If you’re shopping around for life insurance you’ve likely come across the term “insurable interest,” and have wondered what it means, and why you need it. While the term might sound complicated, its application is actually fairly intuitive.
What is Insurable Interest?
Insurable interest is simply defined as the level of hardship (financial dependency and otherwise) a person will suffer from the loss of something or someone they have insured. In the case of life insurance, it refers to the potential needs the beneficiary will require from the financial loss of the insured person. It it helps, you can think of it as a question: “Do I have a reasonable interest in insuring this person’s life?” The term interest here refers to necessity or motivation, and has no relation to traditional banking or accruing of wealth.
Insurable interest exists to prevent the moral hazard individuals have from taking out insurance policies for the wrong reasons. General insurance is meant to ease the distress of a unexpected events, and it’s not intended to be used as a means to bet on, or profit on insurance proceeds from the unfortunate circumstances of others. For instance you’re not allowed to get insurance on your neighbor’s car just because you think they’re a bad driver. Similarly, you’re not allowed to get insurance on your neighbor Betty just because she’s 85.
Examples of Insurable Interest
When it comes to life insurance, family members (by blood relation or marriage) are usually considered to constitute interest (considered they are immediate). Some commonly accepted examples are:
- Husband or wife (including former spouses)
- Engaged couples
- Children and grandchildren
- Other financial dependents
- Aging parents
- Special needs adult children
Certain other kinds of relatives like cousins, nieces, etc. are not automatically assumed to be eligible, however life insurance companies are typically understanding of unusual circumstances. As long as you can prove financial dependency or hardship, you shouldn’t have any trouble with insurance laws.
In certain cases, businesses and business partners can also claim insurable interest. For instance, a business can insure their CEO, an estate can insure an individual in whom they have a vested interest, and you can insure an individual whose debt obligations will net you a financial loss upon their passing. However it’s important to note: insuring another adult requires their consent, and you cannot get a life insurance policy without the permission of the insured.
When is insurable interest required?
Insurance interest is a basic requirement needed to make any life insurance contract valid. While this was not always the case, modern law has evolved to create protections for the insurance industry against persons betting on the lives of others. Insurance laws are strict and any life insurance policy or contract considered lacking in insurable interest are both invalid and illegal. However, this shouldn’t be a problem for most people, as the insured are typically their loved ones.
It’s worth noting that you are always considered to have an interest in yourself, so you’re always allowed to buy your own policy and name whatever beneficiaries you wish. However, in practice most insurance companies exercise the same level discretion in determining insurable interest for beneficiaries as they do policyholders, and will reject those they don’t consider eligible.
Proving insurable interest typically isn’t required for children and spouses, as their interest is apparent. For other situations, you need to submit a case to demonstrate the financial interest of the beneficiary. Examples include if you’re the last remaining relative of an individual or plan to cover an individual’s funeral costs that may be expensive.
It’s also worth noting interest is only required at the time the policy is taken out. If you name a spouse as a beneficiary of your policy and then divorce 5 years later, they are still recipients of your death benefit until you change your beneficiaries.
So if you have questions about whether you have insurable interest, reach out to one of the many top rated providers or brokers (chances are you’re good). Life insurance is designed to protect you and your loved ones, and professionals like ourselves and others are always on standby to help.