Written by Insurable interest is a fundamental principle in the insurance industry.
It is the cornerstone of any valid insurance contract, and without it, an insurance contract cannot be legally enforceable.
Insurable interest means the legal right to insure arising out of the financial relationship between the insured and the subject matter of insurance.
It refers to a legal right or financial interest in the subject matter of an insurance policy.
Simply put, insurable interest means that the insured has a stake in the property or item being insured.
For example, if you own a car, you have an insurable interest in the car because you would suffer a financial loss if it were to be damaged or destroyed.
Similarly, if you have a family member whose death would cause you financial hardship, you have an insurable interest in his/her life.
We can say a person has an insurable interest in the subject matter of an insurance contract if a loss or damage to the subject matter will cause the person to suffer a financial loss or some other loss.
Essential Features of Insurance Interest
1. Existence of a subject matter: The subject matter of an insurable contract refers to the object or person that is being insured. It could be property, a right or interest, or a life.
For an insurable interest to exist, there must be some property, right, interest, or life capable of being insured.
In property insurance, the subject matter is the property that may get damaged or lost upon the occurrence of the covered event( fire, theft, or natural disasters, while In life insurance, the subject matter is the human life assured.
2. Existence of financial interest: Another essential feature of insurable interest is that the insured must have a financial interest in the subject matter.
By financial interest, we mean that he would benefit financially from the safety of the subject matter and would be prejudiced by the loss, damage, and destruction of the subject matter.
For example, if you own a car, you have an insurable interest in that car because you would suffer a financial loss if it were damaged or destroyed.
3. Legally recognized: Insurable interest will only exist if there is a legally recognized relationship between the insured and the subject matter of the insurance.
This means that the law must acknowledge that the insured has a financial interest in the subject matter being insured and that this interest is legitimate and lawful.
If there is no recognized legal relationship between the insured and the subject matter, the insurance contract would certainly be rendered null and void.
For example, if a person tried to take out an insurance policy on his neighbour’s house, without any legal relationship between them, the insurance contract would be void because the person has no insurable interest in his neighbour’s property.
Similarly, if a person tries to insure something illegal, say stolen property, the insurance contract would be unenforceable as it violates the law.
Why is insurable interest Necessary?
Insurable interest is necessary due to the following reasons:
1. To prevent Gambling: Insurable interest is necessary to prevent insurance from being used as a form of gambling.
If there is no insurable interest, people could potentially take out insurance on something they don’t have a financial stake in and hope that it gets damaged or destroyed, so they can collect the insurance payout.
For example, imagine someone who doesn’t own a car taking out an insurance policy on a friend’s car.
Since he has no financial interest in the car, he would hope that the car gets involved in an accident so that he can collect the insurance payout.
This would be similar to gambling, as he is essentially betting on something happening so that he can gain from it.
However, with the presence of insurable interest, such a scenario is not possible.
2. To guard against moral hazard: Moral hazard is the possibility that an insured party may engage in dishonest or risky behaviour that increases the likelihood of a loss, knowing that the financial burden of the loss will be borne by the insurer.
For example, a dishonest person may take life insurance on the life of another person and deliberately kill the person since he did not have an insurable interest
However, since all insurance contracts must follow the principle of insurable interest, such dishonest tendencies are reduced.
3. Measures the amount of the insured loss: Insurable interest measures the amount of the insured loss since the insured cannot insure more than the amount of his insurable interest in the subject matter.
If the insured is allowed to insure more than his insurable interest, then it would be like trying to make a profit from the loss, which is not allowed.
Indeed, in property insurance, the measure of insurance coverage is the insurable interest on the insured and the amount the insured gets compensated for the loss of his property in property insurance is contingent on the extent of the insurable interest at the time of the loss.
When Should Insurable Interest Exist?
The time when the insurable interest must be present varies with the specific type of insurance policy.
- In marine insurance, the insured is not mandated to have an insurable interest at the inception of the insurance contract. However, he must have an insurable interest in the subject matter at the time of loss, otherwise, he loses his claim.
- For a life insurance contract, insurable interest is only required at the inception of the policy and not at the time of the claim or loss.
- In property insurance, insurable interest must exist at the time of entering the contract and at the time of the loss.
Dangers of taking an insurance policy without Insurable interest
If an insurance policy is taken without insurable interest, then such a policy is unenforceable. This means it cannot be enforced by law.
However, if the insurance policy is life insurance taken out as a gamble on someone’s life, such a policy would be rendered void and illegal, which means it has no legal validity and cannot be enforced in a court of law.
So, we can conclude that any insurance contract taken on the life of any other person, or any other event whatsoever without insurable interest by the insured may be null and void.
Examples of people who have Insurable Interest
The following have been proven to have an insurable interest:
- The holder of a good title on a property has an unqualified interest in that property.
- A creditor has insurable interest on his debtor to the extent of the debt.
- A partner in the business has an insurable interest in the life of a co-partner or co-partners.
- Spouses have an insurable interest in each other life to an unlimited amount.
- Executors and trustees of property have an insurable interest in the property.
Case Study
To better understand the principle of insurable interest, Lets us take an example.
Question
John recently sold his 5 months car to James, and he no longer owns, drives, or looks after the car. He forgot to cancel his motor insurance and has just learned that James damaged the car beyond repair in a motor accident. If he claims his motor policy, what can he expect to receive from the insurance company?
Answer
John will not get anything from the insurance company.
In motor insurance, the insurer is expected to have an insurable interest both at the inception of the policy and at the time of the loss.
However, in this case, John only had an insurable interest at the beginning of the policy but did not have an insurable interest at the time of the loss because he had sold the car and was no longer looking after the car. Therefore, John will receive no compensation on the motor insurance policy.
