The principle of insurable interest acts as a safeguard against moral hazard by ensuring that the policyholder has a genuine financial or emotional stake in the subject matter of the insurance — meaning they would suffer a real loss if the insured event occurs. This prevents people from taking out insurance on something they don’t own or have no connection to, just to profit from an unfortunate event. For example, you can’t insure a stranger’s house, because you would have no loss if it burned down — and might even have an incentive to cause the loss.

By requiring insurable interest, insurers make sure that insurance serves its true purpose: protection against loss, not a means of gambling or profit. This principle maintains the integrity and trustworthiness of the insurance industry, prevents fraudulent claims, and promotes fairness by ensuring that only those at risk can benefit from coverage. Without it, the insurance system could be easily abused, leading to increased fraud, higher premiums, and loss of confidence in the entire industry.