A bank lends $50,000 to a business owner and purchases life insurance on the borrower. The bank's insurable interest in the borrower's life:

Why A is correct

Insurable interest is the financial interest a person has in the continued life, health, or property of another, and it exists when the person would suffer a genuine economic loss if the insured died or the property was destroyed. A creditor has an insurable interest in the life of a debtor because the creditor stands to lose the money it lent if the debtor dies before repaying the loan. That interest, however, is limited to the amount of the outstanding debt, no more than the financial exposure the creditor actually faces. Once the loan is repaid, the insurable interest disappears because the economic stake is gone. In life insurance, the insurable interest must exist at the time the policy is taken out, even though the benefit is payable at death.

Why the other options are wrong

• B) The insurable interest of a creditor is strictly limited to the amount the bank could lose, the unpaid balance of the loan. An unlimited interest would let the creditor profit from the borrower's death, which the law prohibits, because insurable interest exists to protect against economic loss, not to create a speculative gain.
• C) A family relationship is only one basis for establishing insurable interest; it is not the only one. A valid creditor-debtor relationship also creates an insurable interest, because the lender would suffer a real economic loss if the borrower died, and the law recognizes financial dependency and financial exposure alike as supporting the interest.
• D) In life insurance, the insurable interest must exist at the inception of the policy, not at the time of death. The controlling question is whether the policyowner faces an economic loss at the time coverage is applied for; the prospect of that loss is what makes the contract valid from the start.

Memory hook

A creditor's insurable interest lasts only as long as the debt does.