South Carolina Life Insurance Practice Exam

In life insurance, what is the "insurable interest" requirement?

1. It allows policyholders to choose any beneficiary

2. It establishes a financial interest in the insured's life

3. It limits policies to family members only

4. It is not necessary for term policies

The correct answer is: It establishes a financial interest in the insured's life

The insurable interest requirement in life insurance is crucial because it establishes a legitimate financial stake in the life of the insured individual. This means that the policyholder must have a reason to benefit from the continued life of the insured or suffer a loss from their death. Insurable interest is typically needed to prevent moral hazard, which could arise if individuals were allowed to purchase policies on anyone, potentially leading to situations where a person might benefit from the untimely death of another. In practice, insurable interest can exist in various forms, such as familial relationships (like spouses or children), business relationships (partners or stakeholders), or even creditor-debtor relationships. This requirement ensures that life insurance is utilized for its intended purpose—to provide financial protection against loss, rather than for gambling on someone's life. The other options do not accurately convey the nature of the insurable interest requirement. While policyholders can choose beneficiaries, this does not relate directly to the concept of insurable interest. Limiting policies to family members is too restrictive; insurable interest can extend beyond familial ties. Furthermore, the assertion that it is unnecessary for term policies is incorrect, as the insurable interest requirement applies to all life insurance products, including term policies, to uphold ethical standards in the