Understand the following key principles and rules in Life Insurance Law. Your Legal Guide of Life Insurance.
REQUIREMENT OF INSURABLE INTEREST
“Insurable interest” is a key principle in life insurance law. It is the requirement imposed by law (and by insurers) to prevent a “gaming” or “wagering” by one party on the life of another through insurance. Simply put, to insure the life of an individual, the applicant must have an insurable interest, i.e., a greater concern in the insured’s living than dying. Courts (and insurers) look for “a reasonable ground … to expect some benefit or advantage from the continuance of the [insured].” Stated in another manner, the public has an interest in preventing the contract of insurance where the applicant has no interest in the continuation of the insured’s life other than the prospect of profiting from the insured’s early demise.
It is almost universally accepted that a person has an unquestionable insurable interest in his or her own life. “The mere fact that a man of his own motion insures his life for the benefit of either himself or of another is sufficient evidence of good faith to validate the contract.” So, most applicant-insureds will face no insurable interest issue in obtaining life insurance. Nor will their naming of someone other than their estates as beneficiary usually pose a problem since it is generally assumed that the insured will not name as beneficiary someone who wished him harm or who would wager on his life. (Of course, if the policy was obtained expressly for the purpose of wagering or if the policy was really purchased by and soon after issue assigned to the third party
beneficiary, the courts will declare such a contract void. Public policy will not allow one to accomplish by fraudulent indirection what one clearly is prohibited from doing directly.)
Every state has either statutory law or case law on insurable interest and all require that either the beneficiary or applicant hold such interest at the inception of the contract. Most states do not require that either the beneficiary or assignee of a policy have an insurable interest. The majority of states hold that there is nothing conclusively illegal about an assignment to one who holds no insurable interest—even where the insured is paid value for the assignment. But some states do require that the assignee have an insurable interest—even though some of the same states allow the insured to name a beneficiary who does not have an insurable interest.
Because each state is free to create its own laws on insurable interest and because different state courts have come to different conclusions on the issue, it is impossible to develop rules that apply without question in every state. Most state laws do not question the insured’s insurable interest in his own life nor the interest of close relatives related by blood or law and bonded through natural love and affection with the insured. With respect to others, statutes favor persons who stand to profit by the insured’s continued life, suffer economic loss at the insured’s death, and who have more to gain by the insured’s continued life than death.
Generally, the following rules regarding insurable interest apply:
1) Blood relatives –
A parent usually is deemed to have an insurable interest in his or her child’s life.
A child usually is deemed to have an insurable interest in his or her parent’s life. (But once the child becomes a financially independent adult, it is not certain that all courts would hold that the blood relationship alone would be sufficient to meet insurable interest tests).
A grandchild usually is deemed to have an insurable interest in the life of a grandparent.
A grandparent usually is deemed to have an insurable interest in the life of a grandchild.
Siblings usually are deemed to have an insurable interest in the life or lives of brothers and sisters.
Other relatives, such as an aunt, uncle, niece, nephew, or cousin, generally are not deemed to have an insurable interest merely by virtue of their blood relationship (but may have an insurable interest arising out of a business or financial transaction or out of financial dependency on the insured).
2) Marriage –
Spouses have an insurable interest on each other’s lives.
A few courts have held that a person engaged to another has an insurable interest in the other’s life.
Other individuals related to the insured by marriage are usually deemed not to have an insurable interest based solely on a marriage relationship (but may have an insurable interest based on financial dependency). In-laws, for example, or step-sons or daughters, or foster children have no per se insurable interest based on family relationships but can obtain insurable interest because of dependency.
3) Business –
A person (or business or financial enterprise) that would suffer a financial loss at the insured’s death will usually be deemed to have an insurable interest (assuming that the amount of coverage bears a reasonable relationship to the loss that would be suffered at the death of the insured). This means an employer can insure an employee, an employee can insure an employer, a partner can insure a partner, and a partnership can insure its partners, a surety can insure the life of his principal, and a member of a commercial enterprise can insure an individual if that person’s death would adversely affect the financial stability or profits of the enterprise. (Although a business generally has an insurable interest in the lives of officers, directors, and
managers, or others on whose continued life or lives the business’ success may depend upon, a corporation may not have insurable interest in the life of a shareholder who has no working or other financial relationship with the business. The point is that it is not the mere legal relationship that creates the insurable interest, but rather the “existence of circumstances which arise out of or by reason of” the entity.)
