Why do life assurance policies require insurable interest?

• Without insurable interest a contract of insurance or life assurance is void.
  
  
• The Life Assurance Act 1774 does not indicate what type of interest is required but subsequent case law and statutes have established four categories.
  
  
• Natural affection is one category and enables an individual to insure his/her own life, or the life of his/her spouse.
  
  
• Decided cases have established that the interest only has to exist at the inception of the contract and not at the time of loss.
  
  
• The Law Commission of England & Wales and the Scottish Law Commission have been asked to simplify and reform the law relating to insurable interest.

The doctrine of insurable interest states, broadly speaking, that in order to have a valid policy of insurance/assurance, the policyholder must:

• Gain a benefit from the continued existence of the item being insured; or
  
  
• Suffer a loss on its destruction.

This concept applies to all forms of assurance and insurance – not simply life assurance.

Without insurable interest a contract of insurance or life assurance is void.

The Life Assurance Act 1774 is for regulating Insurances upon Lives, and for prohibiting all such Insurances except in cases where the Persons insuring shall have an Interest in the Life or Death of the Persons insured.

Own life and life of spouse

Natural affection enables an individual to insure his/her own life, or the life of his/her spouse. The class is therefore extremely limited. Anyone who falls within these classes of natural affection will not need to prove that they have a pecuniary interest recognised by law in the life insured.

In cases of interest established by natural affection, there is no legal limit on the sum insured.

Other family relationships

Other family relationships do not - in the absence of potential financial loss, or statutory provision - give rise to a right to insure. In English law there is no general right for children and parents to insure each other's lives. There is no insurable interest based on natural affection between siblings, persons related by marriage or between cousins, nephews, nieces, uncles or aunts.

In Scots law, the obligation of aliment gives rise to an insurable interest in certain relationships where none exists in England or Wales.

English law

A child who is a minor could suffer a financial detriment on the death of a parent. However, there is no general statutory right under English law for children to receive maintenance from their parents. An insurance policy taken out by a child on a parent's life would require some sort of specific obligation on the parent (e.g. a maintenance order).

Likewise, a parent does not have an insurable interest in the life of a child. In England and Wales, children have no legal duty to maintain their parents and parents have no insurable interest in the life of their offspring on the grounds of natural affection.

The position in Scots law

In Scots law aliment is a maintenance obligation to "provide such support as is reasonable in the circumstances". The Family Law (Scotland) Act 1985 provides that the obligation of aliment is owed only by:

• Spouses and civil partners to each other;
  
  
• A father or mother to his or her child;
  
  
• A person  to a child who has been accepted by him or her as a child of his or her family
   

For the purposes of establishing insurable interest, a child will have an insurable interest in the life of their parents to the value of the obligation of aliment. The duty of aliment ceases when the child reaches 18 years of age, or 25 years of age if in education or training for a trade, profession or vocation. The insurable interest will exist only for as long as the obligation of aliment is owed. This applies equally to a child accepted as a child of the family.

A child owes no obligation of aliment to their parent; therefore, in Scotland as in England and Wales, a parent has no insurable interest in the life of their child.

As spouses and civil partners are presumed by law to have an unlimited insurable interest in the lives of each other, the obligation of aliment has no additional effect for establishing an insurable interest.

Cohabitants and fiancé(e)s

In the absence of any pecuniary and legal interest, there is no right to insure the life of a cohabitant. Nevertheless the Insurance Ombudsman has indicated that he would enforce such contracts.

Fiancé(e)s have no interest in each other's lives. However, the Insurance Ombudsman stated that he would allow an engaged couple to have an insurable interest in each other's lives on the grounds of natural affection.

Where there is no interest in the life insured based on the grounds of natural affection, the policyholder must show an interest in the duration of the life insured which is pecuniary and recognised by law at the time of the contract. However, unlike the category of natural affection, discussed above, case law and section 3 of the Life Assurance Act 1774 limit the sum payable to the economic value of that interest.

The key elements are therefore that the interest must be pecuniary and recognised by law.

A mere expectancy or hope of future pecuniary benefit from the prolongation of the life insured or of the fulfilment by him of moral obligations owed to the assured, are insufficient to sustain an insurable interest.

Therefore, in order to establish a valid insurable interest in a life, the insured must demonstrate a right recognised by law to a pecuniary amount.

It is possible for an insurable interest in a life to be created (or the requirement waived) by statutory provisions.

Civil partners

The law for registered civil partners has been, in effect, brought into line with the presumption of natural affection that applies to married couples. The Civil Partnership Act 2004 gives a person an insurable interest in his or her civil partner and that interest is deemed to be unlimited.

