Insurable interest in life insurance
Life insurance isn’t just for protecting your own financial future; you can also purchase policies for others, provided you have insurable interest and their consent. Insurable interest is a key requirement in life insurance, designed to prevent fraud and moral hazards, such as situations where a policyholder might benefit financially from causing harm to the insured.
A historical example underscores the importance of insurable interest: In the late 1800s, the notorious H.H. Holmes exploited the absence of these regulations, persuading unsuspecting individuals to let him purchase life insurance on their behalf, resulting in tragic consequences. This chilling chapter in history vividly highlights why insurable interest is essential in today’s life insurance practices.
Understanding insurable interest is beneficial when planning your financial future. It determines who can take out a life insurance policy on whom, which makes sure that policies serve their intended purpose of providing financial security rather than creating incentives for harm. In this article, we will delve into what insurable interest is, how to establish it and its significance in life insurance.
What is insurable interest in life insurance?
Insurable interest in life insurance is a fundamental requirement when taking out a policy on someone other than yourself. It ensures that you have a financial stake in the insured person’s continued well-being and would experience financial hardship if they were to pass away. Unlike home and auto insurance, where insurable interest must exist at the time of loss, in life insurance, insurable interest only needs to exist when the policy is purchased.
Examples of insurable interest
Consider a working parent and a stay-at-home parent. The working parent might take out a life insurance policy on the stay-at-home parent because losing them would lead to significant financial strain. The death benefit could help cover childcare costs or allow the working parent to adjust their work schedule.
Similarly, the stay-at-home parent could also take out a policy on the working parent. If the working parent were to pass away, the death benefit would provide financial support to maintain the family’s lifestyle while the surviving parent adjusts to being the sole provider.
Insurable interest can also apply in business contexts. For instance, a professional sports team might buy life insurance on their key athletes to protect against the financial impact of losing a star player. Similarly, partners in a law firm might insure each other to cover potential losses and ensure the business’s continuity.
Difference between economic and sentimental insurable interest
In life insurance, insurable interest doesn’t always have to be economical. Sometimes, sentimental interest based on love and affection is enough. This means that relationships by blood or marriage alone can create insurable interest.
For example, according to Pennsylvania law, if you are related to someone by blood or marriage, your insurable interest can be based on love and affection. However, if you are not related, you must have a financial interest in the insured person staying alive.
However, just because you’re related to someone doesn’t mean you can buy life insurance on any family member you want. Insurable interest is typically recognized in the following family relationships without the need for financial proof:
- Spouse/spouse relationship
- Parent/child relationship
- Grandparent/grandchild relationship
- Siblings
On the other hand, these family relationships tend not to be automatically recognized as having insurable interest:
- Cousins
- Uncle/nephew
- Uncle/niece
- Aunt/nephew
- Aunt/niece
- Parent-in-laws
- Stepparent/stepchildren
Understanding the difference between economic and sentimental insurable interest is crucial for determining who you can insure and that the policy serves its intended purpose of providing financial security.
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Whole life insurance combines life insurance with an investment component.
- Coverage for life
- Tax-deferred savings benefit if premiums are paid
- 3 variations of permanent insurance: whole life, universal life and variable life include investment component
Term life insurance is precisely what the name implies: an insurance policy that is good for a specific term of time.
- Fixed premium over term
- No savings benefits
- Outliving policy or policy cancellation results in no money back
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What is proof of insurable interest?
Proof of insurable interest is part of the initial life insurance application. Insurable interest and consent of the insured person is a requirement before a life insurance company can approve and issue a life insurance contract. Consent is typically given by signing the life insurance application or policy. A phone interview conducted between the life insurance company and the person buying insurance or the person listed as the life insurance beneficiary may also serve as consent.
