Insurable interest

Insurable interest exists when an insured person derives a financial or other kind of benefit from the continuous existence, without repairment or damage, of the insured object (or in the case of a person, their continued survival). A person has an insurable interest in something when loss of or damage to that thing would cause the person to suffer a financial or other kind of loss. Normally, insurable interest is established by ownership, possession, or direct relationship. For example, people have insurable interests in their own homes and vehicles, but not in their neighbors' homes and vehicles, and almost certainly not those of strangers.

The "factual expectancy test" and "legal interest test" are the two major concepts of insurable interest.[1]

Historical background

The concept of insurable interest as a prerequisite for the purchase of insurance distanced the insurance business from gambling, thereby enhancing the industry's reputation and leading to greater acceptance of the insurance industry. The United Kingdom was a leader in that trend by passing legislation that prohibited insurance contracts if no insurable interest could be proven. Notably the Marine Insurance Act 1745 (which introduced the concept of an insurable interest, although it did not use the term expressly), the Life Assurance Act 1774 which renders such life insurance contracts illegal, and the Marine Insurance Act 1906, s.4 which renders such contracts void.

In 1806 Lord Eldon LC sitting in English House of Lords in Lucena v Craufurd (1806) 2 Bos & PNR 269 sought to define an insurable interest, and although that definition is often used, modern commentators regard it as unsatisfactory.[2] Lord Eldon defined it as "a right in property, or a right derivable out of some contract about the property, which in either case may be lost upon some contingency affecting the possession or enjoyment of the party".[3]

Life insurance

Insurable interest refers to the right of property to be insured.[4][5] It may also mean the interest of a beneficiary of a life insurance policy to prove need for the proceeds, called the "insurable interest doctrine".[5] Specifically, insurable interest is:

  • An interest based upon a reasonable expectation of pecuniary advantage through the continued life, health and bodily safety of another person, and, consequently, loss by reason of their death or disability; or
  • A substantial interest engendered by love and affection if closely related by blood or by law.
    — Society of Actuaries [6]

Insurable interest is no longer strictly an element of life insurance contracts under modern law. Exceptions include viatication agreements and charitable donations.[6]

The principle of insurable interest on life insurance is that a person or organization can obtain an insurance policy on the life of another person if the person or organization obtaining the insurance values the life of the insured more than the amount of the policy. In this way, insurance can compensate for loss. A company may have an insurable interest in a President/CEO or other employee with special knowledge and skills. A creditor has an insurable interest in the life of a debtor, up to the amount of the loan. A person who is financially dependent on a second person has an insurable interest in the life of that second person.

Legal guidelines have been established in many jurisdictions which establish the kinds of family relationships for which an insurable interest exists. The insurable interest of family members is assumed to be emotional as well as financial. The law allows insurable interest on the presumption that a personal connection makes the family member more valuable alive than dead. Thus, husbands/wives have an insurable interest in their spouse, and children have an insurable interest in their parents (and vice versa). Brothers/sisters and grandchildren/grandparents are also assumed to have an insurable interest in the lives of those relatives. But cousins, nieces/nephews, aunts/uncles, stepchildren/stepparents and in-laws cannot buy insurance on the lives of others related by these connections.[7] However in life insurance relationships are more looked into than the pecuniary value that one holds against the other, because without an immediate family or a relationship that is recognized by law there is no insurable interest.

Law in the United Kingdom

A person is presumed to have an insurable interest in his or her own life,[8] preferring to be alive and in good health rather than being sick, injured or dead. The unlimited interest extends to the life of spouses (and, since 2004, civil partners), even if there is no financial dependency.[9]

Law in the United Kingdom does not recognize other classes of so-called 'natural affection' however, thus:

  • Parents have no interest in the lives of their children
  • Siblings have no interest in the lives of their fellow siblings
  • Children have no interest in the lives of their parents (Scotland only)[10]

Nor is insurable interest recognized for cohabiting couples. Although many insurers will accept such policies, they could potentially be invalidated because they have not been tested in court. In recent years, there have been moves to pass clear statutory provisions in this regard, which have not yet borne fruit.[11]

In practice these problems are solved by people assigning their policies or placing them in trust with named beneficiaries. If a person obtains an insurance policy on their own life, it is presumed that the person would only name a beneficiary who wants the insured to be alive and healthy. There is no requirement that the beneficiary have a proven insurable interest in the life of the insured when the insured has purchased the insurance.[7]

In 2008, the Scottish Law Commission and the Law Commission of England and Wales tentatively proposed some reforms to the existing law, hoping to clarify the complex rules. Their preliminary recommendations included increasing the category of 'natural affection' to include dependent children and parents and also cohabitees. Officially this is still under review.[12]

Credit default swaps

In eConned, Yves Smith argues that credit default swaps were/are used to take out insurance-like contracts against financial products in which buyers had no insurable interest. This was related to the financial crisis of 2008 because hedge funds and others allegedly helped produce bad subprime mortgages on purpose so that they could buy insurance on them, and then profit when the home buyers failed to make payments.[13]

See also

References
  1. Kimball-Stanley A. (2008). Insurance and Credit Default Swaps: Should Like Things Be Treated Alike Archived 2014-07-30 at the Wayback Machine. CONNECTICUT INSURANCE LAW JOURNAL.
  2. Marine Insurance Legislation. Informa Law. p. 321. ISBN 9781315816678. Retrieved 22 June 2015.
  3. "Insurable Interest and the Doctrine of Privity of Contract". Law Explorer. 23 April 2016. Retrieved 29 June 2018.
  4. The Free Dictionary definition of Insurable interest, citing cases at 1 Burr. 489. See 20 Pick. 259; 1 Pet. 163. Accessed June 18, 2009.
  5. Anthony Steuer, Questions and Answers on Life Insurance: The Life Insurance Toolbook, p. 310 (Anthony Steuer, 2007) ISBN 978-1-58348-470-8 found at Google Books. Accessed June 18, 2009.
  6. Kevin Oldani, You Bet Your Life: Insurable Interest in Life Insurance, found at Society of Actuaries website Archived 2010-08-21 at the Wayback Machine, citing Life Assurance Act (England 1774). Accessed June 18, 2009.
  7. "The Insurable Interest in a Life Insurance Policy". Life Insurance Law. Free Advice. 1995–2009. Retrieved 2009-02-11.
  8. Griffiths v. Fleming [1909] 1 KB 805; M'Farlane v. Royal London Friendly Society (1886) 2 TLR 755
  9. Griffiths v. Fleming [1909] 1 KB 805; Married Women's Property Act 1882, section 11.
  10. "Law Commission Insurance Contract Law" (PDF). Archived from the original (PDF) on 2008-07-25. Retrieved 2010-11-26.
  11. Report on Family Law; Cohabitation, s. XVI Archived 2007-09-27 at the Wayback Machine, Scottish Law Commission.
  12. "Legal basis of insurance: insurable interest". General Insurance Manual. HM Revenue and Customs. 16 August 2016.
  13. EConned, by Yves Smith, 2010, Palgrave Macmillan, p 243, and entire chapter Heart of Darkness
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