Insurance: Understanding the Basics of Insurable Interest

In order to have a valid insurance contract, the owner of the insurance policy must have an insurable interest in the life of the insured.  By definition, you automatically have an insurable interest in your own life because you are financially responsible for you.  Unfortunately when it comes to other people, your insurable interest may not be clear.

Why Do We Need Insurable Interest in Insurance?

Insurable interest is an important concept in insurance.  If we did not have an insurable interest requirement in insurance, anyone could purchase an insurance policy on your life, in the form of life insurance, or on your health, in the form of health insurance, for example.  A criminal might purchase a life insurance policy on your life if insurance companies did not require insurable interest when an insurance contract is written.  Besides criminal activity, insurance companies require an insurable interest in the life or health of the insured because it prevents individuals from profiting from the purchase of an insurance policy.  For example, what if I decided to buy 500, $20,000 life insurance policies on different individuals for a total premium of $12,000 per year?  Why would I purchase so many individual life insurance policies? I have decided to bet that one of the insureds will die within this year.  If one death occurs, I will earn an $8,000 profit.  My intentions would not be illegal, but my behavior is clearly unethical.  Therefore, as a matter of public safety and public decency, we must establish an insurable interest at the time of policy approval.

Examples of Insurable Interest

Again, you will always have an insurable interest in your life and health.  If you are legally married, you will also have an insurable interest in the life of your spouse.  Furthermore, you will also have an insurable interest in any children or incompetent persons that you are legally responsible for.

If you run a business, as a business owner, you have an insurable interest in the lives and health of your employees.  Some employers choose to offer their employees’ group insurance options such as group life insurance and group health insurance.

Some business partners decide to write insurance on one another; however, I suggest you see a lawyer before setting up these insurance arrangements, whether it is life insurance or disability insurance.  There are other situations where you might be able to establish an insurance interest.  For example, church members may want to write life insurance on their Pastor.  But, they should seek legal counsel and an insurance agent if the lines of insurable interest become murky.

Analysis

Insurable interest must be established when an insurance contract is formed.  By establishing insurable interest, the insurance company can feel confident that the owner of the insurance contract did not buy the insurance policy to make a quick profit.  The owner of the insurance contract must have a financial stake in the insured, outside of just paying the insurance premium.