Insurance Contracts | General Insurance Concepts

Essential Elements of an Insurance Contract

An insurance contract is fundamentally based on the utmost good faith of all parties to the contract. The applicant is relying on the promise to pay made by the insurer. The insurer is relying on the truthfulness of the statements made by the applicant on the application. Insurance is also based on the law of contract. For any contract to be valid and enforceable, four conditions must be met:

There must be consideration by both parties.
An offer must be made by one party and acceptance of that offer made by the other party.
All parties to the contract must be legally capable of entering into a contract.
The purpose of the contract must be legal.

Consideration

There must be an exchange of consideration for the contract to be valid. The insurer’s consideration is its promise to pay policy benefits should the insured suffer a covered loss (acceptance of the risk). The applicant’s consideration is the premium. All premiums are calculated on an annual basis, but the policy’s mode of payment may be more frequent. When a policy owner makes a premium payment, part of the premium is used to meet expenses, and part is held in reserve to meet future claim commitments. These funds are placed in investments that earn interest. The net effect is to reduce the amount of premium that would otherwise be required.

Offer and Acceptance

The offer made by one party must be accepted by the other on an unconditional basis. An applicant makes the offer by completing an application. It is either accepted by the insurer as is, or the insurer may make a counteroffer by proposing a rated policy. In the end, both parties either agree to the final terms of the policy or there is no contract.

Legal Capacity

Both parties must be legally capable of entering into a contractual agreement. If the insurer is admitted or authorized in the state, it has legal capacity. The applicant has legal capacity unless he/she is a minor, mentally incompetent, intoxicated, or under the influence of narcotics.

Legal Purpose

A valid contract must be for a legal purpose and not against public policy. A life insurance policy purchased with the intent to have the insured killed is an obvious example of an invalid contract. For an insurance contract to be valid, there must be an insurable interest between the applicant/owner and the insured.

Sidenote

Know this…

Consideration, Offer, Acceptance, and Legal Purpose/Legal Capacity are the 4 essential elements of an insurance contract. “Meeting of the minds” is a fancy way to say “Acceptance by both parties.”

A property and casualty insurance policy is comprised of four basic sections of coverage including:

Declarations
Insuring agreement
Conditions
Exclusions

Declarations

The declarations page provides information regarding the property or exposures being insured. Much of the information in the declarations section is taken directly from the application and include, but are not limited to:

Name and address of the named insured
A description of the type of property to be insured
The location of the property
The coverage limit provided
The amount of the annual premium
Amount of the deductible, if any
The policy period (inception and expiration dates)
The name of a mortgagee, if any
A company officer name, signature or stamp

Insuring Clause

This section provides a summary of the coverage or agreement between the named insured and insurer. More specifically, it identifies the parties to the contract and lists the perils covered by the policy.

Conditions

This section identifies the responsibilities of each of the parties to the contract. If a named insured fails or refuses to comply with policy conditions, an insurer may deny a claim or refuse to renew coverage. Most policy conditions are placed upon the named insured. For example, whenever a risk is altered or increased (i.e. installing a swimming pool after the policy became effective), the insured is required to notify the insurer.

Exclusions

This section of the policy identifies the property and perils that are not covered. Exclusions allow or permit an insurer to protect itself from financial disaster by not providing coverage for catastrophic losses. Insurance contracts are unique in that the applicant must purchase the policy as written without any opportunity to modify or clarify the contract language. Through the years, the court system has used the Doctrine of Adhesion to interpret ambiguous contract terms or conditions in favor of the insured since they had no chance to alter the contract at the time of application.

DICE four basic sections

Insurers go to great lengths to ensure that their contract language is clear and avoid misunderstandings about the policy’s terms. Still, questions and conflicts do arise, and when they do, they often involve the concepts of warranties and representations.

A warranty is a guarantee that a statement is truthful.

Representations are statements made on the application that are substantially true to the best of the applicant’s knowledge.

If a statement is made on an application that the applicant knows is false, it is a misrepresentation and may constitute fraud. If the insurer can prove that the misrepresentation was made intentionally, it may void the contract and may be punishable as a Class 6 felony.

Lesson Summary

An insurance contract is based on utmost good faith, with the applicant relying on the insurer’s promise to pay and the insurer relying on the truthfulness of the applicant’s statements. Legal contract conditions include consideration by both parties, offer and acceptance, legal capacity of parties, and a legal purpose. Consideration involves the exchange of promises, with the insurer promising benefits for covered losses in return for the applicant’s premium.

Offer and acceptance require an unconditional agreement. The applicant offers by completing an application, which the insurer can accept as is or propose changes. Legal capacity means both parties must be able to enter into a contract. The contract’s purpose must also be legal, not against public policy. An insurable interest must exist between the applicant/owner and the insured for a valid contract.

Insurance contracts have unique features:
Applicants must accept policies as written without modification.
The Doctrine of Adhesion favors insured parties in case of ambiguous terms.

Insurers strive for clear contract language to prevent misunderstandings. A valid insurance contract must establish an insurable interest. Additionally, a property and casualty insurance policy consists of four parts:

Declarations: Information about the insured property
Insuring Clause: Summary of coverage and perils covered
Conditions: Responsibilities of each party
Exclusions: Identifies what is not covered

Warranties guarantee truthfulness, while representations are substantially true statements. Misrepresentations, if intentional, can void the contract and may constitute fraud.

Chapter Vocabulary

Definitions

Acceptance: An agreement is reached when the offer (application) is accepted.
Adhesion: Insurance policies are contracts of adhesion because the terms are written by the insurer, and the insured simply “adheres.” For this reason, vague or ambiguous provisions are often interpreted by courts in favor of the insured.
Competent Party: Most entities in a contract are deemed competent except minors, those under the influence of alcohol or narcotics, and mentally incompetent individuals.
Concealment: Neither party may conceal facts that would have affected the creation of the contract.
Conditions: Requirements specified in the insurance contract that must be upheld by the insured to qualify for indemnification.
Consideration: The exchange of values on which a contract is based. In insurance, the consideration offered by the insured is the premium. The consideration offered by the insurer is the promise to pay in accordance with the terms of the contract.
Declarations: Policy statements regarding the applicant and property covered such as demographic and occupational information, property specifications and expected mileage per year.
Exclusions: Provisions in the policy that eliminate coverage for specified losses or causes of loss.
Insuring Clause: The provision of an insurance policy containing the insurance company’s promise. It established the obligation of the company to provide the insurance coverage as stated in the policy.
Legal Purpose: A contract/policy must be drawn for a legal purpose and not against public policy.
Misrepresentation: On the part of an insurer or its agent, falsely representing the terms, benefits, or privileges of a policy. On the part of an applicant, falsely representing the health or other condition of the proposed insured.
Offer: The terms of a contract proposed by one party to another. In insurance, submitting an application to the company is usually considered an offer.
Representations: On an application, facts that the applicant represents as true and accurate to the best of his/her knowledge and belief.
Rescission: The termination of an insurance contract by the insurer when material misrepresentation has occurred.
Utmost Good Faith: Acting in fairness and equity with a sincere belief that the act is not unlawful or harmful to others. The insurance contract requires that each party is entitled to rely on the representations of the other without attempts to conceal or deceive.
Warranty: A statement made on an application for insurance that is warranted to be true in all respects. If untrue in any respect, even though the untruth may not have been known to the person giving the warranty, the contract may be voided whether or not the untruth or inexactness is material to the risk. Statements on life and health insurance applications are, in the absence of any evidence of fraud, representations rather than warranties. (Contrast with Representations.)