An important principle of Insurance is insurable interest. Let us understand it with the help of a few examples.
 

Insurable interest is the term we use to describe the relationship between the insured and the subject matter of insurance (in the above case it is the health of Manoj and his family on one hand and Manoj’s neighbour). This relationship gives Manoj a particular type of interest in the health of himself, his wife and child, whereby he benefits from the good health and suffers a financial loss by way of hospital expenses if one of the members of his family falls ill. 

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We buy insurance to ensure that the loss suffered is compensated for in some way. The position is not so in case of Manoj’s neighbour as Manoj does not suffer any financial loss due to his neighbour falling ill.

Example 1
Shri Manoj was staying with his wife and son. An insurance agent visited him offering health insurance. Manoj indicated that he wanted to take health insurance for all the members of his family. He also wanted to take a policy for his good neighbour. The insurer said that Manoj can take a policy for his family but cannot take a policy for his neighbour.
The reasons why the insurer refused to issue insurance policy to Manoj’s neighbour was because Manoj did not have an insurable interest in his neighbour’s health.

Insurable interest exists when an insured person derives a financial benefit from the continued existence of the insured object or suffers a financial loss from the loss of the insured object. A person has an insurable interest in something when loss-of or damage-to that thing would cause the person to suffer a financial loss.

Example 2
If the house you own is damaged by fire, you suffer 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 but you have not suffered a financial loss from the fire. You have an insurable interest in your own house, but not in your neighbor's house.

Imagine that you had insured your house. Later you sold the house to buy a bigger house.

There was fire in the house after you sold the house. Since you do not own the house anymore, you will not suffer any loss. Therefore, now you do not have any insurable interest in the house. Insurable interest should be there at the time the loss is suffered.

People have an insurable interest in their property to the extent of loss suffered, but not more. The principle of indemnity dictates that the insured is compensated for a loss of property, but is not compensated for more than what the property was worth.

A lender, who gives loan against the security of house, has an insurable interest on the property because if there is a loss to the house, he would suffer a loss by not getting back the money.

However, the insurable interest of the lender is not in excess of the value of the loan.