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What is Insurable Interest in Life Insurance?
Insurable interest is defined as having a reasonable expectation that you’d suffer a financial loss if the event you’re trying to insure against occurs. In terms of life insurance, it means that you would financially suffer if the person who’s insured died.
Insurable interest is a legal requirement of life insurance and determines who you can buy a life insurance policy on—and who can take one out on you. Read on to learn who can legally have insurable interest and how this requirement works in life insurance.
Who needs insurable interest for life insurance?
For a life insurance policy to be legally binding, the policyowner must have an insurable interest in the life of the insured. In other words, the policyowner must reasonably expect to suffer financially if the insured person passes away.
Many people would expect that the beneficiary needs to have insurable interest as well, but this is only true if the policyowner and the beneficiary are the same person. To help explain why, let’s review who’s involved in a life insurance policy.
People involved in a life insurance policy
In a life insurance policy, there are three roles that people can fill: insured person, beneficiary, and policyowner.
Insured person: this is the person whose life expectancy determines the policy’s premiums. When the insured passes away, the insurance company pays out a death benefit.
Beneficiary: this is the person or people indicated in the policy who will receive the death benefit when the insured person dies.
Policyowner: this is the person who is responsible for paying the premiums to keep the policy in force. This person also has the right to choose beneficiaries, change coverage, sell the policy, or cancel the life insurance altogether.
The same person can fill some of these roles. If you take out a life insurance policy on yourself to protect your family, you’re filling both the insured and the policyowner positions. If you take life insurance out on your spouse, however, you’d be both the policyowner and the beneficiary.
In many types of insurance, it’s common for the same person to fill all roles. Take individual disability income insurance. Typically, you’d buy the policy on yourself and received the payouts if you become disabled. But in life insurance, the insured person can’t also be the beneficiary. There must be at least two people (or a person and a trust) involved.
Examples of insurable interest in life insurance
There are four common scenarios where insurable interest may exist:
- You (the policyowner) want to buy coverage for yourself (the insured). There’s an obvious insurable interest here since you’d experience the ultimate loss if you died.
- You may also have insurable interest in your spouse and children, since you may have to pay for funeral expenses, income replacement, and time off from work to grieve.
- A business owner has an insurable interest in a partner or key employee. If one of these associates were to pass away, it could put the business in jeopardy or cost time and money for the company to recover.
- A lender has an insurable interest in the life of a debtor; If the debtor passes away without leaving much of an estate behind, the lender may never receive repayment.
Do you have an insurable interest?
The above examples aren’t all the possible instances of insurable interest. If you’re not sure about your situation, speak with your insurance agent. And remember: the purpose of the insurable interest rule is to prevent one person from taking out a life insurance policy on another person for profit. So, if your situation doesn’t involve profiting from someone’s death, you may be able to make a case for insurable interest.
If you’re ready to buy life insurance on someone you have an insurable interest in, check out the best life insurance companies. Or, if you prefer to look at some numbers, compare rates from multiple insurers in just a few minutes.
A life settlement is when a policyowner sells a life insurance policy to an investor, and it’s a perfectly legal transaction, even if the new policyowner has no insurable interest in the life of the insured. That’s because insurable interest must exist only when the policyowner first applies for coverage. Insurable interest isn’t necessary throughout the life of the policy or when the insured person dies.
Stranger-oriented life insurance (STOLI) is illegal. STOLI is when someone attempts to buy a new life insurance policy on a stranger as an investment. Because there’s no insurable interest at the time of purchase, STOLIs are illegal. This rule prevents a situation where an investor might hope for a shorter lifespan of another human being for the sake of profit.