- Insurable interest means that you have a financial stake in something or someone and would experience financial challenges if that thing or person were damaged or injured.
- You can have insurable interest in a family member, your home or your car.
- Having an insurable interest is required to get insurance coverage.
- If you don’t have an insurable interest, you might have a moral hazard, or a conflict of interest that could encourage you to engage in risky behavior to collect on claims.
Imagine waking up at midnight to the smell of smoke in your home. You quickly discover a fire in the attic, and you wake up your family as fast as you can and rush them out the door to safety. The fire department arrives shortly, but your home has incurred some serious damage by that point.
Fortunately, you have homeowners insurance coverage—but what if you didn’t? You might not have another place to live, and you could lose all your hard-earned home equity. This relates to insurable interest.
Insurable interest is a concept that protects insurers, and though you’re unlikely to use the term in normal speech, you might encounter it when you apply for a policy. Regardless, having coverage on an insurable interest such as your home, car or even a family member helps to protect you financially if something bad happens.
Read on to learn more about insurable interest, how it works and to consider real-world examples.
Inside this article
What is insurable interest?
You’ll often hear insurable interest mentioned in the context of life insurance, though it also applies to other coverages. If you have an insurable interest, it means that you benefit financially and personally from the continued existence of a person or thing. Said differently, you’d experience financial and emotional hardship if you lost a particular person or asset.
If two spouses both work full-time to contribute financially to their family, for example, each would experience hardship if the other died. So each partner has an insurable interest in the death of the other.
How does insurable interest work?
You can have insurable interest in a person, like your spouse, child and business partner, or in an asset like your home and car. In fact, to get a life, home, or car insurance policy, you’ll need proof of insurable interest. Your car registration, mortgage documents, a birth certificate or marriage certificate might be an example of proof of insurable interest.
The requirement of insurable interest is designed to help prevent fraud. For example, while someone could get insurance for their vehicle, they couldn’t get it for a stranger’s car. Having car insurance on a stranger’s car could entice a policyholder to damage that person’s vehicle to get an insurance payout—a big no-no.
Of course, most people wouldn’t commit fraud, but the example illustrates why insurable interest is required.
Examples of insurable interest
While state laws can vary regarding who or what’s considered an insurable interest, here’s a breakdown of how this concept applies to specific coverages. Be sure to check with an insurance agent before making changes to your policy.
We shared the example of a husband and wife having an insurable interest in each other. But young children can have insurable interest in their parents. It might also apply in the case of a family trust or business relationships, where two co-founders own a company together. After all, if your business partner dies, you’d suffer a financial burden.
Think about what would happen if your home was destroyed and you didn’t have insurance. It would be a serious financial and emotional hit, right? In the case of your homeowners policy, you have insurable interest in your home, as significant damage or loss would be devastating.
Your car does way more than just sit in your driveway. You likely use it to get the kids to school or to drive to work every day. Besides, cars are also expensive—and so are car accidents if you don’t have insurance. When you buy a car, you have a financial stake and insurable interest in that asset.
Couples often purchase disability insurance coverage in case one or both of them become injured or ill and unable to work. In this instance, the concept of insurable interest would apply to your partner or yourself.
|Examples of people with insurable interest|
|Family members: For instance, a child might have an insurable interest in their parents.|
|Companies: A business might have an insurable interest in key employees that keep their business running, like a CEO.|
|Creditors: Financial companies that issue loans may have an insurable interest in their borrowers.|
|Sports teams: NBA, MLB or NHL teams have an insurable interest in their players.|
|Business partners: Those running a business together might have an insurable interest in each other.|
Source: Naoshad Pochkhanawala, a Chartered Life Underwriter at Amiko Benefits Inc.
Is insurable interest required for all policies?
When you apply for a policy, your insurer’s underwriters look at your relationship with the person you’re getting coverage for or ownership of the asset you’d like to cover. If you don’t have an insurable interest, you won’t be able to get coverage. (Keep in mind that, in the case of disability insurance, the insurable interest could be yourself.)
Remember that insurance fraud thing we mentioned earlier? No insurable interest equals a major red flag for insurance companies, so they require that applicants have an insurable interest before issuing a policy.
What is a moral hazard?
A moral hazard is a conflict of interest in the context of insurance.
“It exists in insurance when a party purchasing insurance has an economic advantage to take risks it otherwise wouldn’t,” says Naoshad Pochkhanawala, an estate and financial planner at Amiko Benefits Inc., a financial advisory firm.
While a moral hazard occurs infrequently because insurance companies have systems to prevent it, it relates to our earlier example of getting insurance for a stranger’s car.
Let’s say a bad actor manages to secure a policy for a stranger’s vehicle. Then that bad actor lights the car on fire and submits a claim for an insurance payout. They take the money and run. Since that person has no insurable interest in that car, this would be an example of a moral hazard.
How do insurance companies determine insurable interest?
Insurance companies won’t just take your word for it that a person is your partner or your home is actually yours. While you’ll need to confirm these basic details, the insurer will also likely speak with the person named in the life insurance policy, your mortgage lender or another third party.
What isn’t considered insurable interest?
If you don’t have financial stake in the game when it comes to a person or asset, you don’t have insurable interest. For instance, you wouldn’t get an insurance policy on your neighbor’s house because it wouldn’t make sense—you don’t have a mortgage on that house, nor do you live there. And the insurance company wouldn’t let you do that anyway.
Why is insurable interest important?
Having insurable interest in a person or asset helps prevent insurance fraud and issues related to moral hazards. This interest helps protect people and insurance companies from bad actors.
If you’d experience money troubles or a heavy emotional burden due to the loss of a person or asset, you probably have an insurable interest in that person or asset. (Again, you could be your own insurable interest, say in the case of disability insurance.) Insurance companies weigh this factor heavily when you apply for coverage, so keep that in mind if you’re shopping around.