If my favorite sweater gets ruined in the wash, I would wish I had an insurance policy on it so that, at the very least, it could be replaced. Realistically, unless the sweater were a substantial amount of money to the extent that I would suffer a financial loss from its demise, it can’t be insured. There must be proof of financial interest for a person, place, or thing to be insurable.

Your important decisions in life create a blueprint for people to follow. Your business, personal, and financial decisions may support and provide for a large number of people or a few loved ones. Whichever the case, with Insurify, you can find the right life insurance policy to help continue to provide for your loved ones or employees and their families. 

What Is the Meaning of Insurable Interest?

There must be insurable interest for any insurance contract to be legitimate. Insurable interest is the risk of a financial loss. Insurance contracts are a form of risk management that insures a person, place, or thing should a peril, such as death, disability, or natural disaster, occur that would leave the policy owner or beneficiaries with financial hardship.

Insurance contracts cover pure risks, which are risks where there is only the chance of loss and no gain. In property and casualty insurance, such as homeowners and auto insurance, insurable interest must be present at the time of the loss. In life insurance, insurable interest must exist at the time of the application and only at the inception of the contract.

Insurers determine insurable interest during underwriting. Underwriters decide whether an applicant’s policy should be declined or issued and if so, the terms of the contract, such as your premiums. Insurance laws differ from state to state. What may be considered an insurable interest in California may not be one in Ohio. However, most states follow model laws created by the NAIC for symmetry among states.

Insurable interest is a means to prevent moral hazards. A hazard is any condition that raises the chance of a loss. A moral hazard refers to actions that may raise the chance of a loss, including making false representations on the insurance application or making fraudulent claims to receive the benefits from the insurance company

What Is an Example of Insurable Interest?

Insurable interest in general insurance, like auto and homeowners insurance, must exist at the time of the loss. Home and property insurance covers expenses for damages to personal property and is equipped with liability insurance should you harm another’s property. Homeowners and auto insurance covers perils such as theft and damages from natural disasters like hail and rain. They may also cover medical expenses.

General Insurance

Here’s an example of insurable interest in a homeowner’s insurance policy: An owner of a condominium suffers from a fire that they are at fault for. The fire caused damage to the homeowner’s living room and a wall shared with their neighbor. The cost of damages to the homeowner’s property and their neighbor’s damages would leave the homeowner at a severe financial loss

Homeowners insurance would cover the cost of the damage to the policyholder‘s living room and the damage to their neighbor’s property that they are liable for. Similarly, in auto insurance, if a policyholder crashes into a person’s fence and damages his car and the fence, there would be a dire financial loss. Automobile insurance coverage covers the cost of the damage to the car and the damage to the fence he is at fault for.

Life Insurance 

In life insurance, the policy owner must have an insurable interest in the insured at the time of the application. The continuous life of the insured person must be essential for the policyholder‘s financial well-being, such as a spouse, siblings, and children. During the policy’s life, the policyholder can transfer ownership of the policy or no longer have the same insurable interest, such as a former spouse.

Insurable interest in life insurance is best illustrated by a spouse who is the policy owner and a partner who is the insured. The insured makes more income and is the primary breadwinner in the family, so the policy owner has financial dependency and would suffer financial hardship should the insured pass away prematurely. The death benefit from the life insurance policy helps the survivor maintain their standard of living.

What Is an Insurable Interest in Life Insurance?

Life insurance for personal uses is a form of risk management that protects a household when a provider passes away. In business, life insurance provides financial protection should a key employee who has shares in or whose death would be a severe detriment to the company passes away. In both cases, the insurable interest is the financial loss the individuals, family members, or businesses would endure.

Insurable interest must be present at the time of the application and only at the beginning. The policyholder can transfer the policy by assignment only if the designated beneficiary is revocable within the terms of the contract. An irrevocable beneficiary can only be changed with the beneficiary’s permission. If the policyholder is the beneficiary, they can transfer the policy at will.

Insurance contracts are the same as any other contract, with the distinguishing factor of insurable interest. Contracts are agreements that are legally enforceable and are typically commutative, where the parties receive something of equal value. However, insurance contracts are aleatory where one party may receive a benefit that is out of proportion to what they are giving.

In any insurance policy, if you suffer a loss before paying a significant amount of premiums, you are receiving a benefit that is disproportionate to what you are giving. General insurance contracts, such as auto insurance, are indemnity contracts. Indemnity contracts are ones where the benefit cannot be more than the loss. Life insurance contracts are valued contracts, where the benefit is the stated amount.

