New Condo Laws
Insurable interest
Insurable interest—how far will it stretch? Resource kit 90118
By Dan Corbin, CPCU, CIC, LUTC
Insurance practitioners know that although an event under a property insurance policy is covered, that does not necessarily mean that a claimant will be paid. Two additional considerations stand out when determining the legitimacy of a claim: 1) the claimant must be an insured under the policy; and 2) the insured must have an insurable interest.
For the most part, when consumers buy insurance policies, they do not stop to ask if they have an insurable interest, because the whole process is a common and natural part of contemporary living. When most people do think of insurable interest, it is usually in terms of property ownership. Unquestionably, there is an insurable interest in the house or the automobile that is owned.
Legal interests Insurance practitioners, on the other hand, must have a more comprehensive view of insurable interest in order to serve the needs of consumers. Behind every insurable interest is a legal interest, with property rights being just one type. Consequently, without a legal interest, a claimant cannot prevail in enforcing an insurance contract, though named as an insured for a covered event. Legal interests have their origins in common law. However, statutory law and/or new case law may expand or restrict the definition of insurable interest.
Principle of indemnity Insurable interest is so closely tied to legal interest because our society attempts to prevent certain unacceptable behavior which is against public policy. And to do so, it must adhere, as near as possible, to the principle of indemnity, which states that a person should not profit from an insured event, but should simply be made whole again. Insuring something, or someone, where no potential for loss exists, becomes nothing more than gambling. Insuring over and above, or in the absence of, an actual potential for loss leads to moral hazard; for an incentive to profit may lead an insured to promote a loss. While the pursuit of profit works well in the American economy, it would collapse the insurance industry.
Timing Insurable interest can change with the passing of time. Knowing when an interest must exist to make a policy enforceable is critical, and that will depend on whether the subject is life insurance or property (and casualty) insurance.
With regard to life insurance, the beneficiary must have an insurable interest in the life of the insured at the time application is made. It is irrelevant whether an insurable interest still exists when death occurs and a claim is made. When so much can be invested in a policy over potentially many years, it would be too inequitable to
withhold the payment of its proceeds over a question of insurable interest. Besides, under most circumstances, the beneficiary can be changed along with underlying interest changes.
Not so with property (and casualty) insurance. What determines contractual enforcement here is the insurable interest that exists at the time of loss. Payment for a property loss to someone without an insurable interest could easily be abused and would violate the principle of indemnity. Can you imagine a homeowner sharing the settlement on a fire loss with a mortgagee that never got deleted from the policy following satisfaction of the debt?
Insurance law A starting place to define insurable interest is in state insurance laws. New York defines an insurable interest as "any lawful and substantial economic interest in the safety or preservation of property from loss, destruction or pecuniary damage" (Section 3401). This can be contrasted with the more restrictive definition in the California Insurance Code, which states that "a mere contingent or expectant interest in anything, not founded on an actual right to the thing, nor upon any valid contract for it, is not insurable" (Section 283).
Connecticut defines an insurable interest as "an interest which is subject to a risk of loss through destruction or impairment of that interest" (Section 38a-1.10).
New Jersey law defines an insurable interest applicable to life insurance, but it is silent on the property and casualty side. In the absence of a definition, one might construe a very broad interpretation.
Property rights Property that is owned can be described as a "bundle of rights" that has economic value. Certainly, one of these rights is the preservation of the property. The right of preservation equates to an insurable interest. Stated another way, an insurable interest is derived from legal property rights, when the value of the property can be diminished by loss.
Having introduced property rights as the most obvious legal interest forming the basis of an insurable interest, it is appropriate to continue the discussion with additional legal theories that make an insurance contract enforceable. But first, it should be noted that ownership interests do not always exist without some complications. Very frequently, multiple insurable interests apply to the same property.
