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Insurable interest meaning
The meaning of insurable interest in general insurance explains that the subject matter of insurance must have the ability to provide some financial gains to the insured, that is, it must possess financial value. If there is a loss of the subject matter due to theft, fire, damage, etc., it has to result in a financial loss. In other words, the insured (either an individual or business) has an insurable interest in the subject matter of insurance when the damage or loss brings about a financial loss.
What is insurable interest in insurance?
Insurable interest in insurance means the right for a policyholder to insure life or property which arises from a financial relationship between the insurer and the insured. In other words, it refers to the legal right to insure life or property. It can also be defined as the interest of an individual or a business in obtaining insurance cover for life or property.
For you to have an insurable interest, it is necessary to buy an insurance policy that will protect yourself or your property. Here, the insurance policy will reduce the risk of loss if a loss or damage occurs. It is necessary for the subject matter to be insurable.
The principle of insurable interest is an important factor that makes the issuance of a policy to be easy thereby making the event and entity legal. Furthermore, this explains that it is not possible to obtain insurance cover without being subject to the risk of financial loss.
In essence, if there is no insurable interest in the subject matter of insurance, the policy will not be a legal contract. It will therefore not be enforceable. So if one does not suffer a financial loss from the damage or loss of property, he does not have an insurable interest. Therefore, a party must own property to have an insurable interest in it.
The principle of insurable interest works hand-in-hand with the principle of indemnity. Indemnity requires the insurer to compensate the insured in an event of a loss. If insurance policies are poorly organized, this may bring about moral hazards and a financial loss to an insurance company.
The principles of insurable interest
The following are a few principles of insurable interest;
- Theoretically, more should be payable than the amount of actual loss.
- There should be no question of loss or indemnity arising if the policyholder does not have a pecuniary interest in the subject matter of insurance.
- If the loss or damage will not bring about a financial loss, one cannot insure the property.
- If the policyholder does not have such pecuniary interest in the subject matter of insurance, the insurance policy is null and void.
- Any individual that would suffer from the loss or damage of a property has an insurable interest in that property.
The policy must not bring about a moral hazard whereby the policyholder would have the financial incentive to allow or even cause a loss.
Therefore, an insurable interest must be definite, capable of valuation, be legally valid and binding, involve the loss of a legal right, and involve legal liability.
Insurable interest examples
An example of insurable interest is a policyholder buying property insurance for their own house but not for their neighbor’s house. The person does not have an insurable interest in any financial loss arising from damage to their neighbor’s house. Thus, the principle of insurable interest is based on no moral hazards in a policy. A moral hazard occurs when a policyholder has an incentive to cause damage to the property and claim insurance.
The following could be examples of insurable interest;
Property owners have an insurable interest to the extent of full value.
Part owners or joint owners
Part or joint owners have an insurable interest in their property to the extent of their part or financial interest. They are interested in the property they are insuring.
The mortgagor is the owner of the property who has an insurable interest in his property. Although the mortgagee is not the owner of the property, he has an insurable interest to some extent in the property. That is in the money advanced including interest and the amount that will cover up insurance premium.
Bailees have an insurable interest because of a potential liability that comes about if any loss or damage occurs in the goods that belong to others. They have insurable on these goods when they are in their custody as loss or damage would bring about liability.
Just like bailees, carriers have an insurable interest because of the fact that a potential liability may devolve on them in the occurrence of any mishap on the goods that belong to others while still in their custody.
Administrators, executors & trustees
This set of people has an insurable interest because of the responsibility that the law has saddled them with.
In life insurance, one has an insurable interest in his own life. Also, families and close relatives have insurable interests in one another. A wife has an insurable interest in the life of her husband and vice-versa, parents on their children and vice-versa, etc.
Debtor and creditor
A debtor has insurable interest on his own life likewise the creditor. However, a debtor does not have an insurable interest in the life of his creditor. On the other hand, a creditor has an insurable interest in the life of his debtor to the extent of the loan, interest, and something that would cover up the premium. This is because of the financial interest that advancing money has created.
Insurers have an insurable interest as a result of the potential liability that they took upon themselves from the policyholders in the insurance policy. With this, they can justify undertaking a reinsurance policy.
The existence or creation of potential liability is a justification of the existence of insurable interest. Examples could include public liability insurance, third-party motor insurance, employee liability insurance, etc. It is also important to note that if one is in possession of the goods of another, he has an insurable interest as long as he is responsible for the goods. However, there is no insurable interest if there is illegal possession of goods such as thieves. Another thing to note is that it must be capable of possessing a monetary value as sentimental value is not a criterion.
As long as the goods are in existence, a seller has an insurable interest in them.
