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Understanding the Insurable Interest Requirement for Life Insurance Policies, Part 1

The law which requires a policy owner to have an insurable interest in whatever is being insured seems fairly straightforward.  Under Tenn. Code Ann. § 56–7–101, a person who buys an insurance policy must have an insurable interest in what is being insured.  For example, you can only take out a homeowner’s policy on your own home, and not on the home of a stranger.

In the context of life insurance, the insurable interest rule requires that the beneficiary of the policy suffer some type of loss if the insured were to die while the policy was in effect.

For example, a minor child would have an insurable interest in his or her parents.  An investment firm would have an insurable interest in an entrepreneur to whom it had just given a sizable loan to start a company. In contrast, if a stranger convinced a wealthy senior citizen to let him or her take out a policy insuring the senior citizen’s life, that policy would be void.

As it relates to life insurance, the insurable interest requirement prevents speculators from buying insurance on a person’s life in the hopes that the person dies before the death benefit exceeds the amount of premiums paid.

In practice, the insurable interest requirement is not as simple as it seems.  For example, what if there is an insurable interest at the time the policy is issued, but not at the time the person whose life is insured dies? That question was answered by the Court of Appeals of Tennessee in Trent v. Parker (1979).  In that case, a corporation took out a life insurance policy on its CEO.  The CEO later left the company, and then filed suit against the company asking the court to cancel the policy.  Ruling in favor of the CEO, the lower court voided the policy stating that the company no longer had an insurable interest in its former employee.

The Court of Appeals of Tennessee, however, overruled the lower court, and held that the insured was not entitled to have the policy cancelled.  As the court noted, the company clearly had an insurable interest in its CEO when the policy was purchased.  Therefore, the policy was not invalidated after the CEO left the company.  In other words, the insurable interest requirement only applies to the point in time in which the policy is issued, not when the person whose life was insured dies.  As long as the beneficiary had an insurable interest in the life of the insured at the time the policy was purchased, the policy will remain valid even if that insurable interest disappears.

Another important part of the insurable interest rule is that it does not apply if the person buys insurance on his or her own life. The Supreme Court of Tennessee held, in Peeler v. Doster (1982), that an “individual has an unlimited insurable interest in his own life.” What does that mean in practice? Say, for example, Person A buys a life insurance policy and names Person B a beneficiary of the proceeds when Person A dies. This policy is still valid even if Person B never had an insurable interest in Person A.  In effect, under the insurable interest rule, you can insure your own life and direct the life insurance proceeds to someone who has no interest in your life.  However, you buy a policy in order to insure the life of someone in whose life you have no insurable interest.