Out-Law Legal Update | 18 Jul 2018 | 5:19 pm | 5 min. read
Having an insurable interest means that the person buying the cover benefits from the safety and wellbeing of the thing insured, or freedom from liability in relation to it. Alternatively, that person would be prejudiced by damage or loss to the thing insured, or the existence of liability in relation to it. Without such insurable interest, the contract of insurance is void, and in some cases in England and Wales, even illegal.
Historically, insurable interest has been required to prevent "moral hazard", or bad faith; and to distinguish insurance from other activities, such as gambling. However, since betting is legal and with regulatory and tax authorities using numerous factors to define what is and is not insurance, it is unclear whether this doctrine is still relevant for modern day practices. For businesses, the restrictive application of the doctrine remains problematic as UK life insurers are unable to meet a substantial demand for valid policies protecting children, cohabitants or key employees, as these policies, if strictly applied under the current law, would be void or illegal.
On 20 June 2018, the Law Commission published its second draft Insurable Interest Bill. Clause 2 is the key clause, setting out the requirement for insurable interest in contracts of life-related insurance, and a non-exhaustive list of situations in which an insurable interest will exist.
The Law Commission specifically uses the term “life-related insurance" rather than “life insurance” because of consultation feedback it received which suggested “life insurance” did not cover personal accident, critical illness, disability and other insurances dependent on human life even though these should be subject to the same rules. Therefore the “life-related” insurance category encompasses both indemnity and contingency policies as long as they relate to a human life.
The term is also intended to cover investment-linked insurance products which have a life insurance element and contracts under which the insured event is the continuation of an individual’s life, for example, annuities.
The Law Commission consultation process revealed that legislative reform was not required in the non-life insurance area. In its accompanying notes to the draft Bill, the Law Commission makes the point that, in the life-related insurance area "the current law is hindering the development of socially useful products, and our proposals were for substantive law reform".
Reasonable prospect of economic loss
According to Clause 2(2) the insured will have an insurable interest if there is a "reasonable prospect" that it will suffer an economic loss if the insured event occurs.
The law, as it currently stands, makes it a requirement for a policyholder to suffer a financial loss on another's death before being able to insure against this type of loss. Under the draft Bill, this pecuniary interest requirement has been removed and the economic loss test has been expanded. Instead, an insured will have an insurable interest in any circumstance where they have a “reasonable prospect” of suffering economic loss on the occurrence of the insured event (such as the death or illness of, or injury to, the person insured).
This “economic interest” test had originally been included in the non-exhaustive list of circumstances in which an insurable interest exists however, following its consultation process, the Law Commission has decided that it should be treated separately in the legislation and have moved it into its own sub-section.
Circumstances where insurable interest automatically exists
Under Clause 2(3), the draft Bill considerably widens the scope of the law by providing a non-exhaustive list of circumstances where insurable interest will automatically exist. For these listed relationships, there is no need to demonstrate a "reasonable prospect" of economic loss. The insured will now have an automatic insurable interest in their cohabitant - previously, only spouses and civil partners were covered. Furthermore, children and grandchildren are included in this list.
Where the insured is a trustee of a private trust, they can purchase life insurance bonds provided they have the necessary insurable interest, which the draft Bill states would exist where the settlor or trustor would have insurable interest (Clause 2(4)).
In certain circumstances, it is impractical to limit the law to 'specific relationships' where all beneficiaries can be identified. This legal uncertainty has in the past for example dissuaded employers from investing in group life schemes protecting employees and their families.
Clause 2(3)(b) of the draft Bill now recognises the importance of group policies as a common and useful insurance product particularly for long-term insurance and provides that the person who administers the pension or other group scheme will have an insurable interest in the lives of every member of that group or pension. This wording of this clause means it will apply to group schemes which are not formed through trusts. Clause 2(5) of the draft Bill allows the insurable interest for group policies to include individuals who subsequently fall within the category of people the group policy covers, which effectively means that there is no requirement for all the individuals in the group policy to be named.
This approach to group insurance acknowledges the complexities of modern insurance law, and clarifies and strengthens the legal status of such policies, which will certainly reassure stakeholders and support employers' health policies for their employees.
Updates on the effects of untrue statements
Generally, where a contract fails, the premiums are to be returned to the insured. However, the Law Commission highlighted an inconsistency in the principle of return of premium with the provisions under CIDRA 2012 and the Insurance Act 2015 which gives the right to the insurer to retain premiums paid where the policy was procured through fraud, or by the insured deliberately or recklessly misleading the insurer. Under current law, contracts which are void due to the lack of insurable interest are not covered by these provisions.
Clause 3(1) of the draft Bill therefore brings contracts which are void due to the lack of insurable interests in line with the "deliberate and reckless" provision in CIDRA 2012 and the Insurance Act 2015. The clause states that where the insured recklessly or deliberately makes untrue or misleading statements as to the insurable interest in question, the insurer may retain any premiums paid.
There is a narrow exception in the case of consumer insurance contracts (i.e. where the insured is not operating in a professional context) to the above rule. This is reflective of the approach taken in CIDRA 2012. Clause 3(2) of the draft Bill states that the "deliberate and reckless" provision would not apply if it would be unfair to the insured for the insurer to retain the premiums. This is seen to avoid overly harsh results where one policyholder might have made a deliberate misrepresentation whilst the other might have been honest and reasonable.
Relationship with existing law and repeals
Clause 4 provides that the draft Bill will replace any other rule of law relating to the requirement of an insurable interest; therefore common law rules will be effectively repealed. This will have the effect of dis-applying the rule that contracts which are void for lack of insurable interest are illegal, allowing scope for premiums to be recovered by the insured subject to the provisions on untrue statements above.
The Marine Insurance Act 1788 and the Marine Insurance (Gambling Policies) Act 1909 will be repealed under the legislation. Sections 1 (to the extent that it relates to life-related insurance), 2 and 3 of the Life Assurance 1774 Act will also be repealed.
The draft Bill extends the protection available in life-related insurance matters, as well as providing a clearer definition of insurable interest in these circumstances. The Law Commission has created a more generous and permissive system enabling both the insured to protect themselves and their families better, as well as allowing UK life insurers more scope to create useful and economically innovative products.
The Law Commission has asked for comments on this draft Bill to be made by Friday 14th September 2018.
Elaine Quinn and Catherine Lai are insurance experts at Pinsent Masons, the law firm behind Out-Law.com.