Insurable Interest [2023]

Insurable interest is important when it comes to insuring property and belongings because it protects people from taking out insurance policies on things they do not own, lease, or have a claim to.

Insurable interest also covers your right to ensure your property. This is because if you have a stake in the value of the items you own or the properties you invest in, you’re more likely to want to keep them safe.

This guide covers everything you need to know about insurable interest, what it is, and examples of insurable interest in the real world. You’ll most likely hear about insurable interest when you buy life insurance for someone else, but interest on insurance can apply to other types of policies.

What is insurable interest?

If you have an insurable interest in an item, it means that you own it or part of it. If the item were to become damaged or lost, you would suffer financial loss or hardship as a result.

Insurable interest is established by possession or direct relationship with the item or person of value.

For example, homeowners have an insurable interest in their homes and the items inside of them, and vehicle owners have an insurable interest in their cars. A lack of insurable interest creates a moral hazard, which may incentivize you to allow or cause harm to claim the financial benefit.

Moral Hazard Defined

A moral hazard in the insurance world is the assumption that if an individual is incentivized to engage in risky behavior concerning an asset or investment, they will. Further, if someone has limited responsibility for the rest of the item, it is also referred to as a moral hazard.

For example, taking out an insurance policy on a home you don’t own is a moral hazard. You may be tempted to burn down the house and recover the insurance claim money as you.

A moral hazard is created when someone can take careless action without being held liable. So in the example where you do not own the home, you have no stake in the investment. Having a stake in an investment property or item is generally what prevents people from taking malicious or careless action concerning it.

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What You Need to Know About Insurable Interest

Understanding insurable interest relies on two core ideas:

• The principle is that the person taking out an insurance policy on the property or item of value needs to own the item to have a verifiable and insurable interest
• Insurable interest exists to mediate risky behavior concerning investments

You’ll often hear insurable interest come up concerning investment properties and the principle of indemnity in the insurance world.

How is the principle of indemnity relevant to insurable interest?

The principle of indemnity is a required clause for any insurance policy. It states that insurance companies can only compensate the policy owner for the loss incurred.

This is to ensure that no one profits from making an insurance claim. Instead, they are justly restored to the same financial condition they were in before their loss.

In terms of insurable interest, the principle of indemnity is another way to prevent moral hazard. If policyholders could potentially be compensated more than they lost, this may incentivize them to engage in risky behavior concerning the insured items or property.

Examples of Insurable Interest in the Real World

To define insurable interest, you can look at relationships and investments where people have a reasonable amount of stake.

Insurable interest concerning life insurance is an important circumstance to consider because the real-world implications have resulted in many statutes and precedents that changed the insurance world for the better.

Insurable Interest Life Insurance

For most types of life insurance, insurable interest is possible with individuals who have a reasonable interest in your life.

Some common examples include:

• Your parents
• Your spouse
• Your children or grandchildren
• Yourself

Each of these parties will likely have an insurable interest in your life if they have a relationship with you. Proving this insurable interest may involve an interview or spending time describing the nature of your relationship with the insurer.

Do you need insurance interest for life insurance policies?

Yes, insurable interest for life insurance is required for both the insurance policy owner and the person being insured.

While it is possible to take out life insurance for someone else, it is illegal for someone to purchase life insurance for a person they do not have any insurable interest. This would create a moral hazard.

Can I take out a life insurance policy on just anyone?

You can’t take out a life insurance policy on anyone because you would not have an insurable interest in someone you don’t have a relationship with.

This is critical to know when you consider how to buy life insurance properly.

Taking out any insurance policy when you do not have an insurable interest is illegal. It creates a moral hazard where people may be incentivized to bring harm to the investment, also known as insurance fraud.

For a life insurance policy to be legal and valid, both the owner and the insured party need to have an insurable interest in the insured person.

If you wanted to compensate someone who did not have a verifiable insurable interest in you, in case that harm came to your life, you would need to name them as a beneficiary.

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Insurable Interest Property Insurance

When you have an insurable interest in a property, you own the title to that property and would suffer a loss if it were to be destroyed.

Some examples where you would not have an insurable interest in property would include:

• If there is a tax lien on your house
• If you own a redeemable tax deed and the redemption period is not up
• If your family member owns a home and you reside in it
• If a close friend owns a property that you visit daily

Each of these may give you a unique interest in the house, but you would not be the person to suffer a loss if the house were destroyed or burned down.

Because of this, if you were to try and take out an insurance policy on the property, creating a moral hazard, it would be very risky for the insurance company. You would have to prove you would be at a financial loss if the property were lost or destroyed.

Case Studies: Insurable Interest

Case Study 1: Homeowner’s Insurable Interest

John is a homeowner who has purchased an insurance policy to protect his property. As the owner of the house, John has a clear insurable interest in it. If the house were to be damaged or destroyed, John would suffer a significant financial loss.

Having recognized the importance of insurable interest, John took the necessary steps to safeguard his investment and ensure his peace of mind.

Case Study 2: Business Owner’s Insurable Interest

Sarah is a small business owner who runs a bakery. She understands the importance of insurable interest in protecting her business assets. Sarah has insured her bakery equipment, inventory, and property to mitigate the financial risks associated with potential damages or losses.

By recognizing her insurable interest, Sarah has taken proactive measures to safeguard her business and ensure its continuity.

Case Study 3: Parent’s Insurable Interest in Child’s Life

Mark and Lisa are parents who want to secure their child’s financial future in case of any unfortunate events. They have purchased a life insurance policy on their child’s life, ensuring their insurable interest in their child’s well-being.

Mark and Lisa understand that the policy would provide financial support in the event of a tragedy, giving them peace of mind and protecting their child’s future.

Final Thoughts on Insurable Interest

Insurable interest exists to protect both the insurer and the insured. In combination with the principle of indemnity, this is how insurance companies prevent moral hazards and false insurance claims.

Ensuring that you have an insurable interest as a policy owner is a viable way to protect your investments while proving to the insurance company that you are not taking advantage of the coverage and are unlikely to file false or malicious claims.

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