Where business associates have insured each other to fund a purchase of the business interest at the insured’s death or the business itself has insured an owner to fund a purchase of that person’s interest at death, usually there will be an insurable interest.
Creditors have been allowed to purchase policies on debtors as long as the relationship between the amount of insurance and the debt were proportionate. But at the point where the transaction was more of a wager than an effort to secure a debt (decided on a case by case basis), the policy is void as lacking insurable interest. So the closer the insurance amount is to the debt owed, the more likely insurable interest will not be an issue. (However, once the policy has been issued to a creditor, the creditor typically is allowed to keep the entire amount of the proceeds even if the amount exceeds the debt.)
Most states require that insurable interest be present only at the time when the life insurance contract is entered into (i.e., at the inception of the policy) and need not be present at the insured’s death. Therefore, a wife who is married at the time the insurance is purchased on her husband’s life but divorced from him at his death is not barred from collecting. Likewise, if a corporation purchases insurance on the life of a key employee, by definition there is an insurable interest at that time. If the employee later leaves the firm, the corporation can still collect the proceeds of the policy on his life.
Even if the insurable interest tests are met by a third party applicant, state law will void the contract if the insured is not informed and the insured’s consent is not obtained. Even a spouse cannot lawfully purchase a policy on the other spouse’s life in most states without that person’s knowledge and consent. However, there is a practical exception to this general rule: a parent can, without the child’s consent, purchase relatively small amounts of life insurance on the life of a minor child since the child does not have the legal capacity to consent and so such consent would be meaningless.
Passing of the contestable period will not bar an insurer from asserting a lack of insurable interest since the strength and validity of the incontestable clause is predicated on the existence of a valid contract. Absent insurable interest, there never was a valid contract.
An insurer has a legal duty to use reasonable care in ascertaining the existence of insurable interest and in assuring that the insured did in fact consent to the coverage. If the insurer does not use reasonable care in both duties, it may be liable for the harm that occurs to the insured and/or beneficiaries. For this (and sound underwriting economic) reason(s), insurance companies are often more stringent than state law requires.
REQUIREMENT OF INSURABLE INTEREST
“Insurable interest” is a key principle in life insurance law. It is the requirement imposed by law (and by insurers) to prevent a “gaming” or “wagering” by one party on the life of another through insurance. Simply put, to insure the life of an individual, the applicant must have an insurable interest, i.e., a greater concern in the insured’s living than dying. Courts (and insurers) look for “a reasonable ground … to expect some benefit or advantage from the continuance of the [insured].” Stated in another manner, the public has an interest in preventing the contract of insurance where the applicant has no interest in the continuation of the insured’s life other than the prospect of profiting from the insured’s early demise.
It is almost universally accepted that a person has an unquestionable insurable interest in his or her own life. “The mere fact that a man of his own motion insures his life for the benefit of either himself or of another is sufficient evidence of good faith to validate the contract.” So, most applicant-insureds will face no insurable interest issue in obtaining life insurance. Nor will their naming of someone other than their estates as beneficiary usually pose a problem since it is generally assumed that the insured will not name as beneficiary someone who wished him harm or who would wager on his life. (Of course, if the policy was obtained expressly for the purpose of wagering or if the policy was really purchased by and soon after issue assigned to the third party
beneficiary, the courts will declare such a contract void. Public policy will not allow one to accomplish by fraudulent indirection what one clearly is prohibited from doing directly.)
Every state has either statutory law or case law on insurable interest and all require that either the beneficiary or applicant hold such interest at the inception of the contract. Most states do not require that either the beneficiary or assignee of a policy have an insurable interest. The majority of states hold that there is nothing conclusively illegal about an assignment to one who holds no insurable interest—even where the insured is paid value for the assignment. But some states do require that the assignee have an insurable interest—even though some of the same states allow the insured to name a beneficiary who does not have an insurable interest.
Because each state is free to create its own laws on insurable interest and because different state courts have come to different conclusions on the issue, it is impossible to develop rules that apply without question in every state. Most state laws do not question the insured’s insurable interest in his own life nor the interest of close relatives related by blood or law and bonded through natural love and affection with the insured. With respect to others, statutes favor persons who stand to profit by the insured’s continued life, suffer economic loss at the insured’s death, and who have more to gain by the insured’s continued life than death.
