THE LEGAL BASIS OF INSURABLE INTEREST IN INSURANCE CONTRACTS

THE LEGAL BASIS OF INSURABLE INTEREST IN INSURANCE CONTRACTS

Insurance involves the transfer and sharing of risk to another person who is willing to bear it for a cost. It is one of the ways in which risk can be managed. The existence of insurable interest is one of the characteristics of insurance contracts. It is not just a general rule but a statutory requirement, as imposed by the British Life Assurance Act 1774 and the Marine Insurance Act 1906. The requirement for an insurable interest is present in most jurisdictions.

Insurable interest is a right, benefit, or advantage arising out of property that is of such nature that it may properly be indemnified. In the law of insurance, the insured must have an interest in the subject matter of his or her policy, or such policy will be void and unenforceable since it will be regarded as a form of gambling. A basic principle of insurance law is that the insurance policy does not cover any property in which the insured has no insurable interest. The insurance must cover property (or other loss) in which the insurance beneficiary has some legal right.

An individual ordinarily has an insurable interest when he or she will obtain some type of financial benefit from the preservation of the subject matter, or will sustain pecuniary loss from its destruction or impairment when the risk insured against occurs. In other words, it exists when the insured has a legal or equitable relationship to the insured event such that the insured will suffer from its loss, damage or detention or may incur a liability to a third party as a result of its loss, damage or detention. It is not necessary to be an owner to have an equitable interest. Mortgagees, lessees, trustees, the lenders of money, mortgagors and a number of others have an insurable interest as determined either by the courts or statute. The definition nonetheless has two elements, both of which must be satisfied. There must be a legal or equitable connection and the insured must suffer or lose a benefit as a result of the insured incident. The mere suffering of financial loss is insufficient.

In life insurance, an insurable interest must be held when the policy is taken. The rule dates back to the Life Assurance Act 1774, a time when the legislature’s concern was to prevent a “mischievous kind of gaming” because there were fears that the practice might encourage murder. Since then, case law has limited those who have an insurable interest arising out of “natural affection” to the person whose life is being insured and their spouse. In property insurance, insurable interest often arises out of ownership where the insured is the owner of the subject matter of insurance. Therefore the house-owner can insure his house. A shopkeeper can insure his stock. Another example is that of mortgages, which are most common in the area of house purchase; it involves the bank (mortgagee) and purchaser (mortgagor). Both of them have insurable interest.

The 1906 Marine Insurance Act defines insurable interest as where a person stands “in any legal or equitable relation to the adventure or to any insurable property at risk therein, in consequence of which he may benefit by the safety or due arrival of insurable property, or may be prejudiced by its loss, or damage thereto, or by the detention thereof, or may incur liability in respect thereof”. In other words, a person who may suffer financial loss from an event has an insurable interest in the property or interest which is insured against that event. The event must create upon the insured a commercial loss or liability, or it must affect a right of the insured which is recognised and protected by the courts.

The classical definition of insurable interest was given by Lawrence J in Lucena v. Craufurd [1806] 2 BOS & PNR 269. This case was under the Marine Insurance Act but the definition has been so­ far accepted by all decisions and authors which is reproduced as follows:

“A man is interested in a thing to whom advantage may arise or pre­judice happen from the circumstances which may attend it and whom it imported that its condition as to safety or other quality should continue: interest does not necessarily imply a right to the whole or a part of a thing, nor necessarily and exclusively that which may be the subject of privation, but the having some relation to, or concern in the subject of the insurance, which relation or concern by the happening of the perils insured against may be so affected as to produce a damage, detriment, or prejudice to the person insuring: and where a man is so circumstanced with respect to matters exposed to certain risks or danger, or to have a moral certainty of advantage or benefit, but for those risks or dangers, he may be said to be in­terested in the safety of the thing. To be interested in the preservation of a thing, is to be so circumstanced with respect to it as to have benefit from its existence, prejudice from its destruction. The pro­perty of a thing and the interest devisable from it may be very different: of the first the price is generally the measure, but by in­terest in a thing every benefit or advantage arising out of or depending on such thing, may be considered as being comprehended”.

Insurable interest is not dependent upon who pays the premiums of the policy. In addition, different people can have separate insurable interests in the same subject matter or property. For a risk to be insurable it does not need to be measurable, but it does need to be related to a measurable financial loss, or to a valued loss. This means a loss on which a value has been placed. Degree of risk should be distinguished from magnitude of risk. Degree of risk is the probability of the adverse event occurring, whereas magnitude of risk is the amount of the likely loss.

The requirement of insurable interest has historically been said to serve 3 main policies:-

  1. To discourage gaming and wagering in the form of insurance, i.e. betting somebody else’s property is damaged during a particular period;
  2. To minimise the risk of destruction by the insured of the subject matter of the insurance, i.e. somebody talking steps to improve the prospects of the bet winning; and
  3. To restrict the insured to no more than full indemnity for its loss, i.e. if insurance was not restricted to interest; its value would be unlimited.

The principle of insurable interest evolved from the common law. However, the common law has some exemptions for the insurable interest requirement, such as the ‘interest or no interest’ policy, which means that the wager policy is enforceable regardless of whether the assured had an insurable interest and provided that they were not contrary to the public policy.  The real restrictions were actually started in mid-eighteenth century when the UK Marine Insurance Act 1745 was enacted. The 1745 Act, however, did not invalidate wager policy completely. Policies on non-British vessels were unenforceable without an insurable interest unless they contained exemptions for insurable interests. The mandatory rules of the doctrine of insurable interest requirement without any exceptions were concluded in the Marine Insurance Act 1906. Section 4 states that, “every contract of marine insurance by way of gaming or wagering is void”; and Section 6 that “the assured must be interested in the subject-matter insured at the time of the loss though he need not be interested when the insurance is effected: Provided that where the subject-matter is insured ‘lost or not lost’, the assured may recover, although he may not have acquired his interest until after the loss, unless at the time of effecting the contract of insurance the assured was aware of the loss, and the insurer was not.” This section requires the duration of the possession of insurable interest. The requirements of insurable interest are more stringent and more precise in the 1906 Act than in the mid-eighteenth century.

