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Insurable Interest [Life Insurance Coverage Limitation]

insurable interest life insurance policy requirement

We put a picture of a large family as our featured image to emphasize the concept of insurable interest in the context of life insurance. If we look at this family, what would happen if either parent were to die? Maybe they both work or perhaps one parent stays at home to take care of the kids. Either way, if the primary wage earner died, the loss would be financial and emotional. The emotional loss is not necessarily quantifiable, but the financial loss is. That loss would be the “interest”.

The same holds true for a stay at home or work from home parent. If the parent who watches the kids all day were to die, who will take care of the kids? Even if a parent has no income, the value of their services in and around the home are an “interest”.

So with that in mind, let’s try and define insurable interest.

What is insurable interest?

First and foremost, what does insurable interest mean?We can break it down by looking at each word individually.

Insurable – insurable connotes the idea of being able to get insurance. In our case we are focusing on life insurance. To say someone is insurable is to say they are eligible to get insurance.

Interest – interest connotes the idea that there is some tangible right or claim to something of value. And value can be very subjective because what is one man’s trash is another man’s treasure.

So if we put this together, insurable interest would be someone who is eligible to get life insurance because another has a vested right or claim to some sort of value or benefit conferred from the insured to the beneficiary.

To put it another way, somebody (i.e. the beneficiary) gets some form of benefit (financial or otherwise) from the continued existence of somebody else (i.e. the insured), this is known as insurable interest.

If person B were to suffer a loss if person I got injured or died, insurable interest exists in the relationship between the B and I. As we’ve hinted, a financial benefit seems to be the most common example but it could be care or many other benefits.

Did you know?

You may be surprised to discover that you can’t just get as much life insurance as you want. There are limits to how much coverage you can get. The limits are pretty standard across the board from company to company. The companies use a multiple of income or income replacement multiplier to determine how much life insurance you can get.

Age Multiplier
Up to age 40 Up to 25X to 30X
41-50 Up to 20X
41-60 Up to 15X
61-65 Up to 10X
66-70 Up to 5X
71+ Individual Consideration

With life insurance, insurable interest forms the foundation of every policy because it suggests the insured person is valuable to the interest of the beneficiary of the policy.

Typically, the insured will secure a death benefit for their loved ones because they know income will have to be replaced and medical bills and funeral costs will need to be paid if they die.

In order to decide whether you need life insurance or not, this is a great way to find out because you assess what would happen to those who you love if you died vs if you continue living.

According to the laws available in all states, they suggest that everybody has insurable interest in the health (and therefore life) of themselves, anyone they rely on for financial (“pecuniary”) or other support, and anyone they are owed money that forms a legal obligation.

Why Is insurable interest Important?

We now know what insurable interest means, but why is it important in life insurance? In simple terms, we wouldn’t buy homeowner’s insurance for a house that belonged to somebody else.

That’s because there needs to be some form of insurable interest between the insured and the beneficiary.

Which is why on all potential life insurance policies, if no insurable interest exists, the policy is likely to be declined and some states even have laws against this practice.

Why? Because the insured would be more valuable to the beneficiary injured or even dead and this can lead to intentional harm, i.e. murder for life insurance money.

As we saw earlier, everybody naturally has an insurable interest in their own lives. Additionally, we have an insurable interest in the lives of dependents and spouses.

What if an Insurable Interest Goes Away?

At this point, we should note that situations change regularly so the insurable interest needs to be present at the time of the application. By law, all states now ask insurable interest to be present at the time of the initial life insurance application.

Even if life insurance policies manage to escape the rigorous reviewing process and go in force with no insurable interest, they will not be valid. Through the eyes of the law, the policy will be regarded as ‘null and void’ if no insurable interest existed because it went against public policy.

Although it sounds a little outlandish, these types of policies would encourage murder for profit. Before the laws and insurable interest was introduced to the market, it would be the case that people would take out policies with no insurable interest before then having the insured killed to reap the rewards soon after. Before graded benefits were added, family members with no insurable interest would also try to take out a policy on seriously ill relatives in order to receive the benefit soon after.

How Does Insurable Interest Apply?

