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Life sentences

The current rules of law relating to insurable interest in life assurance contracts are restrictive and, if not complied with, will render the contract illegal and void from inception. That is a severe sanction.

The position is still governed by the Life Assurance Act 1774 which provided that any contract on the life or lives of any person or persons made without insurable interest would be “null and void to all intents and purposes whatsoever”. The Court of Appeal later decided that such a contract would also be illegal.

What are the current rules relating to insurable interest for life assurance?

In every situation, the question of whether there is insurable interest must be answered by reference to the facts at the time when the contract was entered into.

There are four generally accepted categories of insurable interest.

The first is limited, and consists only of cases where the policyholder is also the life assured, that is, so-called own-life own-benefit cases, and cases where one spouse insures the life of the other spouse. This now also includes civil partners, whose partnership has been registered under the Civil Partnership Act 2004, who take out life assurance on each other’s life.

In all such cases, the insurable interest is unlimited and there is, therefore, no limit on the theoretical sum assured.

The limit in practice is what the policyholder can afford and what the life office is prepared to accept having regard to matters such as its assessment of the mortality risk and moral hazard.

The second category consists of other relationships between the life assured and the policyholder where the latter has a potential financial loss arising out of the death of the life assured. The interest has to be one recognised by the law and the amount of the insurance must not exceed the value of the interest.

A typical example would be the interest of a creditor in the life of his debtor up to the amount of the loan.

Another common example is the interest of one joint debtor in the life of another joint debtor up to the amount of the debt. Thus, an unmarried couple who have bought a house together and who are jointly and severally liable for the mortgage debt, have a recognised insurable interest in each other’s life and can insure each other’s lives, either separately or in a joint-life contract.

Keyperson policies provide another example.

The third category consists of cases where the insurable interest in the life to be insured is recognised or waived by statute. For example, under section 11 of the Married Women’s Property Act 1882, a life contract effected by one spouse on the life of the other spouse for the benefit of that other spouse or the children creates a statutory trust of the contract. If the circumstances of the case fall within the terms of that section, the question of insurable interest does not arise.

The final category includes cases where the interest does not fall into one of the other categories but where the courts are prepared to recognise it as sufficient to be an insurable interest.

In a recent case, the Court of Appeal upheld an insurance contract under which a mutual shipping insurer insured its members against claims brought by employees and others injured or killed on board members’ ships.

The Court of Appeal held that the members had a sufficient insurable interest in the lives of those who might bring claims.

It can be seen at once that these categories are either very limited in scope or the scope is vague and uncertain. These limitations and uncertainties lead to difficulties in practice. For example, parents have no insurable interest in the lives of their children and, in England, children have no interest in the lives of their parents. Nor do cohabitees or fiancés and fiancées have a general right to insure each other’s lives.

Some life offices ignore, to a greater or lesser degree, the requirement for insurable interest. But if there was no insurable interest, the life office and the policyholder run the risk that at some time in the future, one or other party to the contract, or a reinsurer, will seek to rely on the absence of insurable interest as the basis for bringing the contract to an end.

Further, even if none of the parties involved in the life contract were to take the point in the course of a court case, the judge is bound to do so because it is the court’s job to uphold the law. He would therefore declare that the contract was illegal and void – a result no one would want.

A life office might take the point, for example, instead of relying on a difficult to prove allegation of non-disclosure, and the policyholder would be deprived of his defences to the non-disclosure. In the shipping case referred to above, it was the reinsurer that sought to rely on lack of insurable interest.

If a life contract is found to be illegal and void for lack of insurable interest, the question of whether the policyholder is entitled to the return of the premiums is a difficult one. There is, however, a good argument that provided the policyholder mistakenly thought that the contract was valid at outset, he or she would be entitled to the return of the premiums.

If the policyholder is entitled to the return of the premiums on the facts of the case, there is a distinct possibility in the present financial climate that he or she would make such a claim.

For example, this might happen if a life office is making the policyholder wait six months for payment of the policy value because the contract is linked to the life office’s property fund, or if the policy fund is worth less now than the sum of the premiums paid.

Against the above background, the Law Commission, which is the body responsible for reviewing aspects of the law and proposing reforms, is consulting on its proposals to change the law relating to insurable interest.

Would it be better simply to abolish the requirement, at least in relation to life assurance?

That is what New Zealand, Australia and recently, the Isle of Man, have done without any apparent ill effects.

The Law Commission tentatively suggests that if the need for insurable interest were to be abolished altogether, individuals would be uncomfortable at the thought that people who do not wish them well could then take out policies on their lives.

But that ought not to be a concern because life offices would still underwrite the proposal and would not be able to get any medical evidence without the consent of the life to be assured. Life offices would also still be concerned about moral hazard.

The Law Commission also proposes that the categories of acceptable insurable interest should be expanded. That would reduce the difficulties and uncertainties but not eliminate them.

There will always be cases just on the wrong side of the line. If the categories are enlarged or the test made easier to satisfy, the argument would then be why have the requirement at all?

That is what happened in Australia. In 1984, Australian law was reformed by enlarging categories. Then, in 1995, Australia abolished the need for insurable interest altogether.

We should do likewise. The Law Commission is being too cautious.

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