Whenever you buy a life insurance policy there has to be an insurable interest between you and the person who’s life you are insuring or designating as a beneficiary. The insurance company will require this interest in order to write the policy, and it is standard throughout the industry.
But what is an insurable interest? For the purpose of life insurance, it is a relationship in which one party will suffer financial loss in the event of the death of the other.
This provision would make it impossible for a stranger to take a life insurance policy on you, and benefit as a result of your death. The stranger simply has no insurable interest in your life, and would be prohibited from taking the policy.
Here are some examples of people who qualify as having insurable interest in you for life insurance purposes.
Yourself
This means that you are free to take a life insurance policy on your own life for the benefit of anyone that you choose, or for any specific purpose. There is no limit on this kind of coverage. You can even name a charity as your designated beneficiary if that is what you choose to do.
Your immediate family
These are the most obvious people having an insurable interest in your life. Not only are they closely related by blood, but they may be dependent upon your financial resources for their survival. Because they are close relations, you can choose to name them as beneficiaries even if they do not rely upon your finances.
Family can include your spouse, your children, your parents, or your brothers or sisters. It can also include extended family members if there is a demonstrated dependence upon your financial resources.
You are only required to have an insurable interest at the time the policy is taken. For example, you can take out a policy on your life when your children are young and dependent upon your income, but the policy will still pay out to them 20 years later when they are no longer your financial responsibility.
The situation also happen in the event of divorce. You can maintain a life insurance policy on an ex-spouse, because their death could result in a financial hardship for you, particularly if you have young children.
A business partner
Immediate family members are not the only parties who can have an insurable interest. Business partners are very common candidates. Many partnerships and small businesses maintain life insurance policies on the principles so that they can complete a buy/sell agreement that provides life insurance proceeds to the other business partners so they can buy out your interest in the business in the event of your death.
This is also a way to help keep the business running after your death, something that would be impossible without additional financial resources that life insurance provides.
An employee
An employer can also have an insurable interest in an employee, and this is especially true when the employee is considered to be a particularly important one. Employers have policies referred to as key man policies that cover particularly significant employees in the event of their death.
If the employee regularly makes important contributions to the operation of the business, or if the future of the company will be in doubt in the event of the employee’s death, the employer may maintain an insurance policy on his or her life to provide resources to cover losses from his or her absence and provide money to hire a replacement.
A creditor
Creditors also have an insurable interest in the lives of their borrowers. This makes perfect sense when you consider that a borrower’s death will mean that the loan will no longer be serviced.
The creditor can take a chance that the debt will be paid out of the borrowers estate or other insurance proceeds, but that is never guaranteed. For that reason, a creditor may require that you take a credit life insurance policy that is specifically established for the purpose of paying off the loan in the event of your death.
