What Is An Insurable Interest In Life Insurance? - Forbes

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Life insurance can provide valuable financial protection for your loved ones. But not just anyone can buy a life insurance policy on someone else. One important concept you’ll encounter when buying life insurance is “insurable interest.” Here’s what that means and how it affects your life insurance options.

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What Is an Insurable Interest?

An insurable interest is an important and required component when someone is buying a life insurance policy, says Tanya Taylor, a CPA and founder and CEO of Grow Your Wealth. ”It means that a person would encounter financial hardship if the insured died,” she explains.

Without an insurable interest, a person cannot purchase a life insurance policy on another person. Additionally, you must have consent from someone before you purchase life insurance on them, even if you clearly have an insurable interest.

Taylor says that immediate family members such as a spouse, children or even aging parents would usually automatically qualify since they may rely on you financially. However, someone outside of your family, such as a business partner, would need to show additional documentation and obtain your consent before purchasing a policy on you.

Examples of Insurable Interest

Taylor provides two scenarios in which insurable interest can be established.

1. You and your spouse have young children and own a home. If either of you were to die, it could create financial hardship for the surviving spouse and children. Therefore, you both have an insurable interest in each other and can purchase life insurance for the other person.

2. You are a partner in a small business. Each business partner can purchase life insurance on the other so that they can fund the ongoing operation of the business if one partner dies.

Related: The right life insurance for a business partner’s death

An example that does not demonstrate insurable interest

Here’s a scenario in which insurable interest cannot be established without additional proof.

Your neighbor wants to take out a life insurance policy on you so that when you die they will receive the payout. Unless there is more to the story and your neighbor can prove your death would cause them financial hardship, they do not have an insurable interest and will not be able to buy a policy on your life, with or without your consent.

Why Is Insurable Interest Important?

One of the main benefits of life insurance is to provide financial protection for survivors who may suffer if the insured dies. “Insurance companies use insurable interest as their protection to prevent fraud and intentional illegal acts,” Taylor says.

If this feature didn’t exist in an insurance policy, anyone could purchase a policy on someone else with ill intent. So, for example, a doctor could purchase insurance on a patient with a serious illness and be less inclined to treat them properly since they’d receive a large sum of money if they died.

How Insurers Prevent Insurable Interest from Being Abused

“Insurance is designed to cover losses, not enrich beyond the actual loss itself,” says Shane Canfield, CEO of WAEPA, a non-profit that provides life insurance for federal civilian employees. This, he explains, is the principle behind the concept of indemnification, or compensation for harm or loss. It’s a fundamental difference between insurance and gambling.

That’s why rules dictate that a person can’t take out a life insurance policy on an acquaintance or stranger, as there is no financial impact from the insured’s death. If that were not the case, buying life insurance would be more like gambling and encourage fraud.

Life insurance companies have specific rules built into their policies that define insurable interest. “This has developed over the years by practice and according to public policy and laws in each state,” Canfield says. Typically, the parties involved fill out a form and make an attestation that the facts are true. “For large policies, there may need to be a notary or other legal representation verifying the information,” he adds.

The general rule is that for certain insurable interests, the person being insured is required to provide consent and sign the insurance authorization form and provide identification. If there’s questionable insurable interest, the life insurance company will ask more questions and require additional documentation to determine the relationship. If the responses to the questions are not satisfactory to the insurance company, it will deny the policy.