by Eric Posner, E. Glen Weyl
January 10, 2013
A rule known as the “insurable interest doctrine”—which first entered British law by an act of Parliament in 1746, and then became a part of the common law inherited by the American legal system—required that individuals seeking to buy insurance have a stake in the event against which they sought to be insured. A person could not, for instance, purchase a life-insurance policy to bet on the death of the prime minister, but he could purchase life insurance to protect his dependents or buy health insurance to protect himself. The aim was to prevent people from disguising gambling as legitimate insurance transactions. If this rule had been applied to credit default swaps—which are mostly used to gamble on the failure of a debtor rather than to insure against it—the multi-trillion-dollar CDS market would never have formed, and the financial crisis would not have been as severe.