If someone would suffer a loss if an object or person was damaged or destroyed, he or she is said to have an “insurable interest.” Insurance companies require people to have an insurable interest before a policy will be issued, confirming that the person taking out the insurance stands to suffer if something happens to the person or object being insured. Put simply: you can insure your car because if something happens to it, you will suffer a financial loss, but you can't insure your neighbor's car, because if something happens to it, you will not be affected financially, although your neighbor may ask for rides and you may feel sympathy for your neighbor's situation.
Insurable interest requirements did not always exist in the insurance industry, which created some complicated situations. Some people purchased insurance as a form of speculation, effectively gambling on the continued existence of an object or person. Perhaps most egregiously, people took out life insurance policies on unrelated individuals, and there are some reports that when these individuals failed to die in a timely fashion, the policyholders helped them along. As a result, insurance companies started requiring that people hold an insurable interest, to eliminate moral hazards.
For property insurance, an insurable interest is easy to establish. If someone owns a house, car, business, or other type of property and the property is damaged, destroyed, or rendered unusable, he or she experiences financial loss, because the property must be repaired or replaced. Additional losses may be incurred indirectly; for example, if someone cannot get to work because his or her car is totaled, he or she loses wages and may be at risk of losing a job.
Likewise, lenders are also considered to have an insurable interest. Banks which issue home loans, for example, often require people to carry insurance so that in the event that the home is destroyed, the bank can make a claim on the insurance to collect the balance of the loan. In order to collect on insurance, it is necessary to hold a lien on the property.
Insurance on people is a bit more complicated. Life insurance policies can be taken out on behalf of dependents, under the assumption that a loss of a parent would cause a financial loss (among other types of losses which are, alas, not insurable). Conversely, a parent could take out a life insurance policy on a dependent under the argument that the loss of a child could cause emotional and financial damages. Life insurance on spouses is also not uncommon. However, people do not automatically have an insurable interest in everyone they are related to; a niece might not be allowed to take out life insurance on an uncle, for example, although the uncle could opt to name the niece as a beneficiary on his life insurance policy.