Therefore, a corporate entity and a stockholder may each have an insurable interest in corporate assets. Various kinds of tenancy ownership of real estate involve multiple insurable interests in the same property. Condominiums, corporations, community property, life estates, partnerships and dower all create their own unique characteristics which must be addressed with regard to matters of insurable interest. Policy provisions are needed to limit the recovery to correspond with the extent of the interest held and to prevent duplication of coverage.
Contract rights Secured debts proceed from contracts which give a mortgagee or lienholder an insurable interest in property to the extent of the debt. Note that this interest is concurrent with the owner's interest.
A use interest in property is implied in a lease of premises. In addition, the lease may obligate the tenant to preserve the property under specified circumstances (some possibly beyond the control of the tenant), extending the interest to the full value of the property.
A contract of primary insurance gives a ceding insurer an insurable interest with which to enforce a reinsurance contract.
A contract of sale produces an enforceable legal interest. Sometimes the contract results in both buyer and seller having an insurable interest in the property for a temporary period of time. A buyer's equitable title to real estate, created by an agreement on the price and other terms of sale, gives the buyer an insurable interest for the full value of the property. This coincides with the seller's interest, which does not expire until the deed is delivered to the buyer.
Similar conditions occur with the sale and delivery of personal property. Rules of title in the Uniform Commercial Code address the identification of insurable interests under these circumstances. Once again, both buyer and seller may each have a legitimate interest in the property at the same time.
Tort liability Under a liability policy, an insured must have an insurable interest, which is equated to legal liability to the injured third party bringing the action. This requisite is stated in the insuring agreement without actual reference to insurable interest. A liability claim is, of itself, sufficient proof that an insurable interest exists.
Insurable interest in property policies likewise can be triggered by tort liability. The operation of law creates liabilities for people who damage the property of others while it is in their care, custody and control. A liability interest simply requires some degree of legal culpability; the commission of a tort. Common carriers, garages, dry cleaners and other bailees, as well as estate executors and tenants are familiar examples of persons or entities that have a potential liability for nonowned property.
Agency What about direct primary or direct excess coverage options on bailee policies or the inclusion of nonowned property as covered property in various policies? These coverages pay for damage to bailed property that has not been caused by the insured's negligence (no legal liability).
You may be surprised to discover that someone having no independent insurable interest in property may acquire it simply by representing someone else (the law of agency). The person or entity represented by the insured may be known at the time coverage is requested or a class of persons or entities may be named instead, even if not individually identified ahead of time. However, the person or entity must be in the class intended to receive the insurance benefit and such protection must not have been rejected. Consequently, a bailee may obtain insurance for the benefit of others, with coverage broader than the extent of such bailee's legal liability.
It must be stressed that if an insured derives insurable interest in this manner, the insured (agent) must act in the best interest of those represented (principals) and fulfill all duties owed, including the payment of insurance proceeds to those represented. Often the policy will state that settlement will be made directly with the property's owner.
Economic interest A limited or qualified interest or any expectancy of gain or advantage may be sufficient to attain an insurable interest. Such is the development of factual expectation as an insurable interest. Some U.S. jurisdictions have given the mere expectation of economic loss the status of insurable interest, apart from the concurrent requirement to have a traditional legal interest.
One example comes from an Illinois court, which ruled that an insurable interest existed when a father orally expressed his intention to will a building to his son. This contradicts a section of property law that does not give future interest to an heir expectant, until the testator actually dies.
New York courts generally apply the pecuniary interest test to the facts of a particular case. Under this test, the insured must have a relationship to the subject matter of the insurance such that some pecuniary benefit or advantage will be derived from its preservation and the insured will suffer pecuniary loss from its destruction.
Complexity It has been the objective of this resource kit to show that an insurable interest may encompass more than the mere ownership of property. In order to determine insurable interest in damaged property, it will be necessary to look at a number of legal theories and a variety of case law in the jurisdiction where a claim is made.
As insurance practitioners, we can better serve the consumer by broadening our understanding of the ingredients that make insurance do what it does so well, though not without complexity. 9/04
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