Life insurance is an important financial tool designed to protect you and your family, but understanding the insurable interest requirement can be complicated. According to most life insurance policies, you must have an insurable interest in the insured person before taking out a policy on them.
This means that if there’s no risk of financial loss for you should something happen to the insured person—as is often the case with strangers or acquaintances—you will not be allowed to purchase a policy for him or her.
In this post, we’ll explore what qualifies as sufficient insurable interest when it comes to life insurance, including how circumstances may change over time and who can benefit from a particular policy. Read on for more detailed information about this essential concept.
What Is Insurable Interest in Life Insurance Policy?
Insurable interest in a life insurance policy is the legally recognized relationship between an insured and his or her beneficiary. Essentially, it means that the person named as the beneficiary must have a financial interest/stake in the insured’s life for the policy to be valid.
This type of interest can be established through ownership of property, large sums of money, or any other significant asset which could lead to loss should anything happen to the insured.
The term “insurable interest” comes from contract law and is used to establish a legal link between the owner of an insurance policy and the beneficiary who is listed on that policy. In most cases, insurable interests are recognized by state law but they may also be included in the language of some life insurance policies.
For instance, your family and partner would likely benefit from having the assurance of you continuing to live (and the same applies in reverse). Not only because of the emotional connection, but also if they depend on your income or other family contributions.
In some cases, organizations such as your business partner or even employer might have an insurable interest in you for financial gain. Others may just be looking to protect their economic investments.
In the event of an unexpected passing, your loved ones will be faced with the financial responsibility of managing or transferring the business. This can be a difficult decision for those closest to you, so it’s essential to take steps now to protect them from future loss.
When Must Insurable Interest Exist?
To procure a life insurance policy, you must demonstrate that the individual being insured has an insurable interest to you.
Your insurance provider will inspect your application, and if lacking an insurable interest, it could be rejected. When you acquire a life insurance policy for someone else’s life, establishing an insurable interest is the primary concern.
Once the coverage and agreement come into effect, there is no longer any need for insurable interest. Typically, no person involved in a life insurance policy–whether it is the policyholder or beneficiary–must possess an insurable interest to receive life insurance payouts.
Let’s look at a married couple who eventually separates. During the marriage, both parties have an insurance interest in each other and can acquire life insurance policies on the opposite party with themselves as beneficiaries.
What if the wife bought a life insurance policy while married and years later, her ex-husband passed away. Even if the ex-wife no longer has any insurable interest in her former spouse, she still can collect the death benefit so long as their divorce settlement didn’t include details that might revoke this.
Carefully read your policy to ascertain if it includes language that defines a beneficiary’s right to collect the proceeds in cases such as divorce.
Lack of Insurable Interest in Life Insurance
When it comes to life insurance coverage, insurable interest is a critical requirement. To obtain a life insurance policy, the insured must have an insurable interest in the person whose life is being insured. A policy cannot be issued if there is no connection between the two parties that would justify an insurance arrangement.
Insurable interest exists when an individual stands to benefit financially from another’s continued existence or suffers some financial loss due to their death (for example, spouses and/or children). It also encompasses business relationships where one party has a vested financial interest in the other’s life—such as business partners who share ownership of a company or debtors with outstanding loans from the deceased person.
Aside from divorce, there are additional cases where the policyholder of a life insurance plan does not have an insurable interest in their intended beneficiary. Selling a life insurance policy through a viatical or life settlement is one of the most popular financial strategies available.
Whether it’s an elderly or a terminally ill person, anyone who holds a permanent life insurance policy has the opportunity to sell their policy for a one-time payment to companies specializing in viatical and life settlements. Once the buyer acquires the policy, they assume responsibility for continuing to pay premiums. Upon the death of the insured person, they will be entitled to receive any applicable life insurance proceeds.
Stranger-oriented life insurance (STOLI) is another type of policy that can be owned by an individual without any insurable interest. Unlike policies related to life or viatical settlements, STOLI policies are bought with the intention of benefiting a stranger who is unfamiliar with the insured.
STOLI investors often tempt seniors or their family members to buy life insurance for the sole purpose of reselling it once activated. These policies have no relation to the insured individual, but instead are acquired as a benefit for unrelated third-party investors. Not only can this practice run afoul of ethical considerations, it may also lead to costly legal issues that could potentially invalidate the policy long after its inception.
How to Prove Insurable Interest
After submitting your life insurance application, the insurer will conduct a thorough review to ascertain if you have an insurable interest in the insured or require additional research. Depending on the insurance provider and your relationship with the insured, it may be necessary to demonstrate a legitimate insurable interest.
For family members such as a spouse or children, insurable interest is typically not questioned. Nevertheless, when it comes to business partners safeguarding each other or creditors purchasing policies on debtors, insurance companies may need to examine the relationship more thoroughly in order to establish insurable interest.
To ensure insurable interest, an insurance company might request interviews with the involved parties and require identification documents. If you can’t provide sufficient evidence of your stake in the insured matter, your application could be denied by insurers.
Additionally, some states have their own regulations that restrict an individual’s ability to purchase life insurance for another person. Therefore, you should check state laws before submitting your application to ensure it meets all requirements. In some cases, you may need a court order or other proof of legal authority in connection with the policyholder’s estate to demonstrate insurable interest.
Ultimately, if you can’t prove the existence of an insurable interest between yourself and the insured, it is unlikely that any insurer will issue a policy. That being said, having an insurable interest is necessary for the approval of most types of life insurance policies. As such, there are important steps you must take when applying for coverage in order to prove your insurable interest.
Be sure to contact your life insurance provider with any questions you may have about the application process and what is needed to show an insurable interest. Doing so can ensure a smooth, successful purchase of life insurance for yourself or a loved one.
Pro Tip: You can also speak to your financial advisor or tax planner to get more information on when insurable interest must exist in life insurance policies. With their help, you can make the best decision for your personal situation and avoid any potential repercussions down the line.
Examples of Insurable Interest in Life Insurance
Insurable interest in life insurance is necessary for anyone who wants to purchase a policy. There are several examples of situations where an individual has a valid insurable interest and can purchase a policy:
- Spouses: A husband or wife has an automatically insurable interest in their partner’s life. This means that either spouse can purchase a policy on the life of the other, so long as they keep up with payments and remain an insured party.
- Business Owners and Co-Owners: When two or more individuals form a business together, each partner may have an insurable interest in the life of one other if all partners agree to it. This helps protect each partner’s financial interests should one of them pass away.
- Parents and Children: If a child has a disability or illness that may require financial assistance in the future, the parent can take out a life insurance policy on the child to help provide for those needs should they pass away. Similarly, parents can also purchase policies on their own lives to ensure that their children are taken care of even after they’re gone.
It is important to understand that insurable interest must exist in life insurance policies in order for them to be valid. As such, the insured person must have a financial stake in the outcome of the policy. This ensures that there are no conflicts of interest between the two parties involved and helps prevent fraud or abuse. Additionally, you should note that the insurable interest requirement applies to both permanent and term life insurance policies.