To purchase a life insurance policy, you must have an insurable interest in the life of the person insured. When a relationship exists between the proposed insured and the proposed beneficiary in which the beneficiary benefits more from the continued life of the insured than the death of the insured, an insurable interest exists.
Significance
Requiring an insurable interest for the purchase of life insurance prevents a proposed beneficiary from gambling on the life of an insured and prevents murder for profit. Without an insurable interest, any person could take out a policy on a individual, gambling that said individual would die soon enough to make the policy profitable. Without an insurable interest, any person could take out a policy on an individual and conspire them to murder them for a profit. A beneficiary with an insurable interest has more to gain from the continued life of the insured than from their untimely death.
Time Frame
An insurable interest must exist at the time of policy purchase, but may not necessarily exist at the time of the loss. For example, you have an insurable interest in your spouse and could take out a policy on their life. Even if you were no longer married to that person at the time of their death, the insurance policy would likely still be valid. Beneficiaries may be named as "contingent beneficiaries" so that they no longer receive insurance proceeds if an insurable interest is not present at the time the policy proceeds become payable. For example, a husband could name his wife as contingent beneficiary, and if they were divorced at the time of his death specify a different beneficiary, such as trustee for his children.
Function
When an insured person dies, the proceeds from any life insurance policies are paid to their beneficiaries to alleviate any undue financial burdens caused by that death. These financial burdens may be personal or corporate. Businesses, for example, may purchase life insurance policies on key employees. Creditors may purchase life insurance policies on debtors. In both cases, the business and creditor have an insurable interest because it is to their advantage for the insured person to continue to live.
Types
A person has an insurable interest in their own life, and can generally choose any person or entity as their beneficiary. The assumption is that a person will name beneficiaries who have more to gain from their continued life than their untimely death. Each state has laws that determine and define insurable interest. Generally spouses and children are always considered to have an insurable interest. Some states include fiances and fiancees in this category.
Considerations
If an insurance company determines that no valid insurable interest existed at the time a policy was purchased, the policy will likely be declared null and void. In some instances, premiums may be refunded. If the policy was purchased with the knowing intent of committing fraud, the insurer or state may pursue criminal action against the purchaser.
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