An insurance contract is fundamentally based on the utmost good faith of all parties. The applicant relies on the insurer’s promise to pay. The insurer relies on the truthfulness of the statements the applicant makes 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:
For a contract to be valid, there must be an exchange of consideration.
Premiums are calculated on an annual basis, even if the policy’s mode of payment is more frequent. When a policy owner pays a premium, part of that premium is used to cover expenses, and part is held in reserve to meet future claim commitments. These funds are invested to earn interest. The net effect is to reduce the amount of premium that would otherwise be required.
To form a valid insurance contract, the offer must be accepted unconditionally.
Typically, the applicant makes the offer by submitting an application, often along with the first premium. The insurer may:
If both parties agree to the final terms, a contract is formed. If they don’t agree, no contract exists.
Both parties must be legally capable of entering into a contractual agreement.
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.
Insurance contracts are unique because the applicant must purchase the policy as written, without any opportunity to modify or clarify the contract language. Over the years, courts have used the Doctrine of Adhesion to interpret ambiguous contract terms or conditions in favor of the insured, since the insured had no chance to alter the contract at the time of application.
Insurers work hard to make contract language clear and to avoid misunderstandings about policy terms. Even so, questions and conflicts do arise. When they do, they often involve 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.
An insurance contract is based on utmost good faith: the applicant relies on the insurer’s promise to pay, and the insurer relies on the truthfulness of the applicant’s statements. For a contract to be valid and enforceable, it must include consideration by both parties, offer and acceptance, legal capacity of the parties, and a legal purpose. Consideration is the exchange of promises: the insurer promises benefits for covered losses in return for the applicant’s premium.
Offer and acceptance require an unconditional agreement. The applicant makes the offer by completing an application, which the insurer can accept as submitted or change through a counteroffer. Legal capacity means both parties must be able to enter into a contract. The contract’s purpose must also be legal and 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.
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