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Reforming insurance law: insurable interest

A person who takes out insurance must have an 'insurable interest' in the subject matter of the cover – otherwise, the contract will be invalid andd may even be illegal in some instances.

This guide is based on the law of England and Wales. It was last updated in April 2015.

 Broadly speaking, having an insurable interest means that the person buying the cover benefits from the safety and wellbeing of the thing insured, or freedom from liability in relation to it. Alternatively, that person would be prejudiced by damage or loss to the thing insured, or the existence of liability in relation to it.

Historically, insurable interest has been required to prevent "moral hazard", or bad faith; and to distinguish insurance from other activities, such as gambling. But with betting now made legally respectable, and with 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?

Responses to two consultation papers published by the English and Scottish Law Commissions in 2008 (2008 consultation) and 2011 (2011 consultation) were mixed on the issue, leading the law reform bodies to conclude that many of the problems with the current law were "theoretical rather than practical" and that law reform of the doctrine of insurable interest was not a priority. However, following a request on behalf of life insurers from the Investment and Life Assurance Group (ILAG), the Law Commissions begun a third consultation in March 2015 (2015 consultation).

According to ILAG, UK life insurers are under pressure to write policies which include cover for children and cohabitants, and to insure "key employees" for substantial amounts. Under the current law, strictly applied, these policies could be considered void while some court cases in England have even labelled them as "illegal". Although the Law Commissions believe it is "unlikely" that anyone would take issues like these to court, the 2015 consultation states that "it is unsatisfactory to have law which is so old and out-dated that the only way in which the market can function is by ignoring it".

In this guide we provide an overview of the inconsistencies in the law of insurable interest, how it is currently applied for different types of insurance – indemnity and life insurance – and what some of the most recent proposals are from the Law Commission for update and reform.

Inconsistencies

The current law on insurable interest is complex and often inconsistent. Even the Law Commissions have admitted that they had trouble analysing it. A large chunk of the doctrine may even 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. For example, the names of all interested parties must 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.

Indemnity insurance

Indemnity policies include most property cover, insurance on goods and liability insurance. It has long been established that indemnity policies require an insurable interest in the subject matter which generally has to be shown at the time of the loss. Insurance policies without insurable interest are unenforceable because they are "wagers".

However, the 2005 Gambling Act introduced uncertainty when it made gambling contracts enforceable in law and, in doing so, arguably removed the requirement in English law for an insurable interest in indemnity insurance. It is still a criminal offence to take out marine cover without insurable interest under the 19090 Marine Insurance (Gambling Policies) Act.

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 was 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 from other risk transfer mechanisms, which are subject to separate regulatory and tax regimes.

Nowadays, 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 Financial Conduct Authority (FCA), is the "assumption of risk" by the provider.

Proposals for indemnity insurance

Having considered these factors, the Law Commissions tentatively concluded in the 2008 consultation that insurable interest in indemnity insurance was no longer necessary. In their view the indemnity principle, which requires the policyholder to show actual loss, was a sufficient safeguard against dishonesty. However, many respondents argued that the principle is still important for four main reasons: it is the hallmark of insurance, it reinforces market discipline, it acts as a barrier to invalid claims, and it may have other specific uses, for example, the requirement may help define where the insurable interest is located which is increasingly important for tax and regulatory purposes.  Accordingly, the Law Commissions agree that, given the doctrine is to be retained, it is desirable to provide a clear statutory basis for the requirement of insurable interest. 

The Law Commissions' do not propose to change the substance of the current law on what constitutes insurable interest, but do recommend that the requirement for insurable interest for all types of insurance should be set out in a new statute. The 2015 consultation  suggested a non-exhaustive list of what constitutes insurable interest, but stressed that the concept should be left open-ended so that it could be developed further by the courts.

The proposed wordingis: "an insured has an insurable interest if the insured has:

(1) a right in the property which is the subject matter of the insurance or a right arising out of a contract in respect of it;

(2) possession or custody of the insured subject matter;

(3) a reasonable prospect (or similar) either of an economic benefit from the preservation of the insured subject matter, or of an economic loss on its damage or destruction, which would arise in the ordinary course of things.

A full list of the Law Commissions' current proposals from the 2015 consultation are included below.

Life insurance

Currently, for a life insurance policy (or other non-indemnity insurance such as personal accident or critical illness) to be valid, an insurable interest must be held when the policy is taken out. This rule dates back to the 1774 Life Assurance Act, 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. 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 2004 Civil Partnership Act extended this to civil partners. A further category is an interest established by statute, as in the case of the civil partnership legislation.

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.

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 any of 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 fiancé(e) 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.

Proposals for life insurance

In the case of life insurance, the Law Commissions propose to restate the law of insurable interest but with some modifications. In particular, the category of those who could insure the life of another on the basis of financial loss would be widened. Instead of having to show a potential financial loss recognised by law, the test would be based on a reasonable expectation of economic loss.

