When must insurable interest be present in order for a life insurance policy to be valid

The Office of General Counsel issued the following opinion on July 17, 2003 representing the position of the New York State Insurance Department.

Re: Insurable Interest – Key Man Insurance

Question Presented:

1. May a corporation that purchased a "key man" life insurance policy continue making premium payments on such policy even though the insured is no longer affiliated with the corporation?

2. May such insured change the beneficiary on the policy from the company to his family?

Conclusions:

1. Yes. N.Y. Ins. Law § 3205(b) (McKinney Supp. 2003) requires that an insurable interest in the life of another need only exist "at the time when the (insurance) contract is made." The subsequent termination of the insurable interest does not affect the rights of the owner of a policy that was valid at its inception.1

2. This is a question of fact and would have to be decided in accordance with the provisions of the Shareholders Agreement and the life insurance policy.

Facts:

The inquirer’s client ("the client") had been a party to a Shareholders Agreement since 1998, which had named him as a "key man". The company took out a $1.5 million life insurance policy on the life of the client. The company is the owner of the policy, the premium payer and also the named beneficiary. In 2001, the client sold his shares to his partner and the Shareholders Agreement was terminated. Since that time the company has continued to pay the premium on this policy.

Analysis:

N.Y. Ins. Law § 3205(b)(2) (McKinney Supp. 2003) provides:

No person shall procure or cause to be procured, directly or by assignment or otherwise any contract of insurance upon the person of another unless the benefits under such contract are payable to the person insured or his personal representatives, or to a person having at the time when such contract is made, an insurable interest in the person insured.

The term "insurable interest" is defined in N.Y. Ins. Law § 3205(a)(1)(B) (McKinney Supp. 2003) as:

in the case of other persons, a lawful and substantial economic interest in the continued life, health or bodily safety of the person insured, as distinguished from an interest which would arise only by, or would be enhanced in value by, the death, disablement or injury of the insured.

Thus, although an insurable interest in another’s life must exist at the inception of the policy in order to create a valid contract, that interest need not continue unless the policy so provides. Accordingly, if the company had an insurable interest in the client at the time that the life insurance contract was made, and the policy does not provide otherwise, the subsequent termination of the insurable interest, as a result of the client’s sale of all of his shares, does not invalidate the policy. Moreover, the longstanding rule in New York is that termination of an insurable interest has no effect on the beneficiary’s right to recover under a policy that was initially valid. See Herman v. Provident Mutual Life Ins. Co. of Philadelphia, 886 F.2d 529, 534 (2d Cir. 1989).

Normally, the company is the applicant, owner, premium payer and beneficiary under a key man life insurance arrangement. Thus, unless there is a provision in the Shareholders Agreement or the life insurance policy to the contrary, it is unlikely that the client would be able to change the beneficiary from the company to a family member. The court in Herman v. Provident Mutual Life Ins. Co. of Philadelphia, 886 F.2d 529, 536 (2d Cir. 1989), addressed the question of whether the policy could be assigned to the insured and the beneficiary changed from the company to a family member of the insured and determined that this would be a question of fact.

For further information you may contact Supervising Attorney Joan Siegel at the New York City Office.

1 The only exception to this rule would be if the policy provided otherwise. See Connecticut Mutual Life Ins. Co. v. Schaefer, 94 U.S. 457, 460, 24 L.Ed. 251 (1876).