Insurance can only be purchased on something the buyer would actually lose. That requirement, called insurable interest, is what separates an insurance contract from a bet on someone else's misfortune.
The doctrine has a historical purpose
Early insurance markets permitted policies on lives and ships in which the buyer had no stake. Those contracts were wagers, and they created an incentive for the insured event to occur.
Legislatures responded by requiring the policyholder to stand to lose from the event insured against. Contracts lacking that interest became unenforceable.
The rule persists because the incentive problem persists. It is a structural safeguard rather than a formality.
Property and life apply it at different moments
For property insurance, insurable interest is generally required at the time of loss. Selling a house extinguishes the interest, which is why coverage does not follow the property to a new owner.
For life insurance, the interest is generally required when the policy is issued rather than when the claim arises. A policy validly issued does not fail because the relationship later changes.
That asymmetry explains outcomes people find counterintuitive, such as an ex-spouse remaining a valid policy owner. The interest was tested at issue.
Who has an interest in a life
A person always has an unlimited interest in their own life. Close family relationships are generally presumed to carry an interest as well.
Beyond family, the interest must be economic. Business partners, creditors within the amount owed, and employers with respect to key employees are the recognized categories.
Consent of the insured is separately required in most states for a policy taken out by someone else. Interest and consent are distinct requirements.
Where the doctrine bites in practice
A landlord cannot insure a tenant's contents, and a tenant cannot insure the building. Each insures what they stand to lose.
Someone who insures a vehicle they neither own nor drive may find the claim contested on this basis. Titling and policy naming should match reality.
Arrangements in which investors fund policies on strangers have been prohibited or restricted in many states. Those restrictions target the same wagering problem.
Why it surfaces at claim time
Insurers rarely investigate insurable interest at application beyond the questions asked. It becomes an issue when a claim is paid on property or a life the claimant did not have a stake in.
A contract found to lack insurable interest may be unenforceable, with premiums sometimes returned instead. That is a poor substitute for the coverage expected.
The definitions, the recognized relationships and the consent requirements vary by state and change over time. A licensed agent or an attorney is the appropriate source before structuring an unusual arrangement.