What is an 'Insurable Interest'

An insurable interest is a stake in the value of an entity or event for which an insurance policy is purchased to mitigate risk of loss. Insurable interest is a basic requirement for the issuance of an insurance policy, making it legal and valid and protecting against intentionally harmful acts. Entities not subject to financial loss from an event do not have an insurable interest and cannot purchase an insurance policy to cover that event.

BREAKING DOWN 'Insurable Interest'

Insurance is a method of pooled risk exposure, and it protects policyholders from financial losses. A number of insurance tools have been created to cover losses related to automobile expenses, health care expenses, loss of income through disability, loss of life and damage to property.

Principle of Indemnity

The indemnification principle holds that a policyholder should be compensated for a covered loss, but that holders should be neither penalized nor rewarded by a loss. This suggests that policies should be designed to cover the value of the at-risk asset appropriately. Poorly conceived or poorly designed policies create moral hazard, in which parties have incentive to allow or even affect a loss. If moral hazard is too prominent, it would increase the costs to insurance companies, thereby driving up premiums to unsustainable levels.

Identifying Insurable Interest

Homeowners insurance compensates a policyholder who suffers a major financial loss in the event that his home is destroyed by a fire. The homeowner has insurable interest in the property; the loss of that home would create a catastrophic loss for the policyholder.

You cannot purchase homeowners insurance on a neighbor's house. There is no insurable interest in a neighboring property, because it is owned by another entity. If a neighboring property is destroyed, but your property is unaffected, then there has not been an insurable loss. Purchasing homeowners insurance for a neighbor’s house creates incentive to cause damage to that house and collect the insurance proceeds, whereas appropriate underwriting would not create such an incentive. That is an example of moral hazard.

Insurable interest is also necessary in life insurance, though this has not always been the case. There are anecdotes of people buying life insurance policies on elderly acquaintances strictly with the expectation of that person's imminent death. Life insurance regulations have evolved to require a relationship in which the policy owner will suffer a financial loss in the event of the insured's demise. This can include immediate family members, more distant blood relatives, romantic partners, creditors and business associates. The face value of life insurance policies must not exceed human life value of the insured, otherwise the indemnity principle would be violated, creating moral hazard.

RELATED TERMS
  1. Life Insurance

    A protection against the loss of income that would result if ...
  2. Assessable Policy

    A type of insurance policy that may require the policyholder ...
  3. Total Insurable Value

    Total insurable value is the value of property, inventory, equipment, ...
  4. Insurance

    A contract (policy) in which an individual or entity receives ...
  5. Cover Note

    A temporary document issued by an insurance company that provides ...
  6. Key Person Insurance

    A life insurance policy that a company purchases on a key executive's ...
Related Articles
  1. Insurance

    The History Of Insurance In America

    Insurance was a latecomer to the American landscape, largely due to the country's unknown risks.
  2. Insurance

    How To Invest In Insurance Companies

    Knowing the special circumstances that insurance companies operate under helps in evaluating whether or not a listed insurance company is a good investment and whether the economic environment ...
  3. Insurance

    How to Protect Your Income No Matter What

    What does it mean to insure your income? Here are a variety of ways to do it and some insights into when it might make sense to invest in income insurance.
  4. Insurance

    Exploring Advanced Insurance Contract Fundamentals

    Understanding your contract can help you protect our family's financial security.
  5. Insurance

    Do You Need Casualty Insurance?

    Find out how different types of coverages can protect you and which policy is right for you.
  6. Insurance

    4 Things That Keep You From Getting Life Insurance

    We look at four common reasons people give for not applying for life insurance, and see if they're legitimate.
RELATED FAQS
  1. What is the average return on total revenue for the insurance sector?

    Learn about the three main segments of the insurance industry, and find out what the average return on revenues is for the ... Read Answer >>
  2. Can your insurance company cancel your policy without notice?

    Learn about your rights as an insured when it comes to your insurance policy being canceled, including how to access your ... Read Answer >>
  3. What are some examples of industries that practice price discrimination?

    Understand the various types of insurance coverage offered in the insurance marketplace, and learn why each policy should ... Read Answer >>
  4. What are some examples of when insurance bundling is a bad idea?

    Learn about situations where insurance bundling may not be a favorable option. Bundling insurance is often a good idea, but ... Read Answer >>
Hot Definitions
  1. Straddle

    An options strategy in which the investor holds a position in both a call and put with the same strike price and expiration ...
  2. Trickle-Down Theory

    An economic idea which states that decreasing marginal and capital gains tax rates - especially for corporations, investors ...
  3. North American Free Trade Agreement - NAFTA

    A regulation implemented on Jan. 1, 1994, that eventually eliminated tariffs to encourage economic activity between the United ...
  4. Agency Theory

    A supposition that explains the relationship between principals and agents in business. Agency theory is concerned with resolving ...
  5. Treasury Bill - T-Bill

    A short-term debt obligation backed by the U.S. government with a maturity of less than one year. T-bills are sold in denominations ...
  6. Index

    A statistical measure of change in an economy or a securities market. In the case of financial markets, an index is a hypothetical ...
Trading Center