Married Women's Property Act 1882

A policy of insurance taken out by a husband for the benefit of his wife or children, or by a wife for the benefit of her husband or children creates a statutory trust of the policy in the hands of the executors. The proceeds therefore do not fall within the estate of the deceased person who took the policy out and the benefit can be paid directly to the beneficiary.

This is relevant to insurable interest because it means that parents can take out a policy on their own lives and declare that the benefits are payable to the children.

Interest recognised by the courts that does not fit into any of the above categories are “rare birds”.

In certain situations the Courts have held that insurable interest exists where the general principles discussed above would indicate otherwise.

1. Cases where the Court has defined the subject matter as a particular life of a particular person and where the insurance is to recover a sum on the death of that person. A legal and pecuniary interest in the life insured is necessary.
   
   
2. Cases “in which the Court has recognised interests which are not even strictly pecuniary”. These include cases where insurable interest is based on natural affection and, importantly, cases where it is not necessary to show a pecuniary or legal interest.
    

These situations generally require a decision by the Court. They generally involve group life policies.

When must the interest exist?

Decided cases have established that the interest only has to exist at the inception of the contract and not at the time of loss.

Once the policy has been properly created, the policyholder does not need to continue to hold an insurable interest in the life insured. The contract is still legal if the policyholder has no insurable interest at the time of the death. It is, for example, possible to hold an insurance policy on the life of a divorced spouse.

(This has enabled life policies to be assigned, bought and sold on the Traded Endowment Policies ("TEPS") market.)

Naming interested persons

Section 2 of the 1774 Act requires the person or persons interested in a policy, or for whose benefit the policy is effected, to be named in the policy document. If the interested person is named, it can be established whether or not he or she has an insurable interest. The person interested will commonly be the policyholder.

(The Insurance Companies Amendment Act 1973 allows policies to be for the benefit of unnamed members of a stated class, provided that the members of that class can be identified at any given time. This permits "group life" policies to be offered.)

Amount of recovery

Under section 3 of the 1774 Act, the amount of any recovery is limited to the interest of the policyholder in the life insured.

The principle that insurers cannot recover a sum greater than their interest does not apply to policies where the interest is based on natural affection, - policies on one's own life or the life of a spouse. Here the amount of interest is unlimited.

The 1774 Life Assurance Act imposes a requirement for the policyholder to show an insurable interest in the life insured at the time the contract is taken out.

This interest can be created in the following circumstances:

1. Where the policyholder has a relationship of natural affection with the life insured; (In England and Wales this only covers the policyholder's own life or his spouse, not other family members. In Scotland, additionally, children to whom an obligation of aliment is owed have an interest in the lives of their parents.)
   
   
2. Where the policyholder will suffer a pecuniary loss recognised by law on the death of the life insured;
   
   
3. Where statute 'creates' interest; and
   
   
4. Where the policyholder suffers a loss under a policy on many lives which has been taken out for a substantial period of time.

The interest must exist at the time the policy is taken out. Where the insurable interest is created under categories 2, 3 and 4 above, the amount that can be insured is limited to the amount of interest the policyholder has in the life insured.

Where a policyholder cannot show insurable interest in the life insured, the policy is illegal and claims will not be paid under it.

The Law Commission of England & Wales and the Scottish Law Commission have been asked to simplify and update  the law relating to insurable interest. Draft legislation has been published but at the time of writing it remains draft.

https://www.lawcom.gov.uk/document/insurable-interest-consultation/

Natural affection

The current category of natural affection could be expended so that it covered more than "own life" and the life of a spouse.

The proposal is that insurable interest arising out of natural affection could be held to exist as follows:

1. Any individual - in his or her own life and in the life of his or her spouse or civil partner;
   
   
2. Any individual who is cared for and dependent on his or her parent or guardian - in the life of his or her parent or guardian;
   
   
3. Any parent - in the life of his or her adult child;
   
   
4. Any individual - in the life of his or her cohabitant
    

Where there is a relationship of natural affection between the policyholder and the life insured, then the policyholder should be permitted to insure that life for an unlimited amount.

Legal pecuniary loss

The category of insurable interest supported by a legal pecuniary loss should be amended so that the policyholder has a reasonable expectation of pecuniary or economic loss on the death of the life insured. Policyholders with an interest based on pecuniary or economic loss should be able to insure the life for the value that is equivalent to the reasonable expectation of the loss.

It is proposed that consent of the life insured should provide an alternative ground for establishing insurable interest. This would be available where the policyholder and the life to be insured do not fit within the categories of natural affection or a reasonable expectation of loss.

It is not known when these proposals would be implemented.