Understanding Insurable Interest in Life Insurance
What do insurable interest and gravity have in common? Both are fundamental concepts that impact our lives daily, and yet we hardly think about either one. Gravity keeps your feet on the ground, and insurable interest underpins every insurance policy you’ve ever owned.
What is insurable interest?
So, what is insurable interest? It’s the concept that you must have a financial interest or risk of loss in whatever it is you are insuring. The purpose of your insurance coverage is to protect you against that potential for loss. You insure your home, because major damage to that home would cost you. You insure your health, because medical treatments for injuries and disease are expensive.
By comparison, damage to your neighbor’s home, car, or health wouldn’t impact you financially. Therefore, you do not have insurable interest in your neighbor or your neighbor’s stuff.
Insurable interest as a concept seems like common sense. Of course you need to have some risk of loss to justify the payment of insurance premiums. But insurable interest goes beyond common sense; it’s a legal requirement for any valid insurance policy. You cannot buy insurance on something or someone if you don’t have insurable interest.
If you did purchase a policy and the insurance company later determined insurable interest didn’t exist, the policy would be deemed void and unenforceable. Plus, you might get into legal trouble. State law generally views insurance without insurable interest as gambling and, potentially, criminal insurance fraud.
Insurable interest on life insurance
Insurable interest is a prerequisite for any form of insurance, but it has interesting implications with respect to life insurance. For one, insurance companies assume you have an insurable interest in your own life and wellbeing. For that reason, you can always initiate life insurance coverage on yourself. Interestingly, if you own the policy, you have the right to name any beneficiary you want. There’s no requirement to prove your beneficiaries have an insurable interest in you.
Insurable interest becomes an issue when a person or entity initiates life insurance coverage on someone else. For example, you might take out a life insurance policy on your spouse. Or, you are a CEO and your employer might want life insurance coverage on you. Both scenarios are straightforward: You clearly have insurable interest in your spouse’s life and your employer has an interest in your life.
But the lines get blurred quickly with other examples. What if your niece or a half-brother wants life insurance on you? How about an elderly neighbor who depends on you to buy her groceries? Or a cousin you haven’t seen in 20 years?
Now imagine taking out a $100,000 life insurance policy on a stranger. It sounds like the start of a movie plot, right? There is no insurable interest; the stranger’s death would only affect you in a positive way. You might even be tempted to end the stranger’s life prematurely to get your payout. This scenario is exactly why insurable interest is a legal requirement for insurance.
State-mandated insurable interest on life insurance
State law requires insurable interest on all life insurance policies, but it also goes one step further. Many states define which family, business, and creditor relationships are presumed to have insurable interest:
- Family relationships with presumed insurable interest include spouses, parents and children, grandparents, grandchildren, siblings, and sometimes, engaged couples. Go one branch wider on the family tree, however, and insurable interest disappears. Legally speaking, nieces, nephews, cousins, uncles, aunts, stepchildren, and stepparents do not have presumed insurable interest.
- Businesses can legally insure key leaders and officers within the organization, as well as business partners. A business relationship can have insurable interest even when a family relationship does not. For example, say your nephew is the COO in a business you own. The business has an insurable interest in your nephew, even if you, personally, do not.
- Lastly, creditors can insure debtors, as long as the debtor consents to the coverage.
It’s also generally illegal to initiate insurance without telling the person who’s being insured. In other words, if you want life insurance on your mom, she needs to know about it.
Real-world insurable interest examples
In 2019, Sun Life Assurance won a lawsuit against Wells Fargo over a $5 million life insurance policy taken out on a woman named Nancy Bergman. The policy was owned by a trust set up in Bergman’s name, and her grandson was the trustee and beneficiary of that trust. Premiums for that life insurance policy were funded by investors who did not know Bergman. This policy was part of a larger scheme involving $37 million in insurance coverage on elderly individuals.
Although Bergman’s grandson may have been able to prove insurable interest in his grandmother, the investors paying the premiums had no connection to her. The New Jersey Supreme Court ruled that no insurable interest existed and, therefore, no death benefit was payable.
Another case involved a Los Angeles couple that initiated life insurance on a client. In 2014, Peter and Jin Kim collected $1 million in life insurance benefits for their client who died of a terminal illness. Peter Kim, a licensed insurance agent, allegedly sold his wife two policies on the client, fraudulently listing her as niece of the insured. Separately, Jin Kim purchased another policy on the client, identifying herself as the insured’s sister. None of these life insurance applications disclosed that the insured had been diagnosed with a terminal illness. And, the insured himself knew nothing of these policies.
The Kims lied about Jin Kim’s relationship to the client because they were trying to establish insurable interest. While they initially got away with it, the scam caught up to them. They were arrested in 2018 on three felony counts of grand theft and three felony counts of insurance fraud.
Proving insurable interest
When you apply for life insurance on someone else, the insurer should take steps to verify that insurable interest exists, and that the insured has consented to the coverage. You’ll provide documentation of your identity, and you and the insured may be interviewed by the insurance company. If the insurer concludes that insurable interest does not exist, the policy will not be accepted. Even if the policy is accepted initially, there’s a chance the insurance company could later question the presence of insurable interest. As in the Bergman case, a policy can be voided after the fact for a lack of insurable interest.
Getting around the insurable interest requirement
In real life, you may have good reason for wanting to establish insurable interest in someone who is not a close relative or a key business associate. As a first step, review the life insurance statutes in your state. These will specify when the insured’s consent is required, plus any relationships that have presumed insurable interest. Know that if your relationship with the person you want to insure falls outside of state law, you’ll have a tough time getting that coverage.
Even so, you can get around the question of insurable interest. You can simply ask the other person to initiate the life insurance policy and name you as the beneficiary. As noted, state law and insurance companies assume individuals have insurable interest in their own lives, so this strategy would be legal and the policy would be valid.
Wrapping up insurable interest
Insurable interest underpins all insurance coverage, but it’s critical with respect to life insurance. In that context, insurable interest exists when you are financially benefiting from the insured’s ongoing health and safety. Said another way, you are at risk of financial loss if the insured were to pass away. Life insurance coverage protects you against that loss.
Initiating life insurance on someone else without insurable interest is illegal. These laws are in place to protect public safety, essentially by prohibiting individuals from profiting on the death of strangers. The law assumes there isn’t any reasonable rationale for initiating life insurance on someone you don’t know.
The boundaries are less clear, however, with respect to once-removed family members like nieces, nephews, aunts, and uncles. In these situations, it’s best to rely on presumed self-interest. Your aunt, for example, can always take out her own life insurance policy and name any beneficiary she wants. If you are truly justified in having insurance on your aunt’s life, ask her to purchase the insurance and name you as her beneficiary. That’ll keep you in the good graces of your insurance company and your state’s legal system.
Insurable interest generally isn’t questioned with close family members. You can take out life insurance on your spouse, your kids, your grandparents, and your siblings, for example. Those closer relationships are assumed to meet the insurable interest test.
You may have a scenario that falls outside the norm or isn’t well addressed by state insurance law. Remember when we said insurable interest was like gravity? You wouldn’t pick a fight with gravity, and you shouldn’t rally against the concept of insurable interest, either. Instead, talk through your situation with a financial advisor. An advisor can counsel you on the feasibility of establishing insurable interest when it isn’t obvious. But more importantly, an advisor can also help you explore other ways to protect your legitimate interest in that individual.