What is an Insurable Interest?
If you are applying for a life insurance policy on someone's life, you must have an insurable interest in that person's life. To have an insurable interest means to have an interest in that person remaining alive or to expect an emotional or financial loss or harm from that person's death. This requirement prevents people from buying life insurance policies on others' lives and having an incentive to cause or hasten their deaths. If you are buying a policy on your own life, you are assumed to have an insurable interest in such circumstances. If you are buying a policy on someone else's life, you must have a sufficiently strong relationship based on blood or marriage or on monetary interest to qualify as having an insurable interest in that person's life.
To put it simply, you have an insurable interest in someone else's life if you have reason to value them alive more than dead.
Family Ties That Establish Insurable Interests
The types of family ties that give rise to an insurable interest are husband-wife relationships and parent-child relationships. In addition, grandparent-grandchild relationships and sibling relationships are now more frequently considered sufficient for establishing insurable interests. The emotional bonds and financial bonds in these situations are often strong enough to establish the expectation of harm from the death of the insured person. The ties between cousins, aunts and nephews, and other more distant relatives don't by themselves give rise to insurable interests because their emotional and financial bonds are less strong.
Example(s): Brutus may want to take out a life insurance policy on his mother-in-law's life but can't, based on his family ties alone. The relationship between a son-in-law and a mother-in-law doesn't involve strong enough emotional and financial bonds to create either an interest in her continued life or an expectation of harm, emotional or financial, from her death.
Tip: If you have more distant relatives who live in your household, you might, in some circumstances, have an insurable interest in their lives.
Certain Financial Relationships That Establish Insurable Interests
Certain relationships founded on monetary interests can give rise to insurable interests if the person taking out the policy stands to gain from the insured person's continued life or suffer harm from the insured's death. One example is a creditor-debtor relationship: A creditor is considered to have an insurable interest in a debtor's life. Even though a debtor's death doesn't extinguish the obligation to repay a loan, the creditor faces the potential harm of the debtor's estate lacking enough assets to repay the loan. Another example is the relationship between a business and a key employee, such as one providing unique personal services. For instance, a movie producer has an insurable interest in a star actress's life while the movie is being made.
The actress's death would disrupt production, require refilming scenes, and disrupt marketing efforts. Additional examples are the relationships among partners in a partnership or stockholders in a closely-held corporation. The death of a general partner or active stockholder can cause financial disruption to the business and harm the other business owners. Thus, life insurance often has an important role in business succession planning.
When Must the Insurable Interest Exist?
With life insurance, unlike several other types of insurance, the critical time for the insurable interest to exist is at the time you enter into the insurance contract, not at the time of the loss or harm. In other words, you must have an insurable interest in the life you are insuring at the time you take out the policy. The insurable interest, however, generally doesn't have to remain at the time of that person's death.
Example(s): Phyllis and Frank are married. Each has an insurable interest in the other's life. Phyllis takes out a life insurance policy on Frank's life and continues to pay the premium. A few years later they divorce, but Phyllis continues to pay the premiums on the policy for her now ex-husband's life. At Frank's death, Phyllis no longer has an insurable interest in Frank's life, as ex-spouses don't have an emotional or financial bond sufficient to give rise to an insurable interest. Nevertheless, the beneficiary of the policy has a legal claim to the death benefit and can collect under the policy.
Example(s): Darth owes $8,000 to Stanley. Stanley takes out a $10,000 policy on his debtor's life. Darth pays off his entire debt after 3 years. He then lives another 15 years before finally dying 18 years after Stanley first took out the policy. Stanley continues to pay the premium right up until Darth's death, even though the debt is paid off after 3 years. Although Stanley's insurable interest ended once the full debt was repaid, the beneficiary under the policy can still collect the $10,000 death benefit.
Questions & Answers
Are Engaged Couples Considered to Have an Insurable Interest in Each Other's Lives?
You and your fiance may have insurable interests in each other's lives unless your state's law provides otherwise. Either of you can take out an insurance policy on the other's life.
What Happens if You Take Out a Life Insurance Policy and Don't Have an Insurable Interest in the Insured's Life?
Generally speaking, if you don't have an insurable interest at the time you take out the policy, the insurance contract is illegal and unenforceable. That means the insurance company isn't under any obligation to pay out the death benefit and in some states isn't even required to return your premiums. Certain states, though, allow you or your representative to get your premiums back if you can show you honestly believed that you had an insurable interest at the time you bought the policy. All states let you get your premiums back if an insurance agent fraudulently induced you to buy the policy by convincing you that you had an insurable interest in the insured's life.
If you have an insurable interest in your own or someone else's life, can you then purchase a policy worth any amount?
No. Having an insurable interest doesn't give you total discretion as to the amount of insurance you take out. Your insurable interest, in other words, isn't unlimited. An insurance company won't let you purchase a policy that is worth far more than your reasonable needs under the circumstances.
Example(s): A star basketball player in the NBA who earns more than $1 million a year and has potential movie opportunities might be able to purchase a $10 million policy on his own life. An elementary school teacher who earns $32,000 a year wouldn't be able to purchase a $10 million policy on his life, as the policy's value is disproportionate to the teacher's reasonable needs.
This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.
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