Insurable Interest
A financial stake in an insured person or property such that the policyholder would suffer real loss if the insured event occurred.
What is Insurable Interest?
Insurable interest is a legal requirement that a person or organization purchasing insurance must have a legitimate financial interest in the subject of the policy — meaning they would suffer a real financial loss if the insured person died, became disabled, or if the insured property were damaged or destroyed. The insurable interest requirement exists to prevent wagering on the misfortune of strangers and to reduce moral hazard. For life insurance, insurable interest must exist at the time the policy is issued; for property insurance, it must exist at the time of the loss. Spouses, business partners, employers insuring key employees, and creditors insuring debtors' lives are common examples of valid insurable interest relationships.
Example
A bank extends a $2 million loan to a sole proprietor and requires him to assign a life insurance policy equal to the loan balance to protect the bank's financial interest. The bank has insurable interest in the borrower's life to the extent of the outstanding debt. If the borrower dies before repaying the loan, the bank receives the proceeds and applies them to the balance.
Source: National Association of Insurance Commissioners — Life Insurance