Email FacebookTwitterMenu burgerClose thin

What Is Insurable Interest in Life Insurance?

Share
Insurable Interest

In life insurance, insurable interest refers to what level of loss you’d experience should a specific person become incapacitated or die. It’s important because it helps prevent insurance fraud. If you aren’t sure whether you have insurable interest in someone, this article will cover what insurable interest is, how to prove it and examples of when insurable interest does and does not exist.

Do you have questions about insurance planning? Speak with a financial advisor today.

What Is Insurable Interest?

Because insurance is designed to protect you against the potential for loss, you must have a stake in losing a person. Therefore, insurable interest is the risk of losing whomever you are seeking to insure. You will be asked to prove insurable interest or financial dependency on a person before having the insurance policy approved.

People purchase life insurance for several reasons. Spouses might purchase life insurance on each other to protect themselves from financial struggles in case one dies prematurely. Another common scenario is purchasing life insurance on a business partner because the business would be severely impacted in the vent of the person’s death.

In both examples, the surviving spouse and business partner had insurable interest in the life of the deceased. In other words, they both would have experienced significant financial hardship if the insured were to die. People can’t take out life insurance policies on just anyone. Instead, they must benefit financially or otherwise from the insured being alive.

Establishing Insurable Interest

Insurable Interest

The insurance company and its underwriting staff are responsible for proving insurable interest, and to do so they will seek information about the prospective policy owner, the beneficiary and the insured. The company will ask questions regarding the insured’s relationship to the policy owner and beneficiary and decide if there is an insurable interest. If the insurance company does not find insurable interest, then the application will be denied.

As in the example above, a company can take out a life insurance policy on one of its employees. This is particularly common for executive-level employees. Spouses, business partners, top-tier employees and immediate family members can often easily prove insurable interest. Several relationships automatically guarantee insurable interest:

  • Businesses can insure key employees: Key employees are often considered executives, such as CEOs and presidents, business partners and sometimes board members.
  • Immediate family members can insure each other: Family members that get presumed insurable interest are parents, grandparents, children, siblings and sometimes engaged couples.
  • Creditors can insure debtors: Provided a debtor consents to the coverage, a creditor can sometimes insure his or her life. This is common in large business deals such as franchising and other major loan scenarios.

When Insurable Interest Doesn’t Exist

However, some situations aren’t proven as easily. For example, a distant family member might find it more difficult to prove that he or she has insurable interest in a relative. An example of someone who does not automatically have insurable interest and may need to prove it would be a more distant relative of someone who financially cares for the person.

Another example of insurable interest not existing is if someone were to try to buy a life insurance policy on a stranger. While it sounds peculiar, it happens relatively often even though it is impossible to prove insurable interest on someone you do not know. These scenarios do happen and are the reason that insurable interest exists. Insurance companies use insurable interest to prevent insurance fraud.

You always need someone’s consent to buy life insurance on them. While the lines between insurable interest existing or not may be blurry, you must have someone’s consent because most life insurance companies will need to do a medical exam on them as well as ask them questions confirming the relationship between the insured and the policy owner.

Bottom Line

Insurable Interest

Insurable interest is when a person or business would suffer from the loss of a person. In life insurance, it is important to prove insurable interest to protect both the insured as well as the insurer from insurance fraud. A person must prove insurable interest in the application process by proving their relationship to the insured. This can be harder in some cases than others, so it is important to document the relationship well if you are looking to insure someone outside of your family or that you do not have a direct business relationship with. It is illegal to take out a life insurance policy on someone without their knowledge.

Life Insurance Tips

  • If you need more guidance, a financial advisor can help you plan for a life insurance policy. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
  • One quick way to get a good idea of whether you need life insurance and how much you may need is with SmartAsset’s insurance calculator. Also, check out life insurance quotes to find a policy that fits your budget.

Photo credit: ©iStock.com/kate_sept2004, ©iStock.com/FatCamera, ©iStock.com/Gajus

load more callback