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 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.
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.
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.
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.
A property and casualty insurance policy is comprised of four basic sections of coverage including:
Declarations
Insuring agreement
Conditions
Exclusions
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
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.
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.
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.
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.
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:
Warranties guarantee truthfulness, while representations are substantially true statements. Misrepresentations, if intentional, can void the contract and may constitute fraud.
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