It just seems almost self evident that if you are applying for life insurance there is probably a reason for it (i.e. a close family member, a business partner, etc.), however, it may not be simple. Whether it be based on common law or statutory law every State has a different definition for insurable interest. While the topic likely doesn’t matter for most people it is an interesting area of the law that has a lot of history.
What is an Insurable Interest?
New York is one of those States that codified the definition. Insurance Law § 3025 reads in part,
(a) In this section: (1) The term, “insurable interest” means:
(A) in the case of persons closely related by blood or by law, a substantial interest engendered by love and affection;
(B) in the case of other persons, a lawful and substantial economic interest in the continued life, health or bodily safety of the person insured, as distinguished from an interest which would arise only by, or would be enhanced in value by, the death, disablement or injury of the insured.
While the statute gets a bit more detailed it is a pretty reasonable definition. Attorney Barry Zalma puts it similarly,
Life insurance insurable interest can be defined as an interest based upon a reasonable expectation of pecuniary advantage through the continued life, health, or bodily safety of another person and consequent loss by reason of that person’s death or disability or a substantial interest engendered by love and affection in the case of individuals closely related by blood or law. An individual may have an unlimited insurable interest in his or her own life, health, and bodily safety and may lawfully take out a policy of insurance on his or her own life, health, or bodily safety and have the policy made payable to whomsoever he or she pleases, regardless of whether the beneficiary designated has an insurable interest. It is the life of the person taking out the insurance who must have an insurable interest.
Insurance is also, by definition, the taking of a risk of a contingent or unknown event. It is not a gamble. Gambling on life has been illegal for more than 300 years because the life insured by the gambler would be at risk of murder to collect the funds.
What Happens if You Fail to Have an Insurable Interest at the Time of Contract (or Shortly thereafter)?
I recently came across an article in my favorite industry magazine, Trusts and Estates, titled, “Do Your Clients Have Insurable Interest?: State regulators and insurance companies are paying extra attention to the issue of insurable interest, and advisors better be careful in writing life insurance policies” that highlighted some recent issues:
In one egregious example of a lack of insurable interest, afederal court judge voided a $10 million Prudential Financial insurance policy on the life of a Delray Beach, Fla. retiree. In December 2011, the judge ruled that Prudential also could keep the $620,000 in insurance premiums.
An insurance agent sold policies to senior citizens by telling them that they could get free insurance if they financed multi-million-dollar life insurance policies. The agent said that the retirees would get the death benefits before they sold their policies to a third party. In the case, a retiree, with a net worth of $600,000, was listed as having a net worth of $10 million on application documents.
That same article higlights some of the rules that should be followed by advisors:
Cases won by insurance companies over the years have suggested these caveats:
- There must be proof of an actual business partnership between the purchaser of a life insurance policy and the insured—even if the policies are purchased so that the beneficiary can purchase the insured’s property upon his or her death.
- A client change of the beneficiary on his or her policy could spell trouble. If a cousin or other relative is named a beneficiary when there is a sole surviving sibling, for example, an insurable interest lawsuit could arise.
- A policy taken out on an in-law could be voided—even if the in-law approves of the policy. At least one court ruled such a relationship contained no insurable interest.
While this may not apply for 97% of the policies sold I think it is interesting nonetheless. Personally, I think widespread ownership of Stranger Owned Life Insurance (commonly referred to as STOLI) would be devastating to the industry since lapses are built into the price.