When insurable interest must exist
The time in which the insurable interest must be present varies across the nature of insurance contracts. This would answer the question with regard to whether insurable interest is to exist at the formation of the contract, at the time of claims, or it should continue existing until it is discharged. Let us look at some instances below:
In the case of marine insurance, an insurable interest must exist at the time of claim although it does not need to be in existence at the time of effecting the policy. However, it is necessary for the policyholder or insured to have proof of going to acquire insurable interest soon. (Marine Insurance Act, 1906).
In this type of insurance, an insurable interest must exist both at the time of effecting the policy and at the time of claim.
In life insurance, insurable interest must be in existence at the time of effecting the policy. In this case, it may not be in existence at the time of the claim. For example, if a creditor decides to take out a policy on a debtor’s life and the debtor subsequently pays back the loan, the creditor can continue the policy based on the original terms and will be entitled to sum assured either on the debtor’s debt or on the maturity of the policy even though at the time of claim no insurable interest existed. (The English Case Dalby V. The India and London Life Assurance Co., 1854, laid down this rule).
Just like fire insurance, insurable interest must exist both at the time of claim and at the time of effecting the policy. It is important to note that the contract should be void ab-initio in the absence of insurable interest.
There is a need for underwriters to have a view of the insurable interest at the time of the issuance of the policy. Similarly, it is necessary for claims managers to have a view of the position of insurable interest at the time of claims settlement.
Types of insurable interest
- Fidelity guarantee insurance
- Credit insurance
- Performance bond
Fidelity guarantee insurance
This refers to the type of policy that provides cover to the insured with respect to the number of financial losses incurred. They mostly have a close relationship with dishonesty, fraud, and embezzlement caused by an employee. This insurable interest is specifically designed for business owners as a result of this fact.
This insurance helps in the protection of the fragile nature of credit-based transactions. As a result of the fact that most international trades are credit-based, a possibility of exporters incurring great losses as a result of unforeseen circumstances exists. It is for this reason that this policy makes provision for financial protection to such exporters in case something goes wrong in the course of a trade.
As the name implies, the aim of performance bonds is to protect the individuals bounded by a contract to meet up to certain obligations. Usually, these obligations come with a specified time frame as well as standard expectations. This policy comes in place when one is unable to meet these obligations as agreed on the contract which will bring about loss of capital. Because of this, the principal provider would have the right to request compensation from the contractor as a result of the losses incurred.
What are the essential features of insurable interest?
The essential features of insurable interest are the presence of property rights and interest, there must be a potential risk for insurable interest to be in place, it is critical for the property in question to have a monetary value. Also, the insurable interest must be legal and the possibility of suffering a financial loss in an event of a loss or damage must exist.
Importance of insurable interest
- Prevents gambling
- Prevents moral hazard
- Measures the amount of loss in an insured asset
It prevents gambling
Involving an asset that is at the risk of financial loss as the insurable interest helps in the prevention of gambling. This implies that without insurable interest, the insurance contract or policy would only be gambling with people insuring assets that do not have potential financial losses and yet hope for losses that they can receive payment for. Carrying this act goes against public policy and interest.
Prevents moral hazard
To explain this better, insurable interest helps in preventing moral hazards by restricting one from purchasing a policy if he will not bear any financial loss in case of damage or loss. For example, if an insurable interest is absent, one could buy a neighbor’s house and set it ablaze the next day in anticipation of a payout.
Measures the amount of loss in an insured asset
Insurable interest helps an insurance company to measure the amount of loss that the insured incurred. This helps in ensuring that a policyholder gets the exact payout he deserves in an event of a loss. This is as a result of the fact that claims payment cannot exceed the value of the insurable interest.
Creation of insurable interest
- By contract
- By common law
- By statute
The above are the three major ways in which insurable interest can be created.
Some contracts exist that a person will agree to take liability for something that he or she would not be liable for on a normal note. Usually, a landlord would be liable for maintaining the property he owns rather than his tenants. However, a lease may make the tenant take responsibility for the maintenance, repair, etc. of the asset (building). With this, the contract places a legally recognized relationship to the building. With this, he has an insurable interest that would have been absent if the contract has not been entered into. These special contractual relationships give rise to insurable interest in things that otherwise one has no any form of insurable interest.
By common law
This is a situation whereby the essential elements of insurable interest automatically come into place. We can describe this scenario as insurable interest arising by common law. Ownership is an example that is the most straight forward. if you own a house, you have the entitlement to insure it and equally the common law duty of care that one owes to the other which may give rise to liability and it is insurable. For example, the use of a motor vehicle in a public place is sufficient insurable interest for the purpose of effecting an insurance policy that favors the third party.
There are times in which an act of parliament can bring about an insurable interest by either granting some benefit or imposing a duty. The statute may bring about insurable interest in a place where none would otherwise exist. Some statutes can exist which have the capacity to restrict liability thereby also restricting insurable interest.