The law on insurable interest is complex and often inconsistent. It is governed by different statutes and the rules on what constitutes a valid insurable interest vary according to the subject matter of the insurance. There is no single uniform rule whether an interest is required and if it is, whether it is required when the policy is taken out or when the loss is suffered. Its application to modern commercial law is sometimes questioned and nowadays, a range of features are looked at to identify what is and is not insurance, insurable interest is no longer a deciding factor.

Uncertainty was introduced by the UK Gambling Act 2005 which made gambling contracts enforceable in law and in so doing, removed the requirement in English law for an insurable interest in indemnity insurance.  But under the Marine Act, it is still a criminal offence to take out a marine cover without insurable interest.

In Australia, the common law rule of insurable interest was amended by Sections 16 and 17 of the Insurance Contracts Act which reads as follows:

Section 16(i) – Insurable Interest Not Required:

“A contract of general insurance is not void by reason only that the insured did not have, at the time when the contract was entered into, an interest in the subject matter of the contract”

Section 17- Legal or Equitable Interest Not Required At Time of Loss:

“Where the insured under a contract of general insurance has suffered a pecuniary or economic loss by reason that property being the subject matter of the contract has been damaged or destroyed, the insurer is not relieved of liability under the contract by reason only that, at the time of the loss, the insured did not have an interest at law or in equity in the property”

Under Section 16, an insurable interest is not required when the contract is entered into, it is sufficient that the insured suffers a pecuniary or economic loss because of the damage to or destruction of the subject matter of the contract.

The discussion about the retaining or the abolishing of ‘insurable interest’ arose when the insurance contract law reform was conducted in many countries. Some from the insurance industry supported the retention of the requirement of insurable interest, while others gave a contrary viewpoint. The main reason for the retaining of the requirement of ‘insurable interest’ is the objectives of insurable interest, which is the prevention of gambling or wagering policies under the guise of insurance and the deterrence of moral hazards. Another reason for the requirement is that the existence of an insurable interest reduces any temptation to bring about the loss insured against.

In the 1970s, the insurance contract law in Australia was fairly piecemeal which included common law, the statutes of imperial, State and Federal Parliaments. Australia adopted most of the principles of the United Kingdom in common law, therefore the academics in Australia consensually suggested that Australia needed a more systematic and national law and also the language of the imperial Acts should be clearer, be more easily-understood and State Law should be unified and extended etc. In the Section 16 of Insurance Contract Act 1984, insurable interest was no more a requirement of certain insurance contracts, except for life insurance. This followed the majority recommendation contained in Australian Law Reform Commission (ALRC) 20.

The English and Scottish Law Commissions paid close attention to the Australian Law Reform Commission (ALRC). They published issues on insurance including issues about ‘insurable interest’. In January 2008, on the issue paper 4, the issue about whether there was still a need for the specific doctrine of ‘insurable interest’ was raised. The proposal somewhat agreed with the reform of Australia Law Reform Commission (ALRC). They said the reforms outlined by ALRC are both “constructive” and “bold”. Therefore, in the UK, ‘insurable interest’ was no more a requirement of certain insurance contracts, except for life insurance.

Under the South African law, the insured must prove that an insurable interest existed in order to prove loss. The test is whether the insured will incur financial loss or will fail to derive an anticipated financial benefit if the event insured against occurs. If the insured does not have an insurable interest in the object, the contract will be void and unenforceable, and regarded essentially as a gamble or wager.  South Africa formally imported the doctrine of insurable interest from England but in 1977, the legislature repealed the colonial ordinances which had achieved this.

There is no South African statute which lays down the need for insurable interest but it could be said to be implied. Whether or not an indirect economic interest is enough to constitute an insurable interest as opposed to a mere wager will depend on the facts of each case. In Littlejohn v. Norwich Union Fire Insurance Society (1905) TH 374, a husband had taken out fire insurance in his own name over the contents of a shop owned by his wife. The court found that he had an insurable interest because he would obviously be in a worse position in patrimonial terms after his wife’s property was burnt.

The position is quite the same in Nigeria. For a claimant to make a claim under a policy of insurance, he must have an insurable interest in the subject matter of the insurance policy. Of necessity and as a matter of public policy, the law does not allow an insured person to recover more than what he may have lost as a result of the occurrence of an insured peril; no matter what he may have paid as a premium. This is because Insurance consists of various pools of resources from where any loss can be made good.

The arguments of the academics that support the retention of insurable interest are that, ‘insurable interest’ is still needed in the prevention of gambling and wagering policies and the deterrence of moral hazards. While, on the contrary, some academics hold a different view, they believe that the doctrine of insurable interest should be abandoned, because the requirement of such restriction is no longer applicable in modern insurance industry especially in the marine insurance industry and the claims on the issue of insurable interest is redundant in the court. They also argue that the concept of insurable interest could extend the effect of moral hazards rather than reduce it.

Many academics have often criticized the doctrine and they have argued that the law on insurable interest lacks coherence, since the law had been developed through a long peroid with many legislative revolutions and reforms; the law seems to be too slow, irregular and still has a lot of omissions. They agree that the present existing law is inaccessible, uncertain, unduly restrictive, and lacks coherence. I am of the view that there should not be an abandonment of the doctrine of ‘insurable interest’ but a review of the doctrine is necessary and essential. There is real need for clarity.

Mandyen Brenda Anzaki