In state law, the people who may or may not have insurable interest in an individual are separated into three main categories;

Blood or Marriage – Including husbands, wives, children (biological and adopted), siblings, grandparents, parents, and grandchildren; in most states, engaged couples will also be included in this list. However, there are some relatives who may NOT fall into the insurable interest category and this includes stepchildren, stepparents, nephews, nieces, cousins, uncles, aunts, and relatives through marriage. This being said, there are always exceptions to the rule.

Business Relationships – If there’s a financial dependency from one party to the next, insurable interest is said to exist. For example, the beneficiary should have a continued interest in the health and life of the insured; with business relationships, this is most commonly related to money. For example, business partners who invest equal amounts of money might want to have a buy sell funded with life insurance in place just in case one business partner was to pass away. As soon as one partner dies, the other loses half the investment as well as their help in keeping the business alive. In this scenario, there’s clearly insurable interest because they need each other for the viability of the business.

Creditors – Finally, the third category for insurable interest is creditors. Despite popular belief, creditors can actually open life insurance for their debtors as long as the debtor gives consent. Since the creditor will lose their debt and owed money if the debtor passed away, there’s insurable interest here. However, there are two main caveats to this type of insurance and we’ve address one already.

If the policy is to be opened, the debtor will need to give consent. Whether the insurance will deal with two companies, two people, or a combination of the two, the debtor will need to agree to the policy before it’s introduced. Secondly, the insurance coverage cannot exceed the value of the loan. Since the purpose of the policy is to cover the loan (or owed amount), the coverage will be limited to the extent of the debt.

We see this often when someone applies for life insurance for an SBA loan. The insurance is used as collateral for the loan. The life insurance is collaterally assigned to the lender, with the remaining balance going to the insured’s beneficiary of choice.  That way, if the insured dies, the lender gets back its share, with the remaining amount going to the insured’s beneficiary, avoiding unjust enrichment.

In all three of these scenarios, the insurance company will need to take great care in allowing a life insurance policy to be placed on the life of the insured. Whenever an application comes in, it’ll be the company’s responsibility to assess insurable interest.

If insurance companies do not show the right attention and allow a policy to be set up when it shouldn’t have been, the provider can actually be sued, so you can bet the comapny does its due diligence.

Finding the Right Life Insurance Policy

Nowadays, the life insurance market is more expansive than ever before. As well as the traditional providers with over 100 years of experience, there are some younger companies making waves.

Also, with hundreds of companies offering their own unique blend of coverage, there are hundreds of different life insurance policies to choose from. This can make the buying decision incredibly tough. Particularly when you consider the different life insurance riders you can add to the mix.

With this in mind, how are you supposed to know which policy to buy? While this is a tricky topic, we have some basics for you to consider today and it starts with your needs. Every year, people listen to the advice of their friends and family members and make their decision based on this. However, while opinions on the providers can be helpful for customer service reasons, the opinions on individual policies are useless if you don’t have the exact same needs as those giving the advice.

With life insurance, this is a personal experience so you’ll need to assess your needs before then finding the most appropriate policy for these needs. Once you do this, you can be sure it covers everything you need rather than molding your needs around a certain policy and making sacrifices. As we said, there are many combinations and we should look at this as a positive because it gives us a chance to meet our needs exactly.

With the policies themselves, they can be split loosely into two main categories; term life insurance (temporary) and whole life insurance (permanent).

Depending on what you’re looking for, they both have advantages and disadvantages.

With term life insurance policies, they can last for up to 30 years and the policy will remain in place as long as you keep paying the premiums.

If you’re just looking for a cheap life insurance policy to cover you as your kids go through the education system or while the mortgage is being paid, this is an ideal way to do it because the coverage will remain in place until the end of the term. As you get older, you might not need insurance so this temporary solution might be the one you need.

On the other hand, whole life insurance will cover you until death. Although initially more expensive, you’ll find policies that offer a guaranteed level premium which means you’ll pay the same now (at your current age and health) as in 40 years’ time. Simultaneously, you’ll be growing your policy’s cash value which can be used in retirement and you can also use this fund by taking out a life insurance loan.

Once you add in the riders, which add extra protection to your policy, you can get creative and ensure that every feature of your life is covered.

With convertible term life insurance, you can add riders that allow you to convert the policy into a permanent one at any time. If you expect to outlive the policy, you’d normally lose the coverage and all the money you’ve invested but, with the Return of Premium rider, you can have all your premiums returned once the policy comes to an end.

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