Without an insurable interest, an insurance contract is a gambling contract, and gambling contracts cannot legally be enforced. For example, David cannot insure Paul’s house in which David has no insurable interest, betting (gambling) the house will suffer a loss. If David could win this bet, he would receive a return far in excess of the premium he otherwise would pay, but would face no risk other than the cost of the premium.
Insurance provides well recognized opportunities for profit to an insured who deliberately causes an insured event to occur. For example, after purchasing property insurance on Paul’s house, David might deliberately start a fire to collect the insurance. The insurable interest requirement therefore reduces intentional losses created by one party having a disproportionate financial interest in causing a loss. The temptation to cause loss will be reduced when an insurable interest exists. For example, although Paul might destroy the property of an unrelated person like David for his own financial gain, he will be less willing to set fire to his own house, because of the inevitable loss of his own possessions.
The principle of indemnity means a person should not profit from an insured loss. Most property and casualty insurance contracts are contracts of indemnity. In contrast to a valued contract, which provides for the payment of some pre-established dollar amount, a contract of indemnity provides for payment of the sum directly related to the amount lost, subject to the limitations of the policy. The insurer therefore indemnifies the insured for pecuniary loss to that property or activity in which the insured has a personal interest. This is discussed in the 1963, Texas Supreme Court opinion styled, Smith v. Eagle Star Insurance Co.