Life Insurance: What is an Insurable Interest?
When someone buys a life insurance policy, they must have some significant interest in the life they want to have insured by the policy. Obviously, they can buy their own policy. However, a spouse, a parent, or a business party also have legitimate legal interest to buy a life insurance policy on someone else. This is typically called having an “insurable interest.” In some states, a person who takes out a life insurance policy on themselves may only name someone with an insurable interest as a beneficiary. As society has changed, most state laws have changed to allow a person to name anyone they want to be the beneficiary of their life insurance policy. However, legal issues still cause life insurance benefits to be denied in many circumstances when individuals do not have an insurable interest.
Who has an insurable interest?
In modern American law, a person has an insurable interest in another person’s life when there is some degree of love and affection when they are closely related by blood or law, or for unrelated people, there must be a lawful and substantial economic interest in the continued life, health, or bodily safety of the person insured. As explained below, this applies to a person who buys a life insurance policy on someone else’s life, and in some states, it applies to who you may name as a beneficiary under your own policy.
The reason for the Insurable Interest Doctrine
Understanding how the concept of insurable interests works in life insurance requires a short look back at how the doctrine evolved. It can actually be traced back to insurance policies issued on ship in the 1700’s in England. People would buy what were called “gambling contracts” or “wagering contracts” on the ships back then, but the English Parliament passed a law in 1746 making it illegal to buy marine insurance policies unless someone had an actual financial interest in the ship that was insured. This same concept was extended to life insurance in 1774, so someone could not buy a life insurance policy on a person in whom they did not have some significant interest. Parliament did not want Englishmen gambling on each others lives. Although the United States obtained independence soon after that, it retained English law, and the insurable interest doctrine made its way from the law of the colonies to the law of the new American states.
In 1876, the United States Supreme Court solidified the concept of insurable interests in life insurance in the USA in a case called Connecticut Mutual Life Insurance Company v. Schaefer. The Court summed up the concept as follows: “The essential thing is, that the policy shall be obtained in good faith, and not for the purpose of speculating upon the hazard of a life in which the insured has no interest.”
The reason for the doctrine is rather straightforward – discouraging dishonesty, fraud, or inappropriate conduct in life insurance claims. Allowing someone to buy a life insurance policy on the life of someone they do not know or have an interest in that person continuing to live encourages people to take the life of someone else. While murder is extreme, many people in history haved killed someone else to get the life insurance benefits that came with the person’s death (this is also the reason for so-called “slayer statutes” that prevent someone from benefiting for a murder they commit).
Examples of why one person might legally buy life insurance on another
So what legitimate reason would someone have to take a life insurance policy out on another person? There are many possible examples, including:
- A parent buying term life insurance for a child as to pay for burial;
- A parent buying whole life insurance as an investment vehicle to pass on to the child in adulthood;
- A spouse buying life insurance on their spouse to insure a possible loss of income;
- An ex-spouse buying life insurance to insure alimony or child support obligations; and
- A business partner insuring the life of a another partner who is integral to the business (often called “key man insurance”).
All of these are examples of proper insurable interests.
Are there insurable interest problems with beneficiary designations?
Over the years, many states have had laws that prohibited a person from naming a beneficiary who did not have an insurable interest. This presented many problems, particularly as social habits surrounding marriage have changed. Depending upon the state and year the life insurance policy was purchased, any of the following could be invalid beneficiaries:
- The live-in girlfriend or boyfriend of the person buying the policy;
- A same-sex partner;
- An ex-spouse with no financial support obligation owed to them; or
- A roommate or friend.
It was particularly problematic with older insurance policies involving partners in the LGBT community. Although most states have changed this older laws to allow a person to name anyone they wish as a beneficiary, new laws may not apply to policies originally bought many years ago.
To have a valid life insurance policy, an insurable interest is required
Every state continues to have some type of insurable interest law. One should always confirm that a life insurance policy they are buying on the life of another person will be valid based upon their insurable interest. Similarly, it is a good idea to check beneficiary designations, particularly under older policies that may be governed by an older law to make sure they are valid as well.