An insurance contract is built on utmost good faith from everyone involved. The applicant relies on the insurer’s promise to pay covered benefits. The insurer relies on the applicant’s truthful answers 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 allows more frequent payments. When the policy owner pays a premium, part of that money covers expenses and part is held in reserve to pay future claims. Insurers invest these funds to earn interest, which helps reduce the 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 with the first premium. The insurer may:
A contract is formed only when both parties agree to the final terms. If they don’t agree, 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 violate public policy. For example, a life insurance policy purchased with the intent to have the insured killed is not a valid contract.
For an insurance contract to be valid, there must also be an insurable interest between the applicant/owner and the insured.
Insurance contracts are unique because the applicant generally must accept the policy as written, without the 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 change the language 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 the applicant knowingly makes a false statement on the application, it is a misrepresentation and may constitute fraud. If the insurer can prove the misrepresentation was intentional, 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 the contract to be valid and enforceable, it must include consideration by both parties, offer and acceptance, legal capacity, and a legal purpose.
Consideration is the exchange of value: the insurer promises to pay benefits for covered losses, and the applicant pays the premium.
Offer and acceptance require unconditional agreement. The applicant usually makes the offer by submitting an application, and the insurer may accept it as submitted or respond with a counteroffer. Legal capacity means both parties must be able to enter into a contract. The contract must also have a legal purpose and not violate public policy. A valid insurance contract also requires an insurable interest 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 when terms are ambiguous.
Insurers strive for clear contract language to prevent misunderstandings.
Warranties guarantee truthfulness, while representations are statements that are substantially true. Intentional misrepresentations can void the contract and may constitute fraud.
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