Do we still need insurable interest?
This guide is based on the law of England and Wales. It was
last updated on 14th February 2008.
A person who takes out insurance must have an insurable interest
in the subject matter of the insurance, otherwise the contract will
be invalid. In some instances, it may be illegal.
What is an insurable interest? In broad terms, it means the
person buying the cover must benefit from the safety and well-being
of the thing insured or his freedom from liability in relation to
it. Alternatively, he would be prejudiced by its damage or loss, or
the existence of liability.
Historically, insurable interest has been required to prevent
"moral hazard" (bad faith) and to distinguish insurance from other
activities, such as gambling.
But with betting now made legally respectable and regulatory and
tax authorities using a number of other factors to define what is
and is not insurance, does the doctrine still serve a purpose?
This is the question addressed by the English and Scottish Law
Commissions in their latest issues paper on insurance law reform,
published on 14th January 2008.
Confusion
The law on insurable interest is complex and often inconsistent.
Even the Law Commissions admit they had trouble analysing it. A
large chunk of the doctrine appears to have been abolished by
accident under the Gambling Act 2005, which made gambling contracts
enforceable in law for the first time.
Other statutory remnants still apply, such as a requirement that
the names of all interested parties be listed in a life policy,
otherwise the policy is illegal (although group policies can be
taken out for the benefit of members of a stated class). It is also
a criminal offence to take out a contract of marine insurance
without insurable interest.
In recent years, however, the English courts have been
stretching the boundaries of insurable interest rather than hold a
policy invalid on what is often seen as a technicality.
Life insurance
In life insurance (and other non-indemnity insurance such as
personal accident and critical illness) an insurable interest must
be held when the policy is taken out.
The rule dates back to the Life Assurance Act 1774 when the
legislature’s concern was to prevent a “mischievous kind of gaming”
by stopping people from taking out insurance on the lives of
distant family members or public figures.
Newspapers at the time were publishing the odds on celebrity
survival (there are websites doing something similar today). There
were even concerns that the practice might encourage murder.
Since then, case law has limited those who have an insurable
interest arising out of “natural affection” to the person whose
life is being insured and their spouse. The Civil Partnership Act
2004 extended this to civil partners.
Anyone else (such as an employer taking out key man insurance)
has to show an interest arising out of a potential financial loss
recognised by law – and the amount insured is limited to the value
of that loss. In the case of an employee, this might only cover the
contractual notice period. In group life schemes, it may also
prevent the employer offering benefits to employees' families
A further category is an interest established by statute (such
as the Civil Partnership Act). In recent years, the court
has also recognised other types of interest held at the time of the
contract which do not fit neatly into the other
categories.
In practice, the restrictions on life insurance are frequently
avoided by an individual taking out cover on his own life and
assigning it to whom he likes.
In addition, many insurers will provide cover on the life of a
cohabitee or fiancée and these contracts will be upheld by the
Financial Ombudsman Service. The danger in stretching the rules, of
course, is that an insurer's liquidator, administrator or reinsurer
may not take the same view.
Indemnity insurance
Until recently, indemnity policies (such as most property cover,
insurance on goods and liability insurance) also required an
insurable interest in the subject matter. Generally, this had to be
shown at the time of the loss. Insurance policies without insurable
interest were unenforceable because they were "wagers".
But the Gambling Act 2005 made gambling contracts enforceable in
law and, in doing so, has probably removed the requirement in
English law for an insurable interest in indemnity insurance. Under
the Marine Insurance (Gambling Policies) Act 1909, however, it is
still a criminal offence to take out marine cover without insurable
interest.
All indemnity policies are also subject to the indemnity
principle, which dictates that the insured cannot recover more than
he has actually lost.
One anomaly is valued policies - non-indemnity policies taken
out on property that pay out a set amount regardless of actual
loss. Requirements for insurable interest in a valued policy differ
according to the subject matter but the law in this area is very
unclear. If there were no need for insurable interest, such
contracts would be very similar to credit derivatives.
This touches on another argument in favour of retaining
insurable interest - it distinguishes indemnity insurance contracts
from other risk transfer mechanisms, which are subject to separate
regulatory and tax regimes.
Nowadays, however, authorities look at a range of
features to identify what is and is not insurance. Insurable
interest is no longer a deciding factor. More important, according
to the FSA, is the “assumption of risk” by the provider. The Law
Commissions are satisfied that it is not necessary to preserve the
doctrine for these purposes.
Proposals
The Law Commissions tentatively conclude that insurable interest
in indemnity insurance is no longer necessary. The indemnity
principle, which requires the policyholder to show actual loss, is
sufficient safeguard against dishonesty.
But should insurers be required to ask whether there is
sufficient possibility of loss before the contract is made? The Law
Commissions believe most insurers do this already for underwriting
purposes. Arguably, it falls within the duty to treat customers
fairly (by not selling them a policy which is void for lack of
insurable interest).
In the case of life insurance, however, there is still unease
about allowing people free rein to insure the lives of strangers.
The Commissions, therefore, propose retaining insurable interest,
but with some modifications.
It would expand the "natural affection" category to include
co-habitees and dependent children and parents, and asks what
should be done about other relationships, such as fiancées,
siblings, grandparents and grandchildren.
In the "pecuniary interest" category, a reasonable expectation
of economic loss on the death of a life insured would be
sufficient. Key man insurance, for example, would be able to cover
reasonable expectations of future lost business.
The Commissions ask whether there should be special rules for
group life schemes. Should employers taking out group life
cover be exempt from the requirement to show a reasonable
expectation of loss, enabling them to offer unlimited benefits to
the employee and his family?
They also tentatively suggest that, when pecuniary interest or
natural affection cannot be shown, the consent of the life insured
should provide an alternative method of establishing insurable
interest.
As for the grey area of valued policies (non-indemnity insurance
of property), the Commissions ask for more information and for any
comments on whether the requirement for insurable interest should
continue.
Policies without insurable interest would be void rather than
illegal (so premiums would be returnable). Other tidying up
measures would include abolishing the need for interested parties
to be named in the policy.
Next steps
The Law Commissions ask for any comments on insurable interest
to be submitted by 11 April 2008. The responses will be taken into
account in the Commissions' second consultation paper, which will
also deal with issues of post-contractual good faith (including
fraud and damages for late payment of claims).
The consultation period for the Law Commission's paper on
pre-contract information and warranties closed in November 2007.
The Commission is planning to publish a summary of responses in
April 2008. The final report and a draft Bill are planned for
2010.
Contact: Colin Read (colin.read@pinsentmasons.com /
020 7418 7305)
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