The Q&A Files: Who can I name as my life insurance beneficiary?

Michael Burton, CFP®, LHICLife Insurance Beneficiary, Q&A

Life Insurance Beneficiary Bag of Money 714x700 Compressed

Assuming you own the life insurance policy in question, there are two basic time-frames in which you can name a life insurance beneficiary.

  • You can name the life insurance beneficiary at the time of your application, and
  • You can change the life insurance beneficiary any time after the policy is placed in force.

Let’s explore both instances.

The First Time-Frame:  Naming a life insurance beneficiary at the time of application

At the time of your application, state insurance laws require that your beneficiary have an insurable interest in your life. In general, this is how life insurance companies prefer it, too.  These laws and practices were established by insurance regulators in the infancy of the industry.  They were created to reduce the speculation in human life through life insurance.  Lawmakers saw that allowing such practices would effectively create a motivation for murder.  Which would be creepy, to say the least.

What Is “Insurable Interest”?

A simple way to understand insurable interest is to learn when it exists.  An insurable interest is present when the value of the person being insured (the Insured) is so great that under no circumstance would the beneficiary want him/her to die just to collect the death benefit.  This type of value is legally presumed to exist within one’s core family attachments.  So spouse’s can always name their spouse’s or children as their life insurance beneficiary.  For that matter, a person can name any legal dependent as the beneficiary of their policy.

Although it is less common and typically requires a written explanation, siblings can also be deemed to have an insurable interest in each other’s lives.  Nephews, nieces, and grandchildren can be named beneficiaries as well.

Family ties also permit a policy owner to name a Trust as his/her life insurance beneficiary, provided that the Trust’s beneficiaries have an insurable interest in the life of the insured.

Legitimate Insurable Interests Exist in The Business World.

For example, business partners commonly take out life insurance policies on one another to provide liquidity to buy back the deceased partners business interests from his/her heirs.  This keeps business ownership consolidated with those who know the business and run it.

Similarly, a lender to (or investor in) a small business is also allowed to be the beneficiary of a life insurance policy insuring the life of the business owner/borrower. This provides assurance that the lender/investor will be made whole if the business suffers or fails due to the loss of its key fixture.

Insurable Interest in a Famous Non-Profit Setting

Similar to a lender whose investment depends heavily on the life of the owner-operator borrower, an employer can have an insurable interest in a key employee.  For example, the University of Michigan recently established a life insurance policy on Jim Harbaugh, its head football coach. Now, that policy was tied into an arrangement for extra compensation for Harbaugh himself, the complexities of which are not the subject of this article. An Uncommon Life Insurance Beneficiary RelationshipNevertheless, life insurance could not have been used as the funding mechanism for Harbaugh’s extra benefits were it not for the Wolverines’ insurable interest in Harbaugh’s life.

So, that’s the main stipulation when it comes to naming a life insurance beneficiary at the time of the application.  The beneficiary must have an insurable interest in the life of the Insured.

The other stipulation which should especially be mentioned in a business setting is that any adult insured must provide informed consent to the arrangement.  Informed consent exists by definition, of course, if you are taking out insurance on yourself.  But that is not the case for the business instances described above.  The University of Michigan cannot just take out a life insurance policy on Harbaugh without his signing off on the deal.  And don’t worry.  Your business partner or employer cannot take out a life insurance policy without your knowledge, either.  At least not after Walmart did so and got busted with a bevy of very expensive lawsuits.

The Second Time-frame:  Naming a life insurance beneficiary after the policy is issued and accepted

The second category of time in which you can name a life insurance beneficiary is after the policy has been issued and accepted.

After a policy is placed in force, the rules for naming a life insurance beneficiary are much more liberal.  In fact, they’re about as liberal as they can be.  

After the life insurance policy has been placed in force, the policy owner has the immediate legal authority to name anyone as his/her life insurance beneficiary.
After the life insurance policy has been placed in force, the policy owner has the immediate legal authority to name anyone as his/her life insurance beneficiary.  Yes, that would even include someone who would prefer for you to die and pocket the death benefit.

A Closing and Creepy Reality

The freedom that allows a policy-owner to change the beneficiary to someone without an insurable interest in the insured is what gives rise to the little-known and controversial secondary market for life insurance. This secondary market for life insurance is also known as the “life settlement” market, or sometimes the “viatical” market.

Without going into too much detail about the secondary market for life insurance, I’ll simply offer that, whatever your visceral reaction might be to letting some stranger happily profit from your death, there are occasions when a policy owner’s financial needs are so accute that he/she would even be willing to sell his/her life insurance to raise some cash.  I’m sure if you think hard enough, you’ll be able to imagine those circumstances.  The courts can.  Thus the courts have consistently ruled that the rule of insurable interest should not interfere with an existing policy owner’s opportunity to dispose of his/her policy under the most profitable terms.

Even the best of rules have exceptions.  That is the why the rule of insurable interest only applies at the time of purchase.

© Michael C. Burton, 2016 and all years.

About the Author

Michael Burton, CFP®, LHIC

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Michael lives in Austin, Texas with his wife, son, and daughter. When he's not designing flag football plays for little boys who will surely have no idea what he's talking about, Mike dedicates himself to providing life insurance advice that puts the client's interests first, no matter what.