If you purchase a life insurance policy as the policyholder and insured, insurable interest automatically exists for you and your beneficiaries. In a direct relationship, either through blood, marriage or adoption decree, insurable interest is generally easy to prove based on the relationship status. In a business partnership, such as a corporation purchasing a life insurance policy on a key officer, a business contract or other form of proof that the company will experience financial hardship and loss upon the insured’s death is needed.
What if you do not have insurable interest?
If you do not have an insurable interest in the insured person, you cannot buy a life insurance policy on them. Life insurance companies require insurable interest as a precautionary measure against wagering, homicide or other mortal perils. If a life insurance application does not demonstrate clear insurable interest, the insurer may request an explanation. If the explanation is unsatisfactory, the insurer will reject the application.
It’s important to remember that insurable interest only needs to exist when the policy is purchased. For example, you can take out a life insurance policy on yourself and name your spouse as the beneficiary. If you later decide to change the beneficiary to a friend, you are allowed to do so, as the insurable interest requirement was satisfied when the policy was initially approved.
All-in-all, without proving insurable interest, the life insurance application will not be approved. This helps keep the life insurance industry’s integrity intact and ensures that policies serve their intended purpose of providing financial security rather than enabling misuse.
Types of life insurance
When you take out a life insurance policy, you have several choices to make. The amount of coverage and the type of life insurance needed are the first decisions to make.
- Term life insurance: Term life insurance offers temporary coverage. The coverage amount and premium paid stay the same for a certain length of time, usually between 10 and 30 years. You may choose to renew the policy at your current age when it expires, convert it into a permanent life insurance policy before it expires based on your insurer’s terms or let it cancel if you no longer need the coverage. Keep in mind that renewing term life insurance will mean that your premium will be assessed at your current age and health status and may result in higher costs. Additionally, if you choose to convert your term life policy to a permanent one, your premiums will increase since permanent life insurance is more expensive than term coverage.
- Permanent life insurance: Permanent life insurance provides coverage for your entire life as long as the premiums are paid, though coverage limits typically max out between ages 90 to 121, depending on the policy terms, so it may not technically be lifelong if you outlive those ages. The initial cost is higher, but it can be more cost-effective if you outlive the term policy. While term life may be a good choice to cover temporary needs like debts and childcare, permanent life insurance could be better for building cash value and covering end-of-life needs, like funeral expenses.
Frequently asked questions
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In community-property states, life insurance regulations can differ significantly because anything acquired during marriage, including life insurance policies and their death benefits, is considered community property. This means that both spouses have equal ownership of assets acquired during the marriage, regardless of who paid for them or whose name is on the title.
For example, if a husband purchases a life insurance policy using community funds (income earned during the marriage) and names his mother as the beneficiary, his mother may not be able to legally claim the full death benefit. In such cases, the wife may have a right to 50 percent of the death benefit, as it is considered community property. This regulation ensures that both spouses’ interests are protected in the distribution of marital assets. Community-property states include:
- Arizona
- California
- Idaho
- Louisiana
- Nevada
- New Mexico
- Texas
- Washington
- Wisconsin
In these states, it’s important to consider community-property laws when designating beneficiaries for life insurance policies purchased with community funds. Consulting with a legal or financial advisor can help ensure that your beneficiary designations comply with state regulations and that your intended recipients receive the benefits as planned.
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To purchase a life insurance policy for your parent, you must have their consent. If you will not be able to afford medical bills, funeral costs or other future expenses when they pass, it may be worthwhile to have a conversation with your parent about life insurance.
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You may purchase life insurance for your child’s parent if you have their consent, as insurable interest is generally automatic in this case. For example, if you co-parent with your child’s mother or father and they provide child support or alimony, this relationship typically establishes insurable interest because you or your child would experience financial hardship in the event of the other parent’s death.
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No. You cannot buy life insurance on anyone you want. Whether you want to buy term life insurance or permanent life insurance, like whole life insurance, on someone else, you need their consent and proof of insurable interest. A life insurance contract without insurable interest is considered wagering and illegal.
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