When Must Insurable Interest Exist in a Life Insurance Policy?

Learn why you can’t take out life insurance on a stranger

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Life insurance is designed to help your family or loved ones overcome the financial burden of your death and maintain their quality of life without your income. And because someone gets paid in the event of an insured person’s death, there’s a legal requirement that you have an “insurable interest” in someone you want to buy a life insurance policy on. 

Insurable interest in life insurance refers to the fact you’d experience loss—either financial or emotional—if the insured person passes away. We’ll take a closer look at what insurable interest is, when it’s necessary for a life insurance policy, when it’s not, and how you can prove it.

Key Takeaways

  • You need to have an insurable interest to take out a life insurance policy on someone else.
  • You automatically have an unlimited insurable interest in your own life.
  • Insurable interest means you have an interest in the continuation of the life of the person who’s insured—it could be financial and/or emotional.
  • You often need to have a blood or legal relationship with someone whose life you’d like to insure.
  • Insurable interest does not need to be maintained after the policy is issued in order for the death benefit to be paid.

What Is Insurable Interest in Life Insurance?

Insurable interest is a requirement for all types of insurance and is, generally, the financial interest you have in something or someone that’s insured. For example, because you could lose money if something happens to your car, you can buy auto insurance that would pay to repair damage from an accident.

In life insurance, one or more beneficiaries gets paid a death benefit if you pass away, and the policyholder (the person who purchased the policy) gets to name the beneficiaries. Insurable interest means that the policyholder benefits more if the insured person stays alive than if they pass away. 

You are considered to have an unlimited insurable interest in your own life. Therefore, you can take out a life insurance policy on yourself and name whomever you’d like as beneficiaries. But if you want to take out a life insurance policy on someone else, you need to prove that an insurable interest exists. 

The insurable interest requirement in life insurance prevents someone from “betting” on a person’s life. It also eliminates the chance of an incentivized homicide by a stranger.

For example, your children and spouse most likely have an insurable interest in the continuation of your life (and vice versa)—not only because of the emotional relationship but also if they rely on your income or other household contributions.

Others may have insurable interests for economic reasons only. For instance, your business partner or, in some cases, your employer might have an insurable interest in your life. If you were to unexpectedly pass away, they would have the full financial responsibility of running the business or finding your replacement.

When Must Insurable Interest Exist?

If you want to purchase a life insurance policy, you’ll need to show the life insurance company that you have an insurable interest in the person being insured. Your insurance company will review your application, and if no insurable interest is found, your application could be denied. Proving insurable interest is primarily a concern when you’re purchasing a life insurance policy on someone else’s life. 

But once coverage begins and the contract is in place, insurable interest does not need to continue. In other words, neither the policyholder nor any beneficiaries need to maintain an insurable interest to collect life insurance proceeds. Take, for example, a husband and wife who later divorce. While married, both spouses have an insurable interest in one another, and either could buy an insurance policy on the other’s life and name themselves as the beneficiary. 

Suppose the wife purchases such a policy during the marriage, and the husband dies years after they divorce. The ex-wife can still collect the death benefit even if she no longer has an insurable interest in her ex-husband (as long as their divorce settlement didn’t include any provisions that might change this).

Read your policy thoroughly. It could include language that outlines whether or not a beneficiary can collect proceeds after events like divorce.

Life Insurance Without an Insurable Interest

In addition to incidents like divorce, there are other occasions when the owner of a life insurance policy does not have an insurable interest in the person insured by that policy. One of the most common is when someone decides to sell their life insurance policy via a life settlement or a viatical settlement

In either case, someone who owns a permanent life insurance policy (often an older or terminally ill person) sells the policy to a viatical or life settlement company in exchange for a lump-sum payment. The buyer becomes the new owner of the policy. They continue to pay the premiums and will collect the death benefit when the insured person passes away.

Another type of policy owned by someone without an insurable interest may be referred to as stranger-oriented life insurance (STOLI). STOLI policies differ from those sold in life or viatical settlements in that they’re purchased for the benefit of a “stranger,” or someone unknown to the insured.

It’s typically illegal to take out a life insurance policy on a stranger.

STOLI investors may approach seniors or their family members to encourage them to purchase life insurance for the purpose of selling it once it’s in force. The owners of these policies have no insurable interest in the person who’s insured. Instead, the policy is purchased as a benefit to third-party investors. Aside from ethical concerns, this can cause legal issues which may void the policy, even years after it’s been in force.

How Do You Prove Insurable Interest?

After completing your life insurance application, the insurance company reviews it. They will then decide if the owner of the policy has an insurable interest in the insured or if further investigation is necessary. Depending on your insurance company and your relationship with the insured, you may have to prove you have an insurable interest.

Family members like your spouse or children don’t generally raise alarms. But in cases of business partners insuring one another or a creditor insuring a debtor, the insurance company may want to take a closer look at the relationship to prove insurable interest. This could include an interview with the involved parties and requests for identification. If you can’t prove insurable interest, the insurance company could deny your application.

Ask your life insurance agent or company what documents, if any,  you’ll need in order to prove insurable interest.