An insurance contract is built on utmost good faith from everyone involved. The applicant relies on the insurer’s promise to pay. The insurer relies on the applicant to provide truthful information on the application.
Insurance is also governed by contract law. 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 (something of value).
Premiums are calculated on an annual basis, even if the policy’s payment mode is more frequent. When a policy owner pays a premium, part of that premium covers 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:
If both parties agree to the final terms, a contract is formed. If they don’t, no contract exists.
Both parties must be legally capable of entering into a contract.
A valid contract must have a legal purpose and must not be against public policy. For example, a life insurance policy purchased with the intent to have the insured killed is 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 an opportunity to modify or clarify the contract language. Over time, courts have applied 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 can 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 an applicant makes a statement 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 unconditional agreement. The applicant typically makes the offer by completing an application, and the insurer may accept it as submitted or propose changes. 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.
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 statements that are substantially true. Misrepresentations, if intentional, can void the contract and may constitute fraud.
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