What does the term 'insurable interest' signify in insurance?

The term 'insurable interest' signifies that the policyholder must possess a legitimate interest in the insured property or person. This means that the individual or entity purchasing the insurance must stand to suffer a financial loss or hardship if the event insured against occurs, such as damage to property or death. This principle is vital to the functioning of insurance as it helps prevent moral hazard, where individuals might otherwise have an incentive to cause a loss in order to collect insurance benefits.

For example, if a person insures a car that they own, they have an insurable interest in that vehicle because they would incur a financial loss if it were damaged or destroyed. In contrast, if someone attempted to insure a car that they do not own and have no financial stake in, they would lack the necessary insurable interest, as they would not be affected by the loss.

Understanding insurable interest is crucial for forming valid insurance contracts and ensuring that all parties involved are protected against potential risks.