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Insurance companies require an “insurable interest” before issuing a policy, meaning the person taking out the insurance will suffer a loss if something happens to the insured object or person. Insurable interest is easy to establish for property insurance, but more complicated for individuals. Lenders are also considered to have an insurable interest. The requirement was introduced to eliminate moral hazard.
If someone suffers a loss if an object or person is damaged or destroyed, they are said to have an “insurable interest.” Insurance companies require people to have an insurable interest before a policy is issued, confirming that the person taking out the insurance will suffer if something happens to the insured person or object. Bottom line: you can insure your car because if something happens to you, you’ll suffer a financial loss, but you can’t insure your neighbor’s car, because if something happens to you, you won’t be affected financially, even though your neighbor may request a ride and you may feel sympathy for your neighbor’s situation.
Insurable interest requirements did not always exist in the insurance industry, which created some tricky situations. Some people bought insurance as a form of speculation, effectively betting on the continued existence of an object or person. Perhaps most egregious is that people took out life insurance policies on unrelated people, and there are some reports that when these people did not die in a timely manner, policyholders helped them. As a result, insurance companies began to require that individuals have an insurable interest, in order to eliminate moral hazard.
For property insurance, it is easy to establish an insurable interest. If someone owns a home, car, business, or other property and the property is damaged, destroyed, or rendered unusable, he or she experiences financial loss, because the property must be repaired or replaced. Additional losses may be incurred indirectly; For example, if someone can’t get to work because her car is totaled, he or she loses wages and may be at risk of losing a job.
Also, lenders are considered to have an insurable interest. Banks that issue home loans, for example, often require people to carry insurance so that in the event the home is destroyed, the bank can claim the insurance to collect the loan balance. To collect on the insurance, it is necessary to maintain a lien on the property.
Insurance for individuals is a bit more complicated. Life insurance policies may be written on behalf of dependents, under the assumption that a loss to a parent could cause a financial loss (among other types of losses that, unfortunately, are not insurable). Conversely, a parent might purchase dependent life insurance on the grounds that the loss of a child could cause emotional and financial damage. Life insurance for spouses is also not uncommon. However, persons do not automatically have an insurable interest in everyone to whom they are related; a niece might not be allowed to purchase life insurance for an uncle, for example, although the uncle might choose to name the niece as a beneficiary on her life insurance policy.
Smart Asset.
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