notorious abuse of insurance occurred in Pennsylvania in the late 1800s. Six men obtained an insurance policy on an elderly man, who continued to live longer than expected. Understandably, the premiums on an old man were high. Frustrated by the high costs and impatient for the payoff, the men murdered the old man, a crime for which they were hanged.^[2] The ability of a person to buy insurance on the life of a stranger would create a moral hazard wherein the person owning the insurance policy stands to profit from the death of the insured.

Establishing the principle of insurable interest as a requirement for purchasing insurance distanced the insurance from gambling, thereby leading to better reputation and greater acceptance of the insurance industry. The United Kingdom provided leadership by passing legislation that prohibited insurance contracts if no insurable interest could be proven, notably the Life Assurance Act 1774 which renders such contracts illegal, and the Marine Insurance Act 1906, s.4 which renders such contracts void.

Property insurance

People have an insurable interest in their property up to the value of the property, but not more. The principle of indemnity dictates that the insured is compensated for a loss of property, but is not compensated for more than what the property was worth. A lender who accepts a house as a mortgage, has an insurable interest on the property used as security, but the insurable interest is not in excess of the value of the loan.

Life insurance

Insurable interest refers to the right of property to be insured.^[3][4] It may also mean the interest of a beneficiary of a life insurance policy to prove need for the proceeds, called the "insurable insterest doctrine".^[4] Specifically, insurable interest is:

An interest based upon a reasonable expectation of pecuniary advantage through the continued life, health and bodily safety of another person, and, consequently, loss by reason of their death or disability; or A substantial interest engendered by love and affection if closely related by blood or by law.

—Society of Actuaries ^[5]

Insurable interest is no longer strictly an element of life insurance contracts under modern law. Exceptions include viatication agreements and charitable donations.^[5]

The principle of insurable interest on life insurance is that a person or organization can obtain an insurance policy on the life of another person if the person or organization obtaining the insurance values the life of the insured more than the amount of the policy. In this way, insurance can compensate for loss. A company may have an insurable interest in a President/CEO or other employee with special knowledge and skills. A creditor has an insurable interest in the life of a debtor, up to the amount of the loan. A person who is financially dependent on a second person has an insurable interest in the life of that second person.

Legal guidelines have been established in many jurisdictions which establish the kinds of family relationships for which an insurable interest exists. The insurable interest of family members is assumed to be emotional as well as financial. The law allows insurable interest on the presumption that a personal connection makes the family member more valuable alive than dead. Thus, husbands/wives have an insurable interest in their spouse, and children have an insurable interest in their parents (and vice-versa). Brothers/sisters and grandchildren/grandparents are also assumed to have an insurable interest in the lives of those relatives. But cousins, nieces/nephews, aunts/uncles, stepchildren/stepparents and in-laws cannot buy insurance on the lives of others related by these connections.^[6]

A person is presumed to have an insurable interest in his or her own life,^[7] preferring to be alive and in good health rather than being sick, injured or dead. If a person obtains an insurance policy on their own life, it is presumed that the person would only name a beneficiary who wants the insured to be alive and healthy. Often there is no requirement that the beneficiary have a proven insurable interest in the life of the insured when the insured has purchased the insurance.^[6]

A person is considered to have an unlimited interest in the life of their spouse, which the law considers broadly equivalent to having an insurable interest in their own life. Even if not financially dependent on the other, it is legitimate to insure against the death of a spouse.^[8] This does not reliably extend to cohabiting couples, however. Although many insurers will accept such policies, they could potentially be invalidated because they have not been tested in court. In recent years, there have been moves to pass clear statutory provisions in this regard, which have not yet borne fruit.^[9] Similar treatment was recently extended to civil partners under section 253 of the Civil Partnership Act 2004.

See also

• Insurability
• Liability insurance
• Life insurance
• Property insurance

References

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