Insurable Interest [2023]
Quick Facts
Insurable interest creates the foundation for insurance policies that connect the insured person or item to the owner of the policy
You have insurable interest if the loss or damage of that item would cause monetary harm to your life
A lack of insurable interest creates a moral hazard which may incentivize you to allow or cause loss to claim the financial benefit
Insurable interest is important when it comes to insuring property and belongings because it protects people from taking out insurance policies on things they do not own, lease, or have a claim to.
Insurable interest also covers your right to ensure your property. This is because if you have a stake in the value of the items you own or the properties you invest in, you’re more likely to want to keep them safe.
This guide covers everything you need to know about insurable interest, what it is, and examples of insurable interest in the real world. You’ll most likely hear about insurable interest when you buy life insurance for someone else, but interest on insurance can apply to other types of policies.
What is insurable interest?
If you have an insurable interest in an item, it means that you own it or part of it. If the item were to become damaged or lost, you would suffer financial loss or hardship as a result.
Insurable interest is established by possession or direct relationship with the item or person of value.
For example, homeowners have an insurable interest in their homes and the items inside of them, and vehicle owners have an insurable interest in their cars. A lack of insurable interest creates a moral hazard, which may incentivize you to allow or cause harm to claim the financial benefit.
Moral Hazard Defined
A moral hazard in the insurance world is the assumption that if an individual is incentivized to engage in risky behavior concerning an asset or investment, they will. Further, if someone has limited responsibility for the rest of the item, it is also referred to as a moral hazard.
For example, taking out an insurance policy on a home you don’t own is a moral hazard. You may be tempted to burn down the house and recover the insurance claim money as you.
A moral hazard is created when someone can take careless action without being held liable. So in the example where you do not own the home, you have no stake in the investment. Having a stake in an investment property or item is generally what prevents people from taking malicious or careless action concerning it.
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What You Need to Know About Insurable Interest
Understanding insurable interest relies on two core ideas:
The principle is that the person taking out an insurance policy on the property or item of value needs to own the item to have a verifiable and insurable interest
Insurable interest exists to mediate risky behavior concerning investments
You’ll often hear insurable interest come up concerning investment properties and the principle of indemnity in the insurance world.
How is the principle of indemnity relevant to insurable interest?
The principle of indemnity is a required clause for any insurance policy. It states that insurance companies can only compensate the policy owner for the loss incurred.
This is to ensure that no one profits from making an insurance claim. Instead, they are justly restored to the same financial condition they were in before their loss.
In terms of insurable interest, the principle of indemnity is another way to prevent moral hazard. If policyholders could potentially be compensated more than they lost, this may incentivize them to engage in risky behavior concerning the insured items or property.
Examples of Insurable Interest in the Real World
To define insurable interest, you can look at relationships and investments where people have a reasonable amount of stake.
Insurable interest concerning life insurance is an important circumstance to consider because the real-world implications have resulted in many statutes and precedents that changed the insurance world for the better.
Insurable Interest Life Insurance
For life insurance, insurable interest is possible with individuals who have a reasonable interest in your life.
Some common examples include:
Your parents
Your spouse
Your children or grandchildren
Yourself
Each of these parties will likely have an insurable interest in your life if they have a relationship with you. Proving this insurable interest may involve an interview or spending time describing the nature of your relationship with the insurer.
Do you need insurance interest for life insurance policies?
Yes, insurable interest for life insurance is required for both the insurance policy owner and the person being insured.
While it is possible to take out life insurance for someone else, it is illegal for someone to purchase life insurance on a person they do not have any insurable interest. This would create a moral hazard.
Can I take out a life insurance policy on just anyone?
You can’t take out a life insurance policy on anyone because you would not have an insurable interest in someone you don’t have a relationship with.
This is critical to know when you consider how to buy life insurance properly.
Taking out any insurance policy when you do not have an insurable interest is illegal. It creates a moral hazard where people may be incentivized to bring harm to the investment, also known as insurance fraud.
For a life insurance policy to be legal and valid, both the owner and the insured party need to have an insurable interest in the insured person.
If you wanted to compensate someone who did not have a verifiable insurable interest in you, in case that harm came to your life, you would need to name them as a beneficiary.
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Insurable Interest Property Insurance
When you have an insurable interest in a property, you own the title to that property and would suffer a loss if it were to be destroyed.
Some examples where you would not have an insurable interest in property would include:
If there is a tax lien on your house
If you own a redeemable tax deed and the redemption period is not up
If your family member owns a home and you reside in it
If a close friend owns a property that you visit daily
Each of these may give you a unique interest in the house, but you would not be the person to suffer a loss if the house were destroyed or burned down.
Because of this, if you were to try and take out an insurance policy on the property, creating a moral hazard, it would be very risky for the insurance company. You would have to prove you would be at a financial loss if the property were lost or destroyed.
Final Thoughts on Insurable Interest
Insurable interest exists to protect both the insurer and the insured. In combination with the principle of indemnity, this is how insurance companies prevent moral hazards and false insurance claims.
Ensuring that you have an insurable interest as a policy owner is a viable way to protect your investments while proving to the insurance company that you are not taking advantage of the coverage and are unlikely to file false or malicious claims.
Frequently Asked Questions
Who needs insurable interest?
For life insurance policies, the owner of the policy needs to have an insurable interest concerning the person insured.
In some cases, the policy owner and the beneficiary are different people, so the beneficiary would also need to have an insurable interest concerning the person insured.
What is an insurable interest in simple words?
Insurable interest is an investment that safeguards items, property, or people of value to you. When you have an insurable interest in an item, it means that you would incur a financial loss or hardship if the person were to die or the item were to be lost or damaged.
When must an insurable interest exist?
As soon as an insurance policy is purchased, insurable interest needs to be present. This is to prevent moral hazards from arising and to keep insurance policyholders from engaging in risky behavior concerning their investments.
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Rachael Brennan has been working in the insurance industry since 2006 when she began working as a licensed insurance representative for 21st Century Insurance, during which time she earned her Property and Casualty license in all 50 states.
After several years she expanded her insurance expertise, earning her license in Health and AD&D insurance as well. She has worked for small health in…
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Written by
Rachael Brennan
Licensed Insurance Agent
Benjamin Carr was a licensed insurance agent in Georgia and has two years’ experience in life, health, property and casualty coverage. He has worked with State Farm and other risk management firms. He is also a strategic writer and editor with a background in branding, marketing, and quality assurance. He has been in military newsrooms — literally on the frontline of journalism.
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Reviewed by
Benji Carr
Former Licensed Life Insurance Agent
