Insurable interest is when you (or a group) have an economic interest in another person’s life or the continuance of a legal entity (such as a company, or organization) or asset. Insurable interest also exists when you have an interest in another person based on love and affection, providing that there is a blood or legal relationship involved, such as through family or marriage.
Definition and Examples of Insurable Interest
Insurance companies use insurable interest to determine whether you or anyone else should be allowed to take out an insurance policy. For example, the policy could be on a car, a house, or someone’s life. If someone without an insurable interest were granted an insurance policy on something they didn’t own or a person they didn’t care about it, the destruction of that thing or person could benefit them financially.
Since this could lead to the intentional destruction of property or even murder, insurers require that you have an interest in maintaining the item or life of whatever is being insured.
The owner of an insurance policy gets to name the beneficiaries—the party that will receive payment if the item is damaged or if the person is injured or dies.
Common Examples of Insurable Interest
There are a number of instances in which you might have an insurable interest in a thing or person in your life. These include insurable interests in
- Property: If you have a car,a home, a boat, jewelry, or any other piece of property that you have a financial interest in, you have an insurable interest in that property. In other words, if it were damaged or destroyed, you would suffer a loss—and insurance can help offset or eliminate that loss by reimbursing the costs of repairs or replacement. A property-casualty insurance policy, such as a homeowners insurance policy, would be used in this case to provide the necessary financial protection.
- Family members: If you are married, for example, and depend upon the income of your spouse to make ends meet, then you have an insurable interest in your spouse. Life insurance can be used to offset the financial loss that would result if your spouse dies prematurely. And, of course, the same goes for you: Life insurance could compensate your spouse if you were to die prematurely. Most life insurance companies will issue coverage for any family member who has a financial interest in any other member, such as a parent, sibling, child, spouse, special needs adult child, or grandchild.
- Employees: If the operations or profitability of your business depend largely upon a single employee or group of employees, insurance could lessen the loss should something happen to them. Your company might decide to purchase life and/or disability insurance policies on a key employee or key employees. This would then allow your company to meet its financial obligations until the insured person(s) have been replaced. A large corporation may take out a large policy on its CEO and board of directors for this reason.
- Yourself: You are naturally considered to have an unlimited insurable interest in yourself, and so you can take out an insurance policy on your own life and name whoever you choose as the beneficiary. For example, if you want to leave an inheritance for your children, you can take out a life insurance policy to accomplish that.
Life insurance death benefits are almost always tax-free to beneficiaries.
How Does Insurable Interest Work?
Insurable interest in this sense has nothing to do with earning interest as you might do with a bank account or fixed-income security. Consider whether you would suffer financially from the loss of someone or something in your life or if you’d lose money from a piece of property being damaged. If you would, then you might have an insurable interest in that person’s, group’s, or thing’s continued existence. And that interest can be protected with life and/or disability insurance, or property insurance.
A Common Requirement
All life insurance companies require the prospective owner to prove insurable interest before issuing a policy.
Insurable interest is required in insurance contracts because it prevents people from gaining money from the loss of something to which they have no relation. For example, you cannot buy a car insurance policy on your neighbor’s car if you notice that they are a bad or reckless driver. You also cannot take out a life insurance policy on a stranger.
One-Time Approval for Life Insurance
Insurable interest only needs to exist when a life insurance policy is initially issued. It does not have to continue once the policy is in force. For example, a husband who takes out a policy on his wife and names himself as the beneficiary can prove insurable interest at the time of application. But if they get divorced and he remains the beneficiary, he will still get the death benefit if his ex-wife dies (and the policy hasn’t lapsed).
For property insurance, however, such as an auto insurance policy, insurable interest needs to exist both when the policy is purchased and when any loss occurs.
- All insurance policies require that there be an insurable interest in the person or object being insured in order to be legal and valid.
- Life and disability insurance are commonly used to protect insurable interest in people while property and casualty insurance may be used to protect tangible objects or intangible entities, such as a business.
- Insurable interest for life insurance is required when the policy is issued, but not when the insured person dies.
- Insurable interest discourages people from betting on the life of a person (or object) and trying to profit from their (or its) untimely demise.