Life insurance is an important estate planning tool that many people buy to provide financial support for loved ones and to ensure that their estate will be able to pay estate taxes when they pass away.
The “Insurable Interest Requirement”. In the U.S., a life insurance policy can only be acquired by a person (or entity) who has an “insurable interest” in the life of the insured. This means the person who acquires the policy must have some reason to wish for the insured’s continued life. This requirement for an insurable interest originated in England in the 18th century when Parliament enacted a law requiring an insurable interest to stop the popular practice of wealth investors purchasing life insurance policies on elderly persons and persons accused of capital crimes so they could reap the profits when the person died (by natural or unnatural causes). This law remains in effect in England today, and has been adopted in all of the U.S. states (and the District of Columbia), at least in some form.
Who has an insurable interest? State law in every state (and the District of Columbia) establishes that an individual has an insurable interest in his or her own life and, therefore, may purchase an insurance policy on his or her own life. Most state’s laws provide that a third party who is related to an insured individual by blood or law has an insurable interest in the life of the insured because such relationships are presumably based upon love and affection for one another, which is thought to protect the insured from someone gambling or wagering on the insured’s life. In addition, most state’s laws also provide that third parties who are not related to the insured may have an insurable interest in an individual if the third party has a lawful and substantial economic or financial interest in having the life of the insured continue – for example, a creditor or a business partner. The various state insurable interest laws differ, however, as to whether (and in what circumstances) certain relatives, trustees or trusts have a valid insurable interest in the life of an insured individual.
Why does the insurable interest requirement matter? The existence of an insurable interest is important because if a person or trust purchases a life insurance policy on the life of another individual and it is later determined that the person or trust did not have an insurable interest in the life of the insured individual, the life insurance policy may be deemed void and the insurance company may refuse to pay the death benefit. As a result, before purchasing a life insurance policy, individuals should always discuss with an estate planner whether the person or trust purchasing the life insurance policy has a valid insurable interest in the life of the insured individual.
Want to Learn More? For more information about the insurable interest requirement, see The Elusive Insurable Interest Requirement: Are you Sure the Insured is Insured?, a two-part article that will appear in the July and August 2011 issues of the Probate Practice Reporter. The article was co-authored by Mary Ann Mancini, a partner in Bryan Cave’s Private Client group, and Caitlin Murphy, an associate in Bryan Cave’s Private Client group.