Insurable interest
The legal condition requiring the policyholder to have an economic interest in the non-occurrence of the risk for the insurance contract to be valid.
Life Assurance Act 1774 (14 Geo. III, c. 48): Parliament bars insuring another person's life without an interest in it, to end wagers on the deaths of well-known people. Insurable interest has since been a condition of the contract's validity in many jurisdictions: the policyholder must have an economic or financial interest in preserving the property or situation covered. Without it, the contract is no longer insurance but a wager on whether an event occurs, void or against public policy in most legal systems. The interest can come from ownership of an asset, a claim against a debtor, a contractual relationship whose breach would cause harm, or, in life and health insurance, a person's life and physical integrity. It is generally assessed when the policy is taken out and when the loss occurs. Parametric insurance puts it to the test, because it pays a fixed amount when an index is triggered, without looking at the actual loss. A farmer who lost nothing still collects if the index triggers, and one who lost everything gets nothing if the index stays below its threshold. That gap calls insurable interest into question as a condition. It also explains why some parametric products sit under special regulatory frameworks or are structured as financial derivatives.
Hypothetical case: an airline buys a parametric weather product indexed to wind speed at the airports in its operating area. When the wind exceeds 80 km/h for more than six hours at a covered airport, a payment of 500,000 euros goes out automatically. That day, the airline may have suffered no loss at all if none of its flights were scheduled at that airport. A regulator could then challenge whether an insurable interest existed at the time of the trigger and ask the airline to prove a link between its revenues and the measured wind. That is why structurers add a minimum operational-link condition.
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