What is Insurance Interest in Life Insurance – Its Importance, Working and Eligibility
Insurable interest forms the foundation of any type of insurance policy, establishing a link between the insured and policyholder. It can either be an object or an individual, the loss of which will result in financial or any other kind of hardship for the insured. A policyholder must purchase insurance on the object or entity for insurable interest to be applicable.
Keep reading to learn about its importance, how it works, eligibility and more.
Why is an Insurable Interest Important?
If you have an insurable interest in something, that means you are significantly benefitting from its existence, and you will experience great loss or hardship from its absence.
By law, you must own the object or have a legit relationship with the entity to have an insurable interest in it. Furthermore, you should have an insurable interest in that entity or individual to get an insurance policy on it.
Just to clarify, you cannot purchase an insurance policy for your neighbour’s property. That will create something known as a “moral hazard”. To explain this, let’s say that you insured your neighbour’s property while having a strong incentive to destroy or damage it.
In this case, an illegal insurance policy will financially help you to rebuild that property even though you didn’t have any financial share in it or own it. This is why an insurable interest is fundamental to an insurance policy.
How Does Insurable Interest Work?
Insurance is a legal and financial contract between a policyholder and a policy provider. Insurable interest is one of the primary principles on which insurance is made.
To have an insurance policy drafted for any entity, living or non-living, you need to have ownership of it, fully or partially. For example, your employer can purchase insurance for you as you are an important asset to that organisation. If you get sick or face untimely death due to any reason, your employer will incur significant loss and difficulty filling in your vacancy.
It is mandatory for an insurance agency to scrutinise before vouchsafing an insurance policy. Each company has their investigation team to talk with the applicant and nominee to confirm its legitimacy.
They further investigate their relationship to find out if the insurance is valid as per their relationship or not. It aids an insurance company in identifying frauds and claims.
What is Insurable Interest in Life Insurance?
There may be plenty of options available from life insurance companies, but you can only purchase a life insurance policy for some. There must exist an insurable interest. To explain it further, in order to take out an insurance policy, the policyholder must have an interest in the life of the insured.
Additionally, if the beneficiary mentioned in the policy is not the policyholder, then the beneficiary must have an insurable interest in the life of the insured.
Who is Eligible to Have Insurable Interest in Life Insurance?
It is not permissible to take out an insurance policy on just anyone. Here are some examples of who is eligible to have an insurable interest in life insurance:
- Your Family Members/Dependants: Your family members, also called “dependants”, are eligible for insurable interest in life insurance. Your spouse, parents, children, and anyone else who has a legal relationship and is financially dependent on you are eligible, as they will face financial difficulty in your absence.
The death benefit received from your policy will help them carry on with their lives and fulfil their responsibilities. - Your Employer: Your employer can also have an insurable interest in you. As an employee, your absence can cause significant loss to your employer. Hence, he can purchase life insurance for you.
Your employer pays the premiums, and in case of your demise, he receives the sum assured, which he can use to cover any monetary loss arising due to your absence. - Your Financer: If you have taken out a loan, your creditor can take out a life insurance policy along with your consent. In this case, the sum assured cannot be higher than the debt amount.
How Important is It to Show Insurable Interest in Life Insurance?
When you are purchasing life insurance, a valid proof of insurable interest is required during application. The principle of insurable interest was introduced to safeguard the interest of a life insurance policy and ensure that it is being used properly.
This is a non-negotiable aspect of the life insurance policy. A policy is considered void without an insurable interest. A policyholder mandatorily has to prove that he has an insurable interest at the time of application, and this needs to be proved at the time of settling the claim as well.
A life insurance company will verify this aspect by talking to the policyholder, beneficiary and insured. They will also investigate the relationship as presented by the applicant to see if there is an insurable interest.
If there is no valid clause regarding the relationship, the application will be rejected, or the death benefit will not be available.
What Are the Requirements of Insurable Interest?
An insurance company will verify the people you have an insurable interest in prior to confirming your insurance application. They have various methods to verify. They can –
- Ask them for official identity proof
- Go through a medical examination
- Give an interview over phone
When Does Insurable Interest Exist in a Life Insurance Policy?
First of all, you can have an insurable interest in your own life. Therefore, you can always take out a life insurance policy on yourself. In such cases, you will be the insured as well as the policyholder. Also, the beneficiaries will not need to prove that they have an insurable interest in you as it is presumed headfirst that you will name people who want you to have a long and healthy life.
Additionally, this term is also applicable for your direct dependents, i.e., your blood relationships. This includes:
- Husband and wife
- Parents and grandparents
- Children (including adoption)
- Brother and sister
These are examples of where insurable interest undoubtedly exists. However, apart from these, there can be relationships eligible for insurable interest, such as employee-employer, creditor-debtor and business partners.
What is the Principle of Insurance Interest?
Unlike many other investment instruments, insurance policies are not a means to accumulate wealth over a long period. It is rather used as a financial safeguarding tool for a situation like accidental loss of someone, which can cause financial hardships.
Hence, the policy owner should have an endowed interest, primarily a financial tie, with the object or person insured.
Getting insurance should only be valid if there is a legitimate, rational relationship with the entity covered under the policy. Further, there should be a moral relevance with the subject matter of the insurance in the life of the person availing insurance. These all sum up the final fact that insurable interest is the most vital aspect for an insurance policy to exist.
Final Word
The presence of insurable interest is one of the fundamental principles of insurance policies. The person who is purchasing the policy needs to have an insurable interest in the insured person. This aspect also helps insurance companies prevent insurance fraud.
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FAQs
Ans: A moral hazard is when an individual with an existing insurance policy is incentivised to cause damage or loss in order to gain from the insurance. For example, an individual with health insurance seeking more expensive treatment that they wouldn’t require otherwise is a situation of moral hazard.
Ans: The Principle of Indemnity states that policies should be designed in such a way that it covers the said loss rather than rewarding or penalising the policyholder. This principle aims to minimise errors and poor planning for insurance policies and to avoid moral hazards.
Ans: To have an insurable interest in something means you own it, and you will suffer great loss from its damage or wreckage. Therefore, tenants cannot have an insurable interest in the building they reside in, but the owner can.
Ans: An insurable interest will not exist for the following blood relationships unless there is proof of financial dependence:
• Cousins
• Nieces and nephews
• Uncle and aunt
• Stepparents and stepchildren
Ans: No, you cannot claim an insurable interest without the said person’s consent. This is to prevent strangers from claiming other people’s assets or properties illegally when they decease.
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Disclaimer: This article has been prepared on the basis of internal data, publicly available information and other sources believed to be reliable. The information contained in this article is for general purposes only and not a complete disclosure of every material fact. It should not be construed as investment advice to any party. The article does not warrant the completeness or accuracy of the information, and disclaims all liabilities, losses and damages arising out of the use of this information. Readers shall be fully liable/responsible for any decision taken on the basis of this article.
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