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 must be 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.

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, is 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.”

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 time of application.

Insurers go to great lengths to make their contract language clear and avoid any misunderstandings about the terms of the policy. Still, questions and conflicts do arise. 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 knowledge of the applicant.

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 applicant 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.

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

Chapter Vocabulary

Definitions

Acceptance: When the offer (application) is accepted, an agreement is reached.
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.
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.
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.)