If you thought you could buy a life insurance policy on your neighbour and profit later if he dies, think again. Worse, what if a stranger bought a life insurance on you, and collected the benefits if you died?
A provision called insurable interest will prevent strangers from doing so. People buy life insurance for many reasons, mostly to protect their loved ones from going through a financial disaster if the breadwinner in the family dies. Life insurance was never meant to provide a lavish lifestyle for the heirs, it was meant to compensate the beneficiary for a financial loss due to a death. Let’s find out what insurable interest is when it comes to life insurance coverage.
What is Insurable Interest?
Insurable interest is a reason to buy life insurance on someone because you could suffer a financial loss if they die. To have a reason, you must first have some type of a relationship to the insured person. This means that you must value the insured’s life more than the money you would get from a life insurance policy if they die. You value them living rather than dying, because they mean something to you.
It is a required provision with all insurance companies, and the main reason it exists is to protect individuals from harmful acts. You can only have an insurable interest if you personally lose in the event of someone passing away. If there is no insurable interest, the life insurance policy is void.
It’s important to mention that insurable interest must only exist at the time of the application. For instance a wife could buy life insurance on her husband and if they get divorced she may still keep the policy. Since it’s obvious that a person has insurable interest on his/her own life, the beneficiaries of that policy do not need to have an insurable interest. The insurance company assumes that the policyholder will name his or her loved ones as the beneficiaries. For that reason a person can name anyone he or she wishes as the beneficiary of the policy.
Why Must Insurable Interest Exist?
It protects human life, and also prevents people from buying life insurance as a form of gambling on someone else’s death solely for financial gain. Imagine buying a 30-year term life insurance policy on your neighbor, paying the premium for 29 years, and he is still alive. Some people might be inclined to make sure the neighbor dies within the year so they can collect the money from the policy.
If there was no insurable interest, this type of crime would be out of control. Also, when you insure something, you actually don’t want to lose it, it’s a fair game for you and the insurance company since the interest is mutual. Why would someone insure something they don’t care about?
Because you don’t have a financial stake in it, you wouldn’t pay for your neighbor’s car or home insurance, right? This is the same reason why buying life insurance on someone whose death will not cause you any financial harm (since you are not dependent on their earnings) is void (and also illegal).
Who Can Have an Insurable Interest?
State laws determine that there are three different categories of which an insurable interest exists:
- Related by blood or marriage: wives, husbands and children have a reason to care and love each other, therefore it’s obvious that they have an insurable interest. Also, they may be dependent on your income for their existence.
- Business relationships: an employer can take key person life insurance on his or her key employees because they impose a financial risk to the company should they die. Partners may need a policy if there is a bank loan that you and your partner are responsible for – if one dies, the other will need to pay for it all by themself.
- Creditors are allowed to take a life policy on their debtors (of course, with the insured’s consent). The only exception is it must be up to the limit of the debt, nothing more.
The Bottom Line
Buying life insurance on yourself will always be possible without any issues (subject to the insurance company’s underwriting guidelines). The insurable interest issue will always be an issue if you buy a life insurance policy on someone else. If the person meets one of the 3 criterias above, you will not have any issues buying life insurance on them, as long as they know about it.
While the purpose of life insurance has always been to replace a loss due to death, the main idea has still remained that if a death does not create a financial burden, than no life insurance is needed. It’s up to the insurance company to determine if an insurable interest exists or not.
You can read more information here about the life insurance underwriting process.