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Insurable Interests?

May 11th, 2007

Does anyone with experience in the insurance industry have any insight on the principle of “insurable interest”? It came up in class the other night, and a number of the other students didn’t agree with the idea – the professor didn’t attempt to explain why it’s a general requirement, only that it is a general requirement for an insurance contract.

The conundrum is highlighted by a specific example: Joe has a life insurance policy that will pay $1M in the event of his premature demise. He has designated his girlfriend as the sole beneficiary of the policy. However, his girlfriend does not have any insurable interest in Joe – the policy may be void. Now, Joe may have designated a charitable organization as the beneficiary, without any problems. The charitable donation certainly has no insurable interest in Joe – if it has any interest whatsoever. Yet, the latter scenario is OK, and the former is generally not.

As far as I can speculate, the primary reason is to avoid over-exposure, which is to say, no insurer wants to write more than one policy for any particular risk – indeed any insurer that routinely did so would find itself in financial distress. But we don’t need an insurable interest requirement to prevent overexposure, only a strict underwriting policy of “one policy per risk.” The insurable interest requirement, then, is a derivative of this fiduciary requirement, and it exists because common law evolved in such a manner that we understand that a certain party may now have (or in the future acquire) a claim of dependence on the insured party/ so the purpose of the insurable interest requirement is to prevent another party from preventing the exercise of that claim. I think this is pure poppycock, and not even applicable in most circumstances*

However plausible, the above does not explain why Joe’s girlfriend and Joe’s favorite charity may not be co-beneficiaries. Nor does it explain why Joe’s girlfriend and Joe’s favorite charity may not be primary beneficiaries on two separate policies written by two separate insurers.  Nor does it explain how a charitable beneficiary can have any interest even approaching “insurable” in an individual.

So my question is: what is the practical application of the ‘insurable interest’ requirement? I certainly understand how it might be used as an underwriting tool – but I don’t understand why it’s an across-the-board requirement. It seems like it might be profitable to offer policies without a traditionally “insurable interest,” doesn’t it?

If you’ve got specific knowledge regarding my inquiry, please post a comment or send me mail.

===
*E.g., The moment the party with the alleged right to dependence decides to exercise that right, the existing policy would be voided and premiums returned to the payor. A new policy could then be written to secure the insurable interest. All of this, however, presupposes that it’s proper to allow usurping claims of dependence. If, after all, I’ve promised a brother, a friend, a girflriend, a charity – that in the event of my death, they will benefit – who is anyone else to intervene in that matter? But that’s a digression I’d rather not examine today. (back)

Comments

3 Comments

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  • KipEsquire says on: May 11, 2007 at 8:45 am

     

    It looks like you’re misconstruing what the IIR actually is.

    There is absolutely nothing wrong with me designating you as the beneficiary of my insurance policy that I pay for, even though you have no II in me.

    (Alternatively, I could simply designate my estate as the beneficiary and then make a provision for you in my will. Same net result.)

    The IIR rule is that YOU cannot take out a policy on ME, since you have no II in me.

    So your second paragraph is simply incorrect as a statement of the rule.

    The only contra rule I know of is that certain tax-advantaged employment benefits, including life insurance, require that the spouse, if there is one, be the beneficiary unless he/she specifically authorizes otherwise.

    P.S. You’re not in my will. Sorry.

  • David Z says on: May 11, 2007 at 9:30 am

     

    Awesome – that’s the clarification I was looking for. The second paragraph reflects the statement of the rule as presented to us; I had a feeling it was not being accurately portrayed.

    Thanks again!

  • KipEsquire says on: May 11, 2007 at 1:16 pm

     

    Well that explains it then. ;-)

    Have a great and study-free weekend…

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