Long established as a fundamental requirement of any contract of insurance, the parameters of insurable interest are being reconsidered by the English and Scottish Law Commissions as part of their review of insurance contract law. Susan McGill from our insurance and reinsurance dispute resolution team considers some of the proposed changes to the law.
In preparation for their second consultation paper on insurance contract law reform which is to address topics including insurable interest and post-contractual good faith, the Law Commissions of England and Wales and of Scotland published an issues paper on insurable interest. The paper sets out the Commissions’ preliminary thinking and their tentative proposals for reform. Although not a formal consultation, comments were invited until April 2008. After a similar process has taken place later this year in relation to the additional topics such as post-contractual good faith, the Commissions aim to publish the second consultation paper in 2009.
The current law
The current law relating to insurable interest distinguishes between indemnity and “non-indemnity” insurance.
Indemnity insurance (for example, liability and property insurance) operates so as to enable the insured to recover the amount it has lost.
Until 2007, indemnity insurance contracts were distinguished from gambling and wagering contracts, which were void. In England and Wales, for most forms of indemnity insurance the insured had to have an interest at the time of loss. In Scotland, the insured had to show a pecuniary interest at the time the insurance was taken out.
The Commissions point out the confused state of the law in relation to indemnity insurance. They suggest that the Gambling Act 2005, which came into force in September 2007 and which applies to England and Wales and also to Scotland, removes the requirement for insurable interest in indemnity insurance. The Gambling Act provides that “the fact that a contract relates to gambling shall not prevent its enforcement”. As the Act does not specifically mention insurance, however, it is unclear whether it was intended to erase the previous distinction between gambling and insurance contracts.
The Commissions propose that no requirement of insurable interest should continue to exist in indemnity insurance, and that the common law “indemnity principle”, which remains unchanged by the Gambling Act, should apply alone.
To be indemnified, an insured would have to prove the occurrence of a loss falling within the terms of the insurance, and compensation should not exceed that loss.
In modernising and clarifying the law, the Commissions propose to repeal the criminal liability imposed by the Marine Insurance (Gambling Policies) Act 1909 in relation to certain types of marine insurance taken out without insurable interest.
The doctrine of insurable interest was introduced to distinguish between gambling and insurance. Paradoxically, it is now gambling legislation which is being used as the basis for the doctrine’s proposed abolition. The operation of the indemnity principle alone may enable the insurance of another’s liability without any link to the subject-matter of the insurance.
In non-indemnity insurance, the insured receives a set amount following a trigger event. Non-indemnity insurance includes life and personal accident insurance, and certain non-life insurance (such as marine and aviation hull policies where the parties agree a value to be placed on the insured property for insurance purposes).
The Life Assurance Act 1774 requires any person taking out insurance to have an insurable interest, otherwise the insurance is void. Uncertainty exists as to whether the Life Assurance 1774 Act applies to other categories of insurance, such as non-life non-indemnity policies.
The Life Assurance Act does not define insurable interest. Subsequent case law and statutes identify ways in which an “insurable interest” may arise:
- At common law by ‘natural affection’ (enabling a person to insure the very limited class of their own, and/or their spouse’s, life).
- Certain statutes confer an insurable interest, for example civil partners in each other’s lives, and local authorities in workers’ lives whilst working on the authority’s business.
Outside these restricted categories, a person can only insure another’s life by demonstrating a pecuniary interest in the duration of that life at the time of the contract (for example, a debt owed). A mere expectation of gain (such as expectation of future interest payments) is insufficient. However, the trend of judgments in the courts appears to be towards a widening of the definition of insurable interest beyond the confines of these traditional categories.
In addition, where no insurable interest exists, people often side-step the rules by insuring their own lives and then assigning the policy to another.
The concept of insurable interest is sometimes used to distinguish “valued” insurance contracts from risk transfer products such as credit derivatives (where one party promises to pay to the other party a sum of money upon the occurrence of a specified event). The distinction is important in England as different tax and regulatory regimes apply (although the FSA distinguishes between the products on the grounds that insurance contracts involve an “assumption of risk”). The Commissions acknowledge the importance today of risk transfer products such as credit derivatives.
The Commissions’ proposals
The Commissions’ proposals for non-indemnity insurance are as follows:
- The question is posed whether there should continue to be a requirement for insurable interest at all in non-indemnity insurance. Other jurisdictions, such as Australia since 1995, have abolished the requirement. The Commissions’ preliminary view is to retain the doctrine in life assurance, expanding the categories of those with ‘natural affection’ to include dependants in the lives of their parents/guardians, cohabitants and parents in the lives of their adult children. In addition, the Commissions are considering the following relationships: parents of children under 18, fiancé(e)s, siblings, grandparents and grandchildren. The irony of broadening the categories of those with insurable interest is that, statistically, most murders are committed by family members, and historically, it was (at least in part) to prevent this moral hazard that insurable interest was introduced.
- For consent of the life assured to be an alternative means of showing insurable interest (resembling the current practice of assigning life policies).
- For the category of insurable interest supported by pecuniary interest to be relaxed to include the insured’s reasonable expectation of pecuniary loss on the death of the life assured.
- To impose a requirement upon insurers to inquire whether a valid insurable interest exists at the outset of a life assurance contract. This would lessen the possibility of insurers defeating a claim by requiring the insured to establish insurable interest where the insurer has already negotiated contract terms and has accepted premiums.
- That insurers should not be permitted to avoid policies only on the basis that the persons interested are not specified (currently, an insurance contract which does not include all interested parties’ names is illegal).
The Commissions also seek to promote and clarify group life insurance, which is often offered as an employee benefit, the sum insured calculated as a multiple of salary: if group life insurance is considered as life assurance, problems currently arise where employers insure their employees as a class without naming individuals, but if it is treated as third party liability insurance, it is difficult to reconcile with the indemnity principle as the actual value to the employer of losing an employee is rarely a multiple of that employee’s salary.
The current law regarding insurable interest is complex and inconsistent. The Commissions are attempting to clarify and modernise the application of the doctrine. The issues paper has attracted significant interest amongst the insurance industry. Whether or not the industry agrees with the Commissions’ tentative proposals remains to be seen and the second consultation paper is eagerly awaited.