Insurable interest in life insurance contract
It is certain that life insurance is not a contract of indemnity. However, the person effecting the policy must have an insurable interest in the life that will be assured. According to life insurance contract law, insurable interest exists when the persons that have a relationship by marriage such as husband and wife, by blood such as father and son, or adoption are being recognized as having insurable interest.
Here are a few examples of relationships that have insurable interest in the life of another;
- A child has an insurable interest in the life of his parents and the other way round, this includes the illegitimate child.
- In marriage, a wife has insurable interest in the life of her husband and the husband also does.
- A debtor has an insurable interest on the life of the creditor, so the creditor does on the life of the debtor.
- In a master-servant relationship, a master has an insurable interest in the life of his servant, the servant does in the life of his master.
- In a company, there is an insurable interest in the life of the manager, board of directors, and other employees and vice-versa.
- Either the husband or the wife has an insurable interest in the life of father in-law or mother in-law, and vice-versa.
- Insurable interest in the life of grandparents and grand children.
- One can have an insurable interest in his own life.
Usually, an insurable interest is not to be confined to a pecuniary interest as sentimental interest or interest that is based on a close family relationship is sufficient to bring about an insurable interest. How close the relationship is, operates as functional protection to the life of the insured since he is not placed in the danger of being murdered. However, when one seeks insurance on his own life, the insurable interest is immaterial.
Marine insurance contract and insurable interest
Insurable interest in marine insurance is a special requirement for the policy to be in place. It validates the policy, and anyone entering into the policy must have an insurable interest in the marine adventure. The most important thing with regard to this is that there has to be a physical object that is exposed or vulnerable to marine perils. Secondly, it is necessary for the policyholder to have some legally recognized relationship with that object from which he stands to gain financial benefits from and stands to suffer loss if any loss or damage occurs.
Few instances can show insurable interest in marine insurance policy such as;
- Under a contract of marine insurance, the insurer has insurable interest in the risk he is insuring and may reinsure.
- The lender of money on bottomry or respondentia has insurable interest in terms of loan.
- Crew masters in a ship have insurable interest in their wages.
Fire insurance and insurable interest
When it comes to fire insurance, one has an insurable interest in fire insurance in cases whereby he will suffer financial loss if the insured property gets damaged by fire.
- A property owner, sole owner, joint owner, a farm.
- Either the vendor or the purchaser has the right.
- Both lessor and lessee have insurable interest on any asset.
- Another example is the mortgagor and mortgagee.
- Trustees and beneficiaries. While trustees are legal owners, beneficiaries are the beneficial owners of a property and both can insure it.
- Warehouse men, carriers, pawnbrokers can insure their property.
Insurable Interest in property insurance
A policyholder has an insurable interest in the property he owns which possesses financial benefits to him. The homeowners’ insurance policy provides compensation to a policyholder who suffers loss in an event of a fire or other destructive agents that may destroy a home. In essence, a homeowner has an insurable interest in the property, therefore, if he loses his home, this will bring about a catastrophic loss. It is a reasonable thing for the homeowner to expect longevity with regard to the ownership of the house. The homeowner seeks to insure against the possibility of unforeseen events that would bring about loss and damage.
A policyholder may buy property insurance for their own home, not the house that is across the street. If one purchases property insurance for a neighbor’s house, this will bring about an incentive to cause damage to that house and collect the insurance proceeds. Appropriate underwriting will not provide room for such temptation which would be a representation of moral hazard, whereby parties have an incentive to permit or even cause a loss to occur.
How to prove insurable interest
To prove insurable interest, the insurer requests identification from the parties that are involved and this can include a phone interview. In this case, the insurer makes inquiries with regard to existing relationships and interests regarding the subject matter of insurance. The inability to prove insurable interest will not allow one to be issued an insurance policy.
FAQs on insurable interest
When must insurable interest exist in a life insurance policy?
In life insurance policy, an insurable interest must exist at the time of effecting the policy.
What is insurable interest in life insurance?
Insurable interest in life insurance describes close relationships either by blood, marriage, business, adoption, etc.
Insurable interest involves what assumption?
The assumption of an insurable interest is that one must have a pecuniary interest in the subject matter of insurance and the policyholder must suffer a financial loss as a result of a loss or damage to the subject matter.
Which contract element is insurable interest a component of?
An insurable interest as an element of a contract is a legal purpose. This is because it involves a legally recognized relationship between the policyholder and the subject matter of insurance.
What arrangements allow one to bypass insurable interest laws?
Although insurable interest forms the basis of every insurance policy, Stranger-Owned Life Insurance (STOLI) is an arrangement for bypassing insurable interest.