Insurable interest

Insurable interest is the requirement that a policyholder stand to suffer a genuine financial loss if the insured event happens. It keeps insurance from becoming a wager and reduces the incentive to cause a loss. A policy bought without it is generally unenforceable, and a claim without it can be denied.

For property, the test is applied at the time of loss. Owners have an interest, but so do tenants responsible for improvements, lenders with a mortgage, contractors with unpaid work in a building and a bailee holding customers' goods. The interest need not be ownership. It is measured by what you would lose, so a lender's interest is limited to the unpaid debt. A seller who has closed on a building and transferred title before a fire has none left to claim.

For life insurance, the interest must exist when the policy is issued. A business has one in an owner, officer or critical employee whose death would cost it money, in a partner under a buy-sell agreement, and, as a creditor, in a debtor's life to the extent of the debt. State consent laws and, for employer-owned policies, the notice and consent rules of IRC section 101(j) add further conditions. Document the reason for each policy at purchase. The guides on key person insurance: protecting the business from a loss of talent and Employer-owned life insurance: notice and consent rules under IRC 101 cover the business side, and indemnity explains the principle behind it.