LIMITING KEY MAN COVER INSURABLE INTEREST AND NON-INDEMNITY POLICIES

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1 LIMITING KEY MAN COVER INSURABLE INTEREST AND NON-INDEMNITY POLICIES 1. Contracts of insurance may be either contracts of indemnity, or contracts of nonindemnity insurance. 2. When indemnity (often called short-term) insurance contracts are concluded the insured is entitled to recover the actual commercial value of what he has lost through the happening of the insured event, be such event damage to property, fire, theft, public liability or marine insurance. 3. In non-indemnity insurance the sum which the insured is entitled to receive from the insurer does not necessarily bear any relation to the actual loss, if any, suffered by the insured. Life insurance contracts, personal accident and sickness insurance are examples of non-indemnity insurance. 4. Although an insurable interest is a requirement in both indemnity and nonindemnity insurance, the time when such interest exists differs. 5. It is not ordinarily necessary that the insured should disclose the nature of his interest to the insurer, but it is permissible that the proposal may require disclosure of the interest - and if its nature is such that the risk may be affected, it must be disclosed. 6. In the case of insurance on the life of the insured, or the insured spouse, an insurable interest is presumed and need not be proved. In all other cases of life insurance, a pecuniary interest is required and it must be in existence at the beginning of the contract. 7. As a life policy is not a contract of indemnity, the interest need not continue until the death of the life assured. If, for example, a creditor insures his debtor s life,

2 2 that particular creditor is entitled to be paid the insured amount in full, even though the debtor repays the debt prior to his death. The insurance is only allowed to the amount of the debt with interest. 8. A person s legal right to claim support from a relative is sufficient to constitute an insurable interest in the latter s life and partners have an insurable interest in each other s lives. The partnership itself has an insurable interest in the life of each partner. 9. A company has an insurable interest in the life of its manager, or managing director, where its prosperity depends on his services and skills and where his death would cause it financial loss. The extent of the insurable interest would depend, inter alia, on the terms of the agreement between the company and its manager or managing director. 10. In the case of employer and employee, if the service contract has a term of several years, an employee has an insurable interest in the life of his employer to the extent of the value of the future salary, whilst an employer has an insurable interest in the life of the employee to the extent of the value of his services while he is under a legal obligation to serve his employer. 11. It needs to be borne in mind that the requirement of insurable interest is generally speaking, a decisive consideration in a broader enquiry as to whether or not an agreement under scrutiny is properly called a policy of insurance (which is enforceable), or a gambling or wagering agreement (which is not enforceable). 12. The question of whether loss or damage to the party concerned is the determinant as to whether or not the party has an insurable interest has been the subject of conflicting decisions. It was accepted by the Natal Courts in

3 3 Manderson vs Standard General Insurance Company Limited, 1996 (3) SA 434 (D) at 441 G-H read with 442 C that the question be answered affirmatively. Indemnity insurance was under consideration in this case. On the other hand, in the Zimbabwe High Court in Brightside Enterprises vs. Zimnat Insurance Company Limited, 2003 (1) SA 318 (ZHC) at 325 I-J to 326 A-B it was held that the existence of an insurable interest could only be determined with reference to the time when the policy was taken out, since it was at that time that the insured perceived the risk against which he wished to guard and the insurer issued a policy on the basis of the contemplated risk. This case also dealt with indemnity insurance. There is no recent case law that deals with insurable interest in the context of nonindemnity insurance. 13. As a matter of practice in underwriting what are commonly called key-man policies, it is important to recognise that this type of policy is construed as a nonindemnity life insurance policy and that as such it would not be necessary for the insured to prove the extent of his insurable interest at the time of claim. However, instances have arisen in a recent experience where low level partners, managers and employees are insured for fantastic sums of money which bear no relation to the financial loss actually in prospect should the insured life end prematurely. Proposals for this type of insurance should, as a matter of course, carefully canvass the extent of the insurable interest at the time that the policy is taken out so that insurance companies issue a policy on the true basis of the contemplated risk and not upon some fanciful figure which bears no relation to the extent of the value of the insured life to the co-partners, company, employer or, indeed, employee. 14. This need to canvass the extent of insurable interest at the time that the policy is taken out seems to have been increasingly pushed aside over recent years, in

4 4 the interests of competitive underwriting, faster turn-around-times in placing cover and the ever growing multiples of gross annual income on offer. 15. Questions pertaining to the extent of insurable interest, proof of such interest (particularly in business partnerships and key man insurance) are often not asked, let alone answered. Financial questionnaires, proof of assets and liabilities, audited financial statements and other relevant documentation make their first appearance at claims stage, by which time it is generally too late to adjust or limit the cover in force. 16. At the time of the claim it is too late to investigate whether the extent of the insurable interest was stated at its true value or whether it was indeed, a fanciful sum, to have placed on risk. 17. In the absence of material non-disclosure or any other obvious attempt at antiselection or fraud, Life Offices have no recourse and the claim will most likely qualify for payment. 18. One might expect that the realisation that too much cover is being allowed to be placed on risk, will alert the underwriting managers to a possible loop hole in the underwriting guidelines, thereby impelling them into taking action by setting up a means of ensuring no re-occurrence. 19. Such action would be considered reasonable and justifiable, given that the shareholders money may be at risk and profit margins may be negatively affected if the extent of genuine insurable interest were to continue to go unchecked at underwriting stage. 20. Surprisingly however, little action appears to be taken in this regard and where the Life Office may carry only a small portion of risk, having elected to share the

5 5 bulk of the sum assured with a Reinsurer, there may be very little incentive to revisit the limited underwriting protocols in place. 21. In the case of the Reinsurer adopting a policy of following the fortunes of the Life Office, the reinsurance partnership may very well continue unaffected and unaltered by the lack of investigation into the extent of insurable interest. 22. In the case of the Reinsurer choosing not to take all the pain in the above scenario however, things may turn out rather differently. 23. It is at this point that one turns to the importance of an alignment of interests between Life Office and Reinsurer. If each party were to have agreed to adhere to specific underwriting guidelines and principles and each party were to equally take the pain in paying out a grossly over-insured key man life, the investigation of insurable interest up-front and the attention given to this aspect of insurance may very well be different. EBH April 2005