Life Insurance Rules: How to Prove Insurable Interest
Not only can you purchase a life insurance policy for yourself, but you can also purchase one for just about anyone else – provided you have an insurable interest in that person.
Insurable interest isn’t a term most consumers are remotely familiar with.
But, it’s one that’s foundational within the insurance industry.
Without an insurable interest, you’ll be unable to purchase life insurance on another person for your own benefit.
Even if you don’t know what it is or what it means, rest assured life insurance companies routinely evaluate insurable interest during the application underwriting process.
Unless it can be clearly established, the policy won’t be approved.
What is an Insurable Interest?
For there to be an insurable interest, and to have the right to purchase life insurance on another person, it must be evident that the person’s death would cause you to suffer a loss.
The most obvious form of loss is financial.
It’s not the only criteria.
The topic doesn’t come up much between insurance agents and consumers because the basic nature of life insurance typically has a built-in insurable interest from the start.
For example, you automatically have an insurable interest if you take a policy on the life of your spouse or your children.
The death of either would result in a loss, emotional certainly, but financially as well in most cases.
The most obvious example is taking a life insurance policy on one of the household breadwinners.
If one spouse or partner is dependent on the other’s income for survival, the dependent spouse has an automatic insurable interest in the life of the breadwinner – even if that dependent has his or her own source of income.
Extended family member
Insurable interest isn’t always limited just to purchasing a policy for yourself for the benefit of another person, or on someone else for your own benefit.
Insurable interest exists if you purchase life insurance on a person who provides financial support, direct care, or some other benefit to a third party.
For example, let’s say an extended family member is caring for your elderly parents. You can take a life insurance policy on the extended family member for the benefit of your parents.
It won’t matter that you are not the direct beneficiary of the policy, an insurable interest is still evident.
In such a situation, you have an insurable interest in the life of the extended family member because his or her death would require you to seek alternative means of caring for your parents.
The Purpose of an Insurable Interest Requirement
Insurable interest is required to prevent someone from purchasing life insurance on a person whose death would not result in a loss to the policyholder.
For example, someone might purchase a life insurance policy on an acquaintance or even a complete stranger solely for the purpose of financially benefiting from that person’s death.
The situation will be even more pronounced if that person is in poor health or leads a high-risk lifestyle.
No loss of tangible benefit
The only reason for purchasing such a policy will be purely to gain from that person’s death, not to cover the loss of any tangible benefit.
If such a limitation didn’t exist, it’s possible millions of people would purchase life insurance policies on random people as a get rich quick scheme.
It would create a vested interest in the death of the insured by the policyholder.
The insurable interest requirement denies individuals the ability to profit from the death of another.
Establishing an Insurable Interest
Even if the applicant is unaware it’s happening, the insurance company will investigate to determine insurable interest.
They’ll be specifically interested in the relationship between the policyholder and the insured party.
If none is found, the application will be denied.
Individual life insurance
Typically, an insurable interest is automatically established by marriage or family relationship.
It’s presumed to exist between spouses, children (both natural and adopted), siblings, grandparents, and grandchildren.
In each case, even if there is not a direct financial loss as a result of the insured’s death, there is an emotional loss.
Obviously, anyone who is dependent on your income – or if you are dependent on the income of another – that’s also evidence of an insurable interest.
It’s even possible – and not uncommon – to establish an insurable interest with an ex-spouse.
If there are children of the marriage, and both former spouses provide for them either financially or with direct care, that represents an insurable interest.
You can therefore take a life insurance policy on an ex-spouse.
After all, should that person die, you’ll bear the cost of providing for caring for the children of the marriage out of your own resources.
Other common areas of insurable interest include employees, business partners and credit arrangements.
Key person life insurance
A small business may have a single employee, or a small number of employees of which one or two are considered crucial to the survival of the business.
The business owner may purchase what’s known as key person life insurance on that employee.
The insurable interest exists because the death of the employee could cause significant financial impairment to the business.
By purchasing life insurance on that employee, the business owner will be gaining the resources to survive the transition during which a replacement employee is found.
Even a large employer may take a key person life insurance policy on an important employee.
These can include company officers, or employees in critical roles, like high production sales people or technical employees with specialized skills.
Business life insurance
And insurable interest is also very common among business partners.
In a closely held business, say one with four partners, each owner will have an insurable interest in the life of the other three partners.
That’s because if one were to die, the business would be financially impaired.
Credit life insurance
Still another example is creditors.
A lender may take a life insurance policy on the debtor because an insurable interest exists by virtue of the fact the creditor would be financially impaired by the death of the debtor and the subsequent non-payment of the debt.
When an Insurable Interest Doesn’t Exist
Even though insurable interest is typically established by blood, marriage, or financial considerations, there are certain exclusions.
For example, extended relatives, like cousins, nieces, nephews, aunts and uncles do not represent an insurable interests unless there is evidence of financial dependence on that person’s resources, or you are somehow providing financial support to that person and taking a policy on your own life for the benefit of that person.
The same is true of friends and other non-relatives.
For example, even if you are caring for a terminally ill friend, you would not have an insurable interest because there will be no financial loss upon that person’s death.
Even in the case of an eligible relative, an insurable interest isn’t necessarily automatic.
For example, if you wanted to take a policy on an elderly grandparent who hasn’t consented to the policy, the insurable interest may be declared invalid. It’s possible the grandparent is refusing permission out of fear you may be taking the policy simply to profit from his or her death. Absent the grandparent’s consent, you would not be able to purchase the policy.
Absence of insurable interest
If for some reason a life insurance policy is approved absent an insurable interest, the insurance company can deny paying the death benefit upon the death of the insured, claiming insurance fraud.
Since the beneficiary of the policy hasn’t sustained a loss due to the death of the insured, no insurable interest exists, and payment of the claim can be denied.
Purchasing life insurance without an insurable interest is a rare occurrence.
But it does happen and is sometimes referred to as “secret life insurance policies”, because the insured is completely unaware the policies exist.
Fortunately, the whole concept of insurable interest is closely monitored by the insurance industry.
There are a number of safeguards each company uses to prevent the practice.
These include requiring the consent of the insured in cases where the interest isn’t obvious, as well as a medical exam on that person. If the insured refuses to provide either signed consent or submitting to a medical exam, the application will be declined.
There are rare situations where a secret life insurance policy is successfully purchased, but it often involves the buyer of the policy forging the signature of the insured as well as other documents.
Such cases represent clear cases of insurance fraud and are subject to prosecution that can result in fines and jail time.
Obviously, the insurance companies take the issue of insurable interest very seriously.