Life insurance is intended to assist your family or other loved ones in coping financially with your passing and preserving their standard of living in the absence of your income. There is a legal requirement that you have an “insurable interest” in the person you want to purchase a life insurance policy on since someone is paid in the case of an insured person’s death.
Insurable interest in life insurance refers to the possibility that you would suffer loss, either material or psychological, in the event that the covered person passed away. We’ll delve more into what insurable interest is, when it applies to life insurance policies, when it doesn’t, and how to establish it.
Key Takeaways
- To purchase life insurance for someone else, you must have an insurable interest.
You have a general, insurable interest in your own life by default. - You have an interest in the insured person’s life beyond the term of the insurance; this interest may be financial or emotional.
- A legal or blood connection with the person whose life you wish to insure is frequently required.
- After the policy is issued, insurable interest does not need to be kept up in order for the death benefit to be paid.
What Is Insurable Interest in Life Insurance?
All types of insurance must have an insurable interest, which is typically your financial stake in the covered person or item.
1 For instance, you can purchase auto insurance that would pay to repair damage from an accident because you could lose money if something were to happen to your automobile.
When you get life insurance, the policyholder (the person who bought the policy) chooses the beneficiaries who will receive the death benefit if you pass away. When a person has an insurable interest, the policyholder stands to gain more from their continued existence than from their demise.
Your interest in your own life is seen as infinite and insurable. Therefore, you are free to purchase life insurance for yourself and designate whatever beneficiaries you choose. However, you must demonstrate that an insurable interest exists if you want to purchase life insurance for another person.
Because of their emotional dependence on you as well as the fact that they may depend on your income or other family contributions, your spouse and children, for instance, are likely to have an insurable interest in your continued existence (and vice versa).
Others might have insurance-able interests solely for financial reasons. A person who has an insurable interest in your life could be your business partner or, in some situations, your boss. They would be fully responsible for managing the company or hiring a replacement if you were to pass away suddenly.
A person must have an “insurable interest” in the insured in order to acquire life insurance. This means that if the covered individual passes away suddenly, the policyholder—the person who holds the policy and designates the beneficiary or beneficiaries—will incur a financial loss.
It’s crucial to remember that the beneficiary is not required to be a part of this connection; just the policyholder and the insured must be. It’s not necessary for beneficiaries to have an insurable stake in the insured (see our previous blog post). An insurable interest can occur in a variety of circumstances, including:
An employer or business partner (if identified as “important personnel”) – A spouse or family member – An ex-spouse who is financially reliant
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Each of these situations involves a policyholder who has a financial or emotional “interest” in the health of the insured. If the existence of an insurable interest were not a prerequisite for purchasing life insurance, strangers could literally gamble with other people’s lives. A policyholder with little to no stake in the insured person’s life would be tempted to hurt them in order to collect an early death payment.
Any type of insurance, including life insurance, must have an insurable interest as a condition. The policy is void if there is not enough of an insurable interest between the policyholder and the insured.
A life insurance policy without insurable interest is considered a “wager” against the life of the insured, according to the Supreme Court of the United States in Warnock v. Davis, which established the legal precedent for insurable interest. Davis, 104 U.S. 775; Warnock v.
Numerous state legislation also contains clauses that specifically define what an “insurable interest” is. For instance, the California Insurance Code 10110. defines an insurable interest as “a substantial interest engendered by love and affection in… individuals closely related by blood or law,” or “a reasonable expectation of pecuniary advantage through the continued life, health, or bodily safety” of the insured.
Many investors look for ways to get around the requirement of having an insurable interest in the insured. They accomplish this by making a deal with a person to pay all of the premiums on the person’s policy on themselves, with the understanding that, in a few years, the investor will become the policy’s owner. Because insurable interests are determined at the time of the first purchase, this avoids the requirement for an insurable interest. In determining whether these measures are legal, courts differ widely.
When Must Insurable Interest Exist?
You must demonstrate to the life insurance company that you have an insurable interest in the individual being insured if you wish to get a life insurance policy.
Your application will be examined by your insurance provider, and it can be rejected if no insurable interest is discovered. When you buy a life insurance policy on someone else’s life, your main worry is proving insurable interest.
However, once coverage starts and the agreement is in place, insurable interest is no longer required. To put it another way, neither the policyholder nor any beneficiaries must hold onto an insurable interest in order to receive the proceeds of a life insurance policy. Consider a husband and wife who eventually get divorced. When married, a couple has an insurable interest in one another, which means either spouse could purchase life insurance on the other, designating themselves as the beneficiary.
Let’s say the wife buys such insurance while they are still married, and the husband passes away years after their divorce. Though the terms of their divorce settlement did not contain any clauses that may alter this, the ex-wife may continue to receive the death benefit even if she no longer has an insurable interest in her ex-husband.
Life Insurance Without an Insurable Interest
There are other situations where the owner of a life insurance policy does not have an insurable interest in the person covered by that policy, aside from events like divorce. The decision to sell a life insurance policy through a life settlement or a viatical settlement is one of the most frequent ones.
In either scenario, the owner of a permanent life insurance policy (often an elderly or terminally sick individual) sells the policy to a life settlement or viatical firm in exchange for a lump sum payment. The policy transfers ownership to the buyer. They carry on making premium payments and will receive the death benefit in the event that the covered individual passes away.
Stranger-oriented life insurance is a different category of coverage held by a person without an insurable interest (STOLI).
The fact that STOLI plans are bought for the benefit of a “stranger,” or someone the insured doesn’t know, sets them apart from those sold in life or viatical settlements.
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