Insurable interest is financial dependence that is based on the existence of something or someone. Only if you stand to lose financially – if someone or something no longer exists or is injured/ damaged – can you be considered to have an insurable interest. This ensures that persons do not gain from buying insurance on the lives or property of others.
• The role of pure risks
This principle arises because insurance covers pure risks only. Pure risks are those where a person suffers a loss when the event occurs and no loss if the event does not occur. Speculative risks involve potential gain. Insuring the life of someone on whom you are not financially dependent, or insuring an asset that does not belong to you (or on which you have no lien in any way), means that you will actually gain if the loss of that person or thing occurs.
Accordingly, all persons have an insurable interest in their own lives and property. With regard to life insurance, a person can purchase as much life insurance coverage as they want on their lives. This is because life insurance is a valued contract – one that compensates or provides a benefit instead of indemnifies. However, financial underwriting seeks to assess how much life insurance coverage a payee could afford.
• When insurable interest must exist
With life insurance, the insurable interest in the insured must be demonstrated at the time of application. Once a life insurance policy contract is issued, insurable interest is no longer relevant. This suggests that the beneficiary of a life policy does not have to provide evidence of insurable interest upon the death of the insured.
With general insurance (property, commercial lines, car or home) an insurable interest must exist at the time of application and at the time of loss. Suppose you own a home and purchase homeowners insurance for it. Insurable interest exists at that time. You sell that home to a friend, and the home subsequently gets damaged; the week after the sale is finalised. The homeowner’s insurance is in force, although it is in your name. Therefore, the insurer is not obligated to pay because insurable interest did not exist between the insured property and policy owner at the time of loss.
• Mandatory interest
Depending on the laws of a state or country, certain relationships – including family relationships- could be the basis of insurable interest. These relationships include parents, spouses, an entity (in the life of an employee or associate) or financial dependent. Even pecuniary interests can be covered under an Insurance Act or Law. Here it is evident that even for life insurance, blood relationship is not a pre-requisite for establishing insurable interest.
Apart from preventing speculation in the lives and property of other people, this insurance principle is vital in deterring illegal wagering. Emotional loss or close friendships are not relevant where insurable interest is concerned either. The principle is fair though: you have an insurable interest in all that is yours or affects you financially.