Insurable interest in the life industry

Dalene Allen, underwriting expert and co-founder of specialist long-term risk cover provider Altrisk, looks at the issues around insurable interest.

The basic principle of insurance is to protect against loss rather than create an opportunity for speculative gain. Based on this premise, the concept of ‘insurable interest’ plays a pivotal role in ensuring that there is a legally recognisable economic relationship between the proposed insured and the proposed beneficiary – and that the beneficiary benefits more from the continued life of the insured. Insurable interest, when it pertains to underwriting for a life policy, is about protecting the interests of the life covered and guarding against the potential for fraud.

The intention or temptation on the part of the insured or any other person to bring about the insured event sooner is known as moral hazard. The sum assured proposed must also be reasonable in relation to the insured’s needs and lifestyle.

Insurable Interest explained

If you want to buy a life insurance policy on someone else's life, you must have an interest in that person remaining alive, or expect financial loss from that person's death. This is called an insurable interest. The insurable interest requirement prevents people from buying life insurance on someone’s life and then causing or hastening that person's death.

Basic principles of insurable interest

• Each individual has an unlimited insurable interest in his or her own life, and therefore can select anyone as a beneficiary.
• A husband and wife have an insurable interest in each other because of the marriage relationship.
• Creditor-debtor relationships give rise to an insurable interest. The creditor can be the beneficiary for the amount of the outstanding loan.
• Business relationships can give rise to an insurable interest.

An insurable interest must be present when the insurance policy is taken, but not necessarily when a claim occurs. For example, business partners could take out policies on each other’s lives but the policies will remain valid even if the partnership dissolves.

Identifying irregularities and moral hazards

While the underwriter evaluates as critically as possible at the underwriting stage, irregularities can often only be identified at claim stage. In a recent case, underwritten according to the facts provided at the time, a client obtained key man cover for one of his employees – a high-income individual critical to business success. The life assured’s accidental death led to a claim, at which point it was discovered that cover had been taken out through several companies.

Further investigation uncovered that the ‘key man’ was in fact a recently contracted, low-income worker.

Questioning insurable interest at underwriting stage is not only in the company's best interest but also in the best interest of the life assured.

Broker’s role

As a broker, always look at the reasons for cover. They are often legitimate but still beg asking the question – does it makes sense? For example: Why would an employer take out ‘key man’ cover on a low income employee? Why would a distant relative take out cover on an elderly, infirm aunt?

Cover should also be in direct proportion to the anticipated loss, for example, a loan of R500 000 does not require cover for R1 million. In buy-and-sell agreements, the changing value of a business needs to be considered with cover being amended as needs change.

Insurance companies and financial advisors have a duty to exercise reasonable care in determining whether insurable interest exists and whether the consent of the insured has been obtained.