Generally, the following rules regarding insurable interest apply:
1) Blood relatives –
A parent usually is deemed to have an insurable interest in his or her child’s life.
A child usually is deemed to have an insurable interest in his or her parent’s life. (But once the child becomes a financially independent adult, it is not certain that all courts would hold that the blood relationship alone would be sufficient to meet insurable interest tests).
A grandchild usually is deemed to have an insurable interest in the life of a grandparent.
A grandparent usually is deemed to have an insurable interest in the life of a grandchild.
Siblings usually are deemed to have an insurable interest in the life or lives of brothers and sisters.
Other relatives, such as an aunt, uncle, niece, nephew, or cousin, generally are not deemed to have an insurable interest merely by virtue of their blood relationship (but may have an insurable interest arising out of a business or financial transaction or out of financial dependency on the insured).
2) Marriage –
Spouses have an insurable interest on each other’s lives.
A few courts have held that a person engaged to another has an insurable interest in the other’s life.
Other individuals related to the insured by marriage are usually deemed not to have an insurable interest based solely on a marriage relationship (but may have an insurable interest based on financial dependency). In-laws, for example, or step-sons or daughters, or foster children have no per se insurable interest based on family relationships but can obtain insurable interest because of dependency.
3) Business –
A person (or business or financial enterprise) that would suffer a financial loss at the insured’s death will usually be deemed to have an insurable interest (assuming that the amount of coverage bears a reasonable relationship to the loss that would be suffered at the death of the insured). This means an employer can insure an employee, an employee can insure an employer, a partner can insure a partner, and a partnership can insure its partners, a surety can insure the life of his principal, and a member of a commercial enterprise can insure an individual if that person’s death would adversely affect the financial stability or profits of the enterprise. (Although a business generally has an insurable interest in the lives of officers, directors, and
managers, or others on whose continued life or lives the business’ success may depend upon, a corporation may not have insurable interest in the life of a shareholder who has no working or other financial relationship with the business. The point is that it is not the mere legal relationship that creates the insurable interest, but rather the “existence of circumstances which arise out of or by reason of” the entity.)
Where business associates have insured each other to fund a purchase of the business interest at the insured’s death or the business itself has insured an owner to fund a purchase of that person’s interest at death, usually there will be an insurable interest.
Creditors have been allowed to purchase policies on debtors as long as the relationship between the amount of insurance and the debt were proportionate. But at the point where the transaction was more of a wager than an effort to secure a debt (decided on a case by case basis), the policy is void as lacking insurable interest. So the closer the insurance amount is to the debt owed, the more likely insurable interest will not be an issue. (However, once the policy has been issued to a creditor, the creditor typically is allowed to keep the entire amount of the proceeds even if the amount exceeds the debt.)
Most states require that insurable interest be present only at the time when the life insurance contract is entered into (i.e., at the inception of the policy) and need not be present at the insured’s death. Therefore, a wife who is married at the time the insurance is purchased on her husband’s life but divorced from him at his death is not barred from collecting. Likewise, if a corporation purchases insurance on the life of a key employee, by definition there is an insurable interest at that time. If the employee later leaves the firm, the corporation can still collect the proceeds of the policy on his life.
Even if the insurable interest tests are met by a third party applicant, state law will void the contract if the insured is not informed and the insured’s consent is not obtained. Even a spouse cannot lawfully purchase a policy on the other spouse’s life in most states without that person’s knowledge and consent. However, there is a practical exception to this general rule: a parent can, without the child’s consent, purchase relatively small amounts of life insurance on the life of a minor child since the child does not have the legal capacity to consent and so such consent would be meaningless.
Passing of the contestable period will not bar an insurer from asserting a lack of insurable interest since the strength and validity of the incontestable clause is predicated on the existence of a valid contract. Absent insurable interest, there never was a valid contract.
An insurer has a legal duty to use reasonable care in ascertaining the existence of insurable interest and in assuring that the insured did in fact consent to the coverage. If the insurer does not use reasonable care in both duties, it may be liable for the harm that occurs to the insured and/or beneficiaries. For this (and sound underwriting economic) reason(s), insurance companies are often more stringent than state law requires.
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