Before your life insurance policy is approved it must be underwritten. You are probably familiar with the term underwriting as it relates to the assessment of your current and past health and risk to the insurer, but did you also know that underwriters are reviewing your choice of beneficiaries as part of the underwriting process?
It’s true. When you apply for a life insurance policy you must choose a primary beneficiary with an insurable interest in you if you want to get your life insurance policy approved by the underwriters. Insurable interest is generally broken down into two types of loss—emotional and financial. In order to have an insurable interest in your life, your beneficiary must fall into one of these categories.
Insurable Interest: Financial Loss
There are many individuals and businesses that could suffer a financial loss if you were to die. Your lenders many not get loans repaid in the event of your death, your spouse might not be able to support him or herself without the assistance of your income, your children may not be able to go to college. In addition, your parents, spouse, or siblings might not be able to afford your funeral expenses. Your business partner or boss may no longer be able to run the business properly and could suffer financially without your knowledge, image or experience.
When naming a primary beneficiary that will experience a financial loss at your death, no justification is required when that beneficiary is an immediate family member. If the beneficiary is a lender, business partner or boss, then additional documentation and letters of explanation may be necessary.
Insurable Interest: Emotional Loss
There is an undeniable group of people who would suffer an emotional loss upon your death. Your immediate family—parents, spouse, children and siblings would certainly feel a tremendous emotional void if you were no longer around. While this emotional loss does not necessarily result in a financial need, it does set up an acceptable environment for the issuance of a death benefit.
Unless you are naming a far removed family member as your primary beneficiary, there should be no need for a justification of the choice that you make. Be sure to be very clear about the amount that you want each beneficiary to receive if you are naming multiple beneficiaries. If you are leaving the benefit to a minor, consider setting up a trust in the event that he or she should receive the benefit before reaching a financially mature stage in life.
Exceptions to the Rules
There are always exceptions to the rules. If you want to leave your death benefit to a funeral home, although they would gain financially from your death, you can do so. This is acceptable because it simply avoids awarding funds to a middle man (such as a parent or spouse) who will only turn the funds over to the funeral home anyway. However, it is important to note that they will receive the entire death benefit when you do so.
If you have no family and no creditors, you may decide to leave your death benefit to a friend. In this event, it is generally preferred that you leave the funds to your estate and simply leave a will with instructions for the distribution of your estate assets. While this will result in your life insurance proceeds going through probate, it is a faster way to get your death benefit approved.
Once your policy is issued, the question of insurable interest no longer has any bearing and you can change your beneficiary to anyone that you would like. Just contact your insurance company and find out how you need to submit the beneficiary change information. Some insurers might have a form you need to complete while others might just request a letter. If you are not the owner of your own insurance policy, remember that it is the owner who must sign off on any beneficiary changes. Once your change is complete, let your beneficiaries know and keep a copy of the submitted change request with your policy to help avoid any confusion after you are gone.