Key-Person Life Policy: Insurable Interest and Medical Non-Disclosure
A 12-person software company takes a GBP 1,000,000 key-person life policy on its 58-year-old founder and majority shareholder. The application, signed by the finance director, answers 'no' to a question asking whether the founder had consulted a cardiologist or been prescribed medication for heart disease in the last five years. In fact the founder had been treated for hypertrophic cardiomyopathy and had been advised to reduce travel. The finance director did not ask the founder about his medical history and relied on a brief verbal assurance. Seven months later the founder dies of a heart attack while on a business trip. The insurer discovers the medical records and avoids the policy. The company has already used the policy as collateral for a bank loan, and the bank has a loss-payable endorsement.
1. Did the company have an insurable interest in the founder's life? Explain the test and whether the bank's endorsement changes the analysis.
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The company has an insurable interest in the founder's life if his death would cause the company a measurable financial loss. As founder, majority shareholder and key person, his death could reduce revenue, trigger a buy-sell obligation, or cause lender concern. A key-person policy is not a wager if the company can show a reasonable expectation of pecuniary loss. Insurable interest is normally required at inception, not at death. The bank's loss-payable endorsement does not create a new insurable interest; it gives the bank a right to policy proceeds to the extent of its loan, subordinate to the policy terms. If the company took the policy purely to speculate on the founder's life, there would be no insurable interest, but the facts here show a genuine key-person exposure. The more difficult issue is the amount: GBP 1,000,000 must be justifiable by the company's expected loss, not merely the founder's desired estate value.
2. Can the insurer avoid the policy for the false medical answer? Discuss materiality, inducement, the finance director's knowledge and the effect of the bank's endorsement.
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The insurer will argue misrepresentation and non-disclosure. The heart condition and cardiology treatment are material: a prudent life insurer would want to know. The answer 'no' was false. The finance director signed the application without asking the founder, and the founder had been advised to reduce travel. The insurer must show inducement: that it would have declined, loaded the premium, or excluded cardiac death. If the misrepresentation was fraudulent or reckless, avoidance is likely. If merely negligent, the remedy may still be avoidance at common law, but some jurisdictions apply a proportional remedy for innocent misrepresentation. The bank's endorsement does not validate an otherwise voidable policy. The company may have a claim against the finance director or broker for failing to complete the proposal properly. The insurer should return premiums if it avoids for innocent non-disclosure, subject to the policy and statute. The bank's position is derivative: it cannot recover more than the company could have recovered.
3. If you acted for the company, what evidence would you obtain and what remedies would you consider?
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Request the underwriting file and the exact questions asked. Check whether the founder himself signed or reviewed the application; if the finance director answered without authority, that affects whose knowledge is attributed to the company. Check whether the broker asked the cardiac question and recorded the answer. Consider whether the insurer would have issued the same policy at a higher premium. The bank should be notified immediately because the collateral is impaired. If avoidance stands, the company may pursue the broker or the finance director for the coverage gap. The bank may have rights against the company under the loan documents. Do not use the policy proceeds to repay the loan before the claim is settled. Also check whether the policy contains a severability clause, because some life policies protect an innocent beneficiary or assignee from the proposer's misrepresentation.