Insurable interest and indemnity
Insurable interest and indemnity tests who may insure and how much they can recover. The exam expects you to apply the principle that insurance restores the insured to the pre-loss financial position and does not create profit.
Insurable interest
- Life insurance: a person has an unlimited interest in their own life and may insure another only with a financial interest recognised at inception; the Life Assurance Act 1774 requires interest when the policy is effected.
- Property insurance: the insured needs a legal or equitable interest in the property. A mortgagee, tenant or bailee may have an interest; a person with no interest cannot enforce a property policy.
- Liability insurance: the insured's potential legal liability to third parties is the interest.
Indemnity
- The sum insured is a ceiling, not the measure of loss. The measure is the value of the insured's actual loss at the time of loss, subject to policy terms.
- Reinstatement or new-for-old cover may replace old property with new, but betterment can be deducted unless the policy provides otherwise.
- A valued policy fixes the agreed value in advance; it is not a pure indemnity contract.
- Subrogation lets the insurer stand in the insured's shoes after payment to recover from the party at fault, but the insured must not be prejudiced.
Worked example
A building is insured for £500,000. At loss its indemnity value is £420,000, while reinstatement would cost £480,000. On an indemnity basis the insurer pays £420,000 less the policy excess; the insured cannot recover £500,000 merely because that is the sum insured. If the policy provides reinstatement cover and the conditions are met, the insurer may pay up to the sum insured, subject to any betterment adjustment.
Traps that cost marks
- Treating the sum insured as the automatic payout.
- Confusing insurable interest at inception with interest at the date of loss for property.
- Assuming new-for-old never involves betterment.
- Forgetting that subrogation cannot put the insurer above the insured's recovery.