Explained: What is insurable interest?

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When 22-year-old Mehul Dadhich got his first job, he instantly decided to buy a life insurance for himself considering the benefits of young age and low premiums. He made his father the nominee in the policy. At the same time, he decided to take another life cover for his childhood best friend who recently lost his father due to Covid-19 infection. However, this request was declined by the insurance company stating a lack of ‘insurable interest’ on Mehul’s part to be eligible to buy the policy for a friend.

If you derive financial benefits from the continuous existence, without repairment or damage, of an insured object, it is known as insurable interest. It is based on the relationship between the insured and the beneficiary (nominee). In simple terms, one has an insurable interest in something if they’re likely to suffer a loss in case the insured object was lost or damaged. At the same time, you would benefit from its continued existence and overall safety. It is the level of financial hardship that one is assumed to suffer from the loss or damage to something they’ve insured.

Why insurable interest?

In insurance contracts, one must have an insurable interest in the property, person, or other goods. Otherwise, the policy is not deemed legal and hence not enforceable. This is because insurable interest works on the principle of indemnification that requires insurance policies to compensate a policyholder for the losses covered.

In the above case, Mehul was denied insurance for his friend because apparently, he doesn’t derive any financial benefits from the concerned friend. Thus, in the eyes of the insurance company, he isn’t expected to suffer any financial loss from any mishap that may occur with the friend. Thus the need for insurance stands null and void.

Who can have insurable interest?

Your blood relations, i.e., parents, spouse, children, and others whose financial dependence on you can be proved to have an insurable interest. They will be exposed to a potential financial risk after your demise. The pay-out received from your life insurance policy can help them deal with impending and regular expenditures to lead a comfortable life. If Mehul’s childhood friend was his cousin or a dependent on him, an insurable interest could be found here. But that wasn’t the case.

Your employer and creditors also have due insurable interest in you. If your loss would cost your employer a great deal since your services are invaluable (eg. you’re the chief executive officer or heading a key department), the company can get you a life insurance policy. The company pays monthly premiums and will get the sum assured in case of your sudden demise.

Your personal loan creditor, or any creditor for that matter, can also buy life insurance in your name to suffice the financial loss in case of an unfortunate event. However, the creditor must take your consent and the sum amount must not be more than total debt you’re liable to pay off.

Insurable interest avoids frauds

The concept of insurable interest is relevant because it ensures your dependents are not deprived of the financial benefits from your policy. Nobody can take undue advantage of your claim proceeds and thus from a larger point of view, this helps to reduce fraud as well.

By establishing a distinct relationship between the insured and beneficiary (nominee), the insurance company is assured that the claim proceeds will go into the hands of the deserved and needy.