No matter where you are in your financial journey, planning for costly emergencies is always important. And most of us will never be in a situation where our emergency fund can cover every possible accident or act of God. That’s where insurance comes in.
However, not everyone uses insurance for its intended purpose. There will always be fraudsters looking to make a quick buck. Insurance companies attempt to prevent this by adding extra hurdles to the application process, such as requiring you to prove that you have an insurable interest in the thing or person you’re attempting to insure.
Insurable Interest in Property
There are several different types of insurance intended to cover your property in the event of an accident or disaster, and all of them require that you have an insurable interest in the property. Essentially, this means there must be some kind of demonstrable financial harm that will come to you if the property is destroyed. Usually this is easy to demonstrate. You would definitely suffer financially if your home or the building in which you run your business met with some kind of disaster and needed to be rebuilt. Therefore, you have a clear need to take out insurance on those properties.
Sometimes this can make things more complicated than they appear at first glance. For example, if you rent, your landlord no doubt pays for property insurance on the house or apartment building in which you live. So you might think that if your house burns down or your apartment floods, the landlord will cut you part of the check and you can replace your stuff. However, your landlord doesn’t actually suffer any kind of financial hardship if all your personal possessions are destroyed, so they cannot purchase insurance on the contents of their rentals. That’s why most landlords will require that you purchase renter’s insurance—and why you should do so even if it’s not required!
Insurable Interest in Life
Life insurance is another area in which insurance companies worry about whether you actually have a financial stake in the insured person remaining alive. We’ve all heard of true crime cases where someone committed murder in order to collect insurance money.
Insurance companies don’t want this to happen any more than you do, so they generally require that the insured verifies their relationship with you and consents to have you take out the policy. You also generally need to demonstrate that you would suffer financially if the person dies.
Most of us will only ever worry about life insurance when it comes to members of our family. If your spouse died, you might need insurance to help cover expenses while you figure out how to cope with the loss of income. If your elderly parent dies, you might need life insurance to cover funeral expenses or pay for their end-of-life medical care.
In some cases, life insurance is necessary for someone outside your immediate family. For example, if you co-own a small business, what would happen if your business partner died? Would you need some extra cash to keep you afloat until you hire their replacement? If so, consider taking out a life insurance policy to cover this risk!
Moral Hazards
If an insurance company sells you insurance you don’t need, that can create a “moral hazard.” If you had nothing to lose and a lot of money to gain, you might be tempted to damage property or risk people’s lives. Even if you weren’t tempted to commit violent crimes, your fraudulent claims would still cost the insurance company a lot of money and drive up rates for everyone else.
As discussed above, one way insurance companies prevent this is by making sure that you have a financial stake in the insured—basically, that you have a bigger reason to not collect insurance money than to collect it!
Another strategy to reduce fraud is to allow you to take out a policy but limit the amount. For property, this is pretty straightforward. Your insurance policy might cover the actual (undamaged) value of your property or its replacement value. For example, maybe the couch you got off the curb for free isn’t worth very much, but you take out an insurance policy that would allow you to actually purchase a similar couch in the event that you suddenly need to replace all your furniture.
With life insurance, things can get more complicated, since human beings don’t exactly come with price tags. There isn’t a legal cap on how much life insurance you can take out, but companies generally have policies that limit coverage to a certain multiple of your income and reduce this limit as you age. They will also generally require you to disclose any existing coverage on your application, so you can’t just take out a bunch of policies from different companies. If you’re purchasing insurance for someone without significant income—for example, to cover funeral expenses for your minor child—the policy will typically have a very low limit.
Protect Your Assets
One of the only constants in life is that you should expect the unexpected. Insurance helps you do that by making sure you won’t be ruined financially the first time disaster strikes. In order to stay in business, these companies want to make sure that you actually need the coverage you’re trying to get. To figure out your own insurance needs and get answers to any other financial questions, contact us today. We’ll match you with an investor hand-picked to be exactly what you need.
