Insurable Interest in Commercial Property Insurance

Your Insurer Will Not Pay More Than Your Insurable Interest in Property

Factory burning at night in Baltimore

The term Insurable interest refers to a person's financial interest in insured property. It represents a person's financial investment or economic stake in the subject of insurance. The concept of insurable interest is fundamental to commercial property insurance.

Doctrine of Insurable Interest

Property insurance law is based on the premise a person may receive payment for the damage or destruction of insured property only if he has an insurable interest in the property. Generally, a person has an insurable interest in property if he derives a benefit from its existence or would suffer a loss from its destruction.

Property insurance is intended to indemnify (compensate) an insured for a loss. It restores the insured to the financial position the insured was in before the loss occurred. If the doctrine of insurable interest did not exist, insureds could use their insurance policies to generate a profit.

To receive payment for a loss under a property policy, a person or business must have an insurable interest in the damaged property at the time the loss occurs.

Ownership and Insurable Interest

A person has an insurable interest in property he owns. For example, suppose Scott buys a warehouse for $1 million in cash. If the structure is destroyed six months later, Scott will have suffered a $1 million financial loss. Assuming Scott has insured the warehouse under a property policy, he will be entitled to seek recovery for the loss from his insurer.

If a building owner sells the property, he loses his insurable interest in it at the time of the sale. For example, suppose Scott sells the warehouse and the building burns down one month later. Scott won't be entitled to receive an insurance payment for the loss because he doesn't have an insurable interest in the building when the loss occurs.

If you file an insurance claim to recover for the loss of property in which you have no insurable interest, you will have committed insurance fraud.

A person need not own property to have an insurable interest in it. For example, suppose that Scott leases a forklift to use in his warehouse. The lease states that Scott is responsible for any damage he causes to the forklift during the term of the lease. Scott has an insurable interest in the forklift because he will incur a financial loss if the machine is damaged.

Interest of Lenders

When a lender provides a mortgage that is secured by a building as collateral, the lender has an insurable interest in property. In the previous example, suppose that Scott purchases the warehouse for $1 million. He makes a $200,000 down payment and borrows $800,000 from Lucky Lending. At the time of the purchase, Lucky's financial interest in the building is $800,000. The lender's interest gradually declines over the term of the mortgage as Scott pays off the loan. If the warehouse is destroyed by a tornado after Scott has paid off half of the loan, Lucky's interest will be $400,000.

The concept of insurable interest also applies to loans obtained to purchase personal property. If you obtain a loan to buy a new truck for your business, the lender will have an insurable interest in the vehicle for the amount of the loan. To protect its interest, the lender will require you to insure the vehicle for auto physical damage and to list the lender as a loss payee in the declarations section of your business auto policy.

Similarly, a lender that extends a loan to you for the purchase of machinery will require you to insure the machine under commercial property coverage. The lender will demand that it be listed on a loss payable endorsement added to the policy. The endorsement protects the lender's interest in the machine (the amount of the loan).

Extent of Insurable Interest

Many property policies address insurable interest in a policy condition entitled Loss Payment. The standard ISO property form contains the following clause:

We will not pay more than your financial interest in the covered property.

This means that the insurer will calculate your loss payment based on your interest in the property at the time the loss occurred.  For example, suppose that Scott purchases the warehouse for $1 million in cash and then sells half of his interest in the building to his brother (Paul). Scott's property insurer adds Paul to his property policy as a named insured. Four months after the sale, the building burns to the ground. At the time the loss occurs, Scott and Paul each own 50 percent of the building. Each will receive compensation based on half the value of the building.