A person has an insurable interest in something when loss or damage to it would cause that person to suffer a financial loss or certain other kinds of losses. For example, if the house you own is damaged by fire, the value of your house has been reduced, and whether you pay to have the house rebuilt or sell it at a reduced price, you have suffered a financial loss resulting from the fire.
By contrast, if your neighbor's house, which you do not own, is damaged by fire, you may feel sympathy for your neighbor and you may be emotionally upset, but you have not suffered a financial loss from the fire.
You have an insurable interest in your own house, but in this example you do not have an insurable interest in your neighbor's house.
The basic principle of insurance is to protect against loss rather than create an opportunity for speculative gain. Early use of insurance as a form of gambling (life insurance on the lives of kings, for example) led to the banning of life insurance in France, Holland and Sweden during the 16th and 17th centuries*.
A notorious abuse of insurance occurred in Pennsylvania in the late 1800s. Six men obtained an insurance policy on an elderly man, who continued to live longer than expected. Understandably, the premiums on an old man were high. Frustrated by the high costs and impatient for the payoff, the men murdered the old man, a crime for which they were hanged. The ability of a person to buy insurance on the life of a stranger would create a moral hazard wherein the person owning the insurance policy stands to profit from the death of the insured.
Establishing the principle of insurable interest as a requirement for purchasing insurance distanced the insurance from gambling, thereby leading to better reputation and greater acceptance of the insurance industry. The United Kingdom provided leadership by passing legislation that prohibited insurance contracts if no insurable interest could be proven, notably the Life Assurance Act 1774 which renders such contracts illegal, and the Marine Insurance Act 1906, s.4 which renders such contracts void.
