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In everyone’s best interests

Confusion over the application of the law of insurable interest makes early reform highly desirable

Last week, I took an initial look at the consultation into the possible reform of insurance law, with particular reference to the law on insurable interest. This principle, which aims to prevent moral hazard, stems from the Life Assurance Act 1774 (still good law) and looks to make void any insurance contract effected where there is no insurable interest.

The base rules regarding insurable interest are enshrined in the Life Assurance Act 1774 but life insurance companies have moved with the times. For example, some companies have dispensed with the need for insurable interest to be proved in connection with single-premium bonds which provide only minimal life cover. Other companies recognise insurable interest between a couple engaged to be married.

Any review of the law is to be welcomed as it offers the opportunity for the rules to be updated, which should make for consistency.

Since the original scoping paper was issued in 2006, the Law Commissions have analysed the responses to the questionnaire included in the scoping paper. They have decided that the review should have a wide scope and it will take a considerable amount of time to conclude. They intend to publish two consultation papers, with a final report not expected before 2010.

The commissions have also decided that insurable interest should be included within the review. The vast majority of respondents to the original questionnaire were apparently in favour of abolishing the requirement for insurable interest. One of the suggestions was the replacement of the Life Assurance Act 1774 with an updated list of relationships giving rights to an insurable interest and/or a new requirement that the consent of the life assured is obtained before any policy is issued.

On the other hand, many respondents thought that insurable interest may still provide useful protection against gambling and moral hazard.

Insurable interest is only one of the areas of insurance law that is being reviewed but one that has the proven capacity to cause headaches. One of the main reasons for this is the development of various inheritance-taxmitigation schemes based on single-premium bonds, such as loan trusts and discounted gift trusts, with policies being effected by other than the life assured or, if by the life assured, the policy having additional lives assured. It is reasonably well accepted that having a multi-life, last-survivor bond would give the greatest chance of avoiding an unwanted encashment at a time that was less than desirable from an investment and/or tax standpoint.

There are already anti-avoidance provisions which bring certain arrangements involving life insurance policies within the gift with reservation of benefit provisions, so that the scheme is ineffective for IHT purposes, if a policy is effected on the life of the settlor or settlor’s spouse (paragraph 7 Schedule 20 Finance Act 1986). To ensure this particular provision does not apply to the assorted IHT schemes involving bonds, it is usually recommended that the bond is effected on the life or lives of, say, beneficiaries under the trust, but in any event not on the life of the settlor or settlor’s spouse. As bonds are usually life insurance policies, the question of insurable interest will inevitably arise.

Readers will be aware that while the Life Assurance Act 1774 makes a life insurance policy without insurable interest null and void, there is a generally accepted view that it is, in effect, a defence for a life office to use if it wants to avoid a claim. In practice, life offices have not been using this defence – and unsurprisingly so, given that they sometimes willingly accept business without any apparent insurable interest.

The problem facing life insurance companies was well summed up by the City of London Law Society’s insurance law committee in its response to a question in the scoping paper. It said: “It is in our view a highly unsatisfactory state of affairs that commercial lawyers practising in this area should have to advise their clients in complex and legitimate transactions that (a) there is a risk that the contract might be void because the present legal requirements are not clear but (b) it is unlikely that a point will be taken.”

The above is similar to the views that have often been expressed in the opinions of counsel on the various IHT schemes involving bonds. This is clearly an unsatisfactory situation and we can only hope reform of the law will take place sooner rather than later.

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