Moral Hazards

Moral hazards in life insurance are actions that increase the risk of loss. This includes things like smoking and drinking, and it also includes taking out illegal life insurance policies on strangers in hopes of a benefit payout. Life insurance companies use insurable interest as protection from this moral hazard.

The principle of insurable interest helps protect the insurance industry from individuals who want to bet on a person’s life. If someone takes out a life insurance policy on a stranger because they are old or sick, they pay premiums in the hope of the policy’s payout. Modern law makes gambling on another person’s life illegal and punishable by law.

How Do You Determine Insurable Interest?

Determining insurable interest in life insurance can be tricky. There are three people to consider, the policy owner, the insured, and the beneficiaries. Insurable interest must exist between the policyholder and the insured at the time of the application. Beneficiaries who are not the policy owner must prove insurable interest. If you insure your own life and are the policyholder, beneficiaries do not have to prove insurable interest.

Common Designations with Insurable Interest

The policy owner of a life insurance policy chooses the beneficiary. As policy owner, you must have insurable interest, and if you are the policy owner insuring someone else’s life and want to name someone other than yourself as the beneficiary, the beneficiary must have insurable interest. The policyholder can choose a natural person, like a child or spouse, or a legal entity, like a corporation, as the beneficiary.

Natural Person

Policyholders can name themselves or a sole individual or multiple individuals as beneficiaries. Individuals with insurable interest are a spouse, children and grandchildren, parents, siblings, special needs children, aging parents, and any financial dependents of the insured. If multiple beneficiaries are named, the policyholder chooses how much of the benefit each is to receive.

Businesses

When a business is the policyholder or beneficiary of the policy, it is an agreement between a business partner, shareholder, or key employee with the business. The business will use the death benefit of the policy to buy the insured’s interest in the company upon the insured’s death. This is to insure the business can continue.

Trusts and Estates

The benefit of a life insurance policy can be designated to the executor of your estate to pay for estate taxes, outstanding debt, and final expenses. You may also name a trust as a beneficiary. A trust is a legal entity that manages assets and property of another individual or group. The trust would manage the proceeds of the insurance policy.

Third-Party Organizations

Third-party organizations include charitable organizations as beneficiaries. Laws vary among states when it comes to third-party organizations and insurable interest. A policy owner who is also the insured is usually considered to have insurable interest in their own life and insurable interest as a donor. As policy owner and beneficiary, you could also transfer your policy to a charitable organization.

Provisions to Protect Beneficiaries

There are provisions within a life insurance contract that protect the best interest of beneficiaries. These include the spendthrift clause and the common disaster provision. The spendthrift clause states that creditors cannot claim any of the death benefit before it is paid to the beneficiaries. The common disaster provision outlines how the death benefit will be paid if the insured and the primary beneficiary die at the same time in a common disaster. 

We buy life insurance to protect our legacy and the people who are emotionally and financially invested in our lives. With Insurify, you will be able to compare quotes from life insurance companies that have the right policy that works in the best interest of the people and things you’ve invested in.

Frequently Asked Questions

What is insurable interest?

Insurable interest is the financial loss an individual, individuals, or legal entity would suffer due to the death of a person or destruction of property. Insurable interest must be proven at the time of application for life insurance and at the time of the loss for general insurance, such as auto insurance.

Why is insurable interest necessary?

Insurable interest protects insurance companies from moral hazards like making fraudulent claims or betting on someone’s life. It is illegal to take out a life insurance policy on someone that you are not financially dependent on because you think that they will die soon and you will get a large benefit payment. 

Who usually has insurable interest?

People in your life that are financially dependent on you, such as your spouse and children, and any legal entity that depends on your survival to continue usually have insurable interest.

Conclusion

If there were no insurable interest in insurance, people could take out insurance policies on their friends and strangers for the sole purpose of receiving a benefit. You can’t insure your best friend’s engagement ring and then claim a benefit when it’s lost in the ocean during the honeymoon. Insurance contracts are contracts that involve only the chance of loss and no gain. Receiving a benefit without suffering a loss is contrary to all insurance contracts.

Use Insurify to find the right life insurance company with the best coverage to ensure the ones who need you will be able to continue to live the lives that you were always there to support. Answer a few basic questions, such as your age, your state of residence, and your desired benefit amount, and Insurify will provide you with a list of quotes for you to compare and choose from.

Updated August 24, 2021

Aissa Martell is a licensed insurance producer in the State of New York. She is a creative writer and has been freelance writing for five years. She’s happy to share her knowledge of the insurance industry and its products.