Life insurance is a policy intended to financially protect your beneficiaries in the event of your death. Although you may be the person who takes out the policy, other people may purchase it as well. Alternately, you may take out a life policy on someone else's life too. Nonetheless, there are limits to how this may be done.
Life insurance companies only allow the purchase of life insurance on another individual if there is a reason to do so. Insurers will not put a policy into effect unless a person has an insurable interest. An insurable interest means that you have a vested interest in keeping the insured alive, or you will experience an emotional or financial loss as a result of the insured's death. This prevents people from taking out insurance policies and hastening the insured's death, or taking them out on elderly strangers to make money.
The benefit of buying a third party life insurance policy is that you protect yourself from the financial risks of another person's death. For example, a business person may purchase life insurance on the life of a business partner to decrease the financial impact it would cause their company. When the partner dies, the businessman receives the proceeds of the policy and can use them to buy out the partner's interest in the company. Otherwise the interest goes to the partner's family, which could slow down or cease business operations if the family does not apply the funds back into the business.
You will always be notified when someone attempts to buy life insurance on your life. Likewise, the insured individual on a policy you purchase must know that you're purchasing a policy. Normally, the insured must undergo a health exam, answer health-related questions and be present to sign the policy.
It is common for insurance companies to inquire as to why you are buying life insurance. If the purchase is excessive, the insurer may only offer a smaller amount of death benefit or reject the application altogether. Even if you can prove an insurable interest, there will be limits to coverage in many instances. For example, the businessman buying life insurance on a business partner can only purchase insurance that equals an objective valuation of the business partner's share of the business, unless he can justify an additional amount.
- "Practicing Financial Planning for Professionals (Practitioners' Edition), 10th Edition"; Sid Mittra, Anandi P. Sahu, Robert A Crane; 2007
- Insurance.com; What is Insurable Interest Mean On a Life Insurance Policy; November 6, 2009