In the 2015 paper, the Commissions agree with feedback from the industry that their previous proposals to extend the "natural affection" insurable interest requirement to other relationships, in addition to spouses, but to impose certain restrictions were too cautious and would not allow for a developing market or changing family structures. They now favour leaving the issue of whether a particular form of insurance may amount to a 'moral hazard' to the good sense of the industry or, failing that, to regulatory rather than statutory intervention.

The Law Commissions also propose that the trustees of pension or group schemes should have an unlimited insurable interest on the lives insured. At present, pension fund trustees often insure the lives of their members but the legal basis for doing so is unclear. The paper asks whether employers that sponsor group schemes offering employee benefits should have a similar insurable interest.Lastly, the requirement that the names of all interested parties be listed in a life policy, otherwise that policy is illegal, would be abolished.

 

Here is a full list of the Law Commissions' proposals from the 2015 consultation:

Proposals for indemnity insurance

Timing and consequences - concluding a valid insurance contract

Proposal 1: An insurance contract is void for lack of insurable interest unless the policyholder has an insurable interest at the time the contract is made or there is a reasonable prospect (or similar) at that time that the policyholder will acquire some form of insurable interest during the life of the contract.

Proposal 2: If the insured actually acquires an insurable interest at any time during the duration of the contract, this should be conclusive proof that they had such a reasonable prospect (or similar) at the time of the contract.

Timing and consequences - when the insured can make a claim

Proposal 3: To make a claim, the insured must have an insurable interest at the time of the loss.

Timing and consequences - consequences for lack of insurable interest

Proposal 4: If an insurance contract is void for lack of insurable interest, the insurer should not be entitled to sue for premium, and the insured is entitled to a refund of premiums already paid.

Repealing obsolete statutes

Proposal 5: The Marine Insurance (Gambling Policies) Act 1909 should be

Repealed.

Proposal 6: The Marine Insurance Act 1788 should be repealed.

Retaining the provisions on insurable interest in the Marine Insurance Act 1906

Proposal 7: For marine insurance, sections 4 to 15 of the Marine Insurance Act 1906 should be left as they are.

Defining insurable interest

Proposal 8: Statute should define insurable interest for the purpose of indemnity insurance using a non-exhaustive list of examples of insurable interest.

Proposal 9: The statute should state that an insured has an insurable interest if the insured has:

(1) a right in the property which is the subject matter of the insurance or a right arising out of a contract in respect of it;

(2) possession or custody of the insured subject matter; or

(3) a reasonable prospect (or similar) either of an economic benefit from the preservation of the insured subject matter, or of an economic loss on its damage or destruction, which would arise in the ordinary course of things.

Consultation questions

Question A: Do you agree that the law of insurable interest in indemnity insurance should be clarified in statute?

Question B: Do you agree in broad terms with these proposals?

Question C: Do you have any detailed comments on these proposals?

 

Proposals for life insurance

An insurable interest based on economic loss

Proposal 10: An insured has an insurable interest where there is a reasonable prospect (or similar) that the insured will retain an economic benefit on the preservation of the life insured or incur an economic loss on death.

Proposal 11: There should be no statutory limit on the amount for which the insured may obtain insurance over the life insured.

Natural affection - cohabitants

Proposal 12: A person should have an insurable interest in the life of another, irrespective of whether they can show economic loss, where they live together as spouses when the insurance is taken out.

Natural affection - children

Proposal 13: (1) Parents should be entitled to take out insurance on the lives of their children of any age, without evidence of economic loss. (2) There need not be a statutory cap on the amount which can be insured.

Trustees of pension or group schemes

Proposal 14: Trustees of pension and other group schemes should have an unlimited insurable interest in the lives of the members of the scheme.

Proposal 15: An employer should also have an unlimited interest in the lives of its employees when entering into a group scheme whose purpose is to provide benefits for its employees or their families.

Repealing section 2 of the Life Assurance Act 1774

Proposal 16: Section 2 of the Life Assurance Act 1774 should be repealed.

A new statutory requirement for insurable interest

Proposal 17: There should be a statutory restatement of the requirement of insurable interest for the purpose of life insurance which replaces the requirement set out in the Life Assurance Act 1774. This should also include a non-exhaustive list of insurable interest in contingency insurance.

Proposal 18: If an insurable interest is not present, the policy should be void but not illegal.

Proposal 19: For composite policies, where an insurable interest is present for some part of the insurance but not others, the policy should be treated as separable.

Proposal 20: For contingency insurance, insurable interest must be present at the time of the contract. It need not be present at the time of the loss in order to make a claim.

Consultation questions

Question D: Do you agree that there is a need for statutory reform in this area?

Question E: Do you agree that the concept of insurable interest should be expanded for life and other non-indemnity insurance along the lines proposed?

Question F: Do you have any detailed comments on these proposals?

Question G: In particular, do you think that people should be entitled to take out insurance on the lives of their grandchildren without evidence of financial