Insurable Interest in Commercial Property Insurance

Insurable interest can affect the amount of your insurance claim

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Insurable interest means a financial interest or economic stake in a piece of property. It's a commonly used term in commercial property insurance. You'll sustain a financial loss if the property is damaged or destroyed, and you'll also benefit financially if the property is preserved.

An Example of Insurable Interest

Sam might pay $500,000 in cash for a warehouse to use in his business. The building has appreciated and is worth $600,000 five years later. Sam would sustain a financial loss of $600,000 if the building were destroyed by a fire. Sam's insurable interest in the building is therefore $600,000.

The Law of Insurable Interest

Property insurance is based on the "law of insurable interest". This rule states that an individual or business cannot receive payment for damage to insured property if he has no insurable interest in it at the time the damage occurs. The rule protects against fraud, dishonesty, and speculation. 

Bill might own a commercial building that he insures under a commercial property policy. He sells the building to Steve six months after purchasing the policy. Bill does not inform his insurance company of the sale and the building is destroyed by a tornado two weeks later. Steve is out of the country when the damage takes place and he doesn't know it has occurred.

Bill files a claim for the replacement value of the building under his property policy and it pays him for the loss. But Bill no longer has an interest in the building. He's collected a windfall for a financial loss he did not sustain. Bill had no insurable interest in the building when the damage occurred. 

Insurance is intended to make the insured "whole" for a loss, not to profit from it. 

The Interest of Lenders

A lender has an insurable interest in property when it's used as collateral for a loan. Suppose that Sarah obtains a $25,000 loan from a bank to purchase a commercial refrigerator. The bank has the right to take possession of the refrigerator if Sarah defaults on the loan. The bank would lose the value of the collateral if the refrigerator were destroyed by a fire or some other peril.

The bank can therefore protect its financial interest in the refrigerator by requiring Sarah to insure the appliance under a commercial property policy.

When someone obtains a mortgage from a bank to buy a building, the bank—the mortgagee—has an insurable interest in the building to the extent of the outstanding mortgage. The bank's interest in the building declines over time as the borrower pays off the loan. The buyer or mortgagor has an insurable interest in the property to the extent of her equity in the property.

Suppose that Bob purchases a building for $1 million and he insures it for $1 million under a commercial property policy. The building is destroyed by a fire five years later. At the time of the fire, Bob still owes the bank $500,000. Bob's insurer determines that the value of the building is $1 million. It sends the $1 million payment to the bank. The bank retains $500,000 to cover the loan balance and forwards the balance to Bob.

The Extent of Insurable Interest

The amount you can recover for a property loss depends on your insurable interest in the property at the time the loss occurred. Your insurer will calculate your loss payment based on your interest in the property at the time of the loss if your interest in the property has changed since the policy was written, 

Suppose you buy a building that you insure under a commercial property policy. You sell half of your interest in the building to your friend Jim four months later. The building burns to the ground two months after the sale so you file a claim under your property policy seeking recovery for the total insured value of the building.

Your insurer discovers that you owned only 50 percent of the building when the loss occurred. Your insurer therefore compensates you for only 50 percent of the value of the building.

Auto Physical Damage Coverage

The rules regarding insurable interest apply to physical damage coverage under a commercial auto policy as well. You must have an insurable interest in the damaged auto at the time of the loss to obtain recovery for loss or damage under comprehensive, specified causes of loss, or collision coverage.