An insurance contract is, therefore, the base of the insurance business and an agreement between parties with a legally defined scope of coverage. In simple terms, it represents the guaranteed benefit against consideration, which is, in most cases, through a paid premium by the insured. This is a very important contract, as it gives protection against the risk of potential loss to an organization or an individual and, hence, gives financial protection and peace of mind.
Insurance contracts are important in the sense as they ensure that both the parties, insurer and insured, are fully aware of their rights and obligations. Many of these basic, legally recognized elements which make insurance contracts effective in a court of law set it apart from a simple agreement. Such elements in the contract consist of an offer and its acceptance, consideration, legal purpose, and competent parties. All of these constituents need to be present for the contract to be valid and legally binding.
Being that the insurance contracts are of great importance, understanding them is one area that any party needs to engage in; whether the prospective policyholder, agent, or insurer. This would ensure awareness to the parties concerned of the responsibilities that should be expected from them, and the protection accorded in the contract. The same knowledge also forms a basis for the passing of most insurance-related exams and for the effective maneuvering through the complexities of insurance policies.
The following sections will discuss in more detail the fundamental principles, characteristics, and legal concepts applying to insurance contracts, for more comprehensive knowledge and understanding. To know more and read further on these, you may also refer to “Essential Elements of an Insurance Contract” and “Characteristics of Insurance Contracts.”
Essential Elements of an Insurance Contract
An insurance contract exists when an agreement between two or more parties binds them legally by exchanging a benefit of promises in return for consideration. An insurance contract, like any other contract, is based on four indispensable elements: offer and acceptance, consideration, legal purpose, and competent parties. Here’s a step-by-step guide to understand each of these elements:
1. Offer and Acceptance:
Offer: A proposal becomes when the applicant sends an application for insurance to the insurance company. This act of sending the application is considered as an offer.
Acceptance: The offer is accepted when the application is accepted by underwriters at an insurance company. This mutual agreement can be the basis of the contract between the applicant and the insurance company.
Example: John makes an application to a medical insurer; the medical insurer processes and accepts his application form. John’s offer is accepted, and there is now a binding agreement.
2. Consideration
Consideration: This is defined as something of value that is given from either party to the other. In an insurance contract, the consideration of the insured would be their premium payment. The consideration to be shown by the insurance company is a promise to pay in case of a loss due to an event covered by the policy.
Illustration: For instance, Sarah pays $100 per month as a premium to the insurance company, which covers her car for accidents. In this case, the insurance company will pay for her car repairs caused by accidents.
3. Legal Purpose
Legal Purpose: The objective of the insurance contract needs to be legal and cannot operate against public policy means it needs to be for some lawful purpose and not for any illegal activity.
Insurable Interest: There should be an insurable interest in the policy, meaning the entity taking the insurance policy, known as the policyholder, has a legitimate reason of insuring the risk, and the entity whose risk is being covered under the policy known as the insured to provide his written consent.
Example: Tom buys a life insurance policy on his name. He holds an insurable interest and provides consent in writing; therefore, the contract is legal and binding.
4. Competent Parties
Competent Parties: Competent parties are parties entering the contract; they have to be legally competent. This means they should be of legal age, be capable of understanding the terms clearly with a sound mind, and not be under the influence of drugs or alcohol.
Illustration: Jane, 30 years old, of sane mind, wishes to insure her house. Inasmuch as the insurer and Jane are competent parties, the contract is considered legally applicable.
To make it even simpler for the reader, an insurance contract is only enforceable if it is based on offer and acceptance, consideration, legal purpose, and competent parties. Indeed, these are the backbone elements in insurance, and understanding them does bear some importance to those involved in this area of business.
Essential Elements of an Insurance Contract
An insurance contract exists when an agreement between two or more parties binds them legally by exchanging a benefit of promises in return for consideration. An insurance contract, like any other contract, is based on four indispensable elements: offer and acceptance, consideration, legal purpose, and competent parties. Here’s a step-by-step guide to understand each of these elements:
1. Offer and Acceptance:
Offer: A proposal becomes when the applicant sends an application for insurance to the insurance company. This act of sending the application is considered as an offer.
Acceptance: The offer is accepted when the application is accepted by underwriters at an insurance company. This mutual agreement can be the basis of the contract between the applicant and the insurance company.
Example: John makes an application to a medical insurer; the medical insurer processes and accepts his application form. John’s offer is accepted, and there is now a binding agreement.
2. Consideration
Consideration: This is defined as something of value that is given from either party to the other. In an insurance contract, the consideration of the insured would be their premium payment. The consideration to be shown by the insurance company is a promise to pay in case of a loss due to an event covered by the policy.
Illustration: For instance, Sarah pays $100 per month as a premium to the insurance company, which covers her car for accidents. In this case, the insurance company will pay for her car repairs caused by accidents.
3. Legal Purpose
Legal Purpose: The objective of the insurance contract needs to be legal and cannot operate against public policy means it needs to be for some lawful purpose and not for any illegal activity.
Insurable Interest: There should be an insurable interest in the policy, meaning the entity taking the insurance policy, known as the policyholder, has a legitimate reason of insuring the risk, and the entity whose risk is being covered under the policy known as the insured to provide his written consent.
Example: Tom buys a life insurance policy on his name. He holds an insurable interest and provides consent in writing; therefore, the contract is legal and binding.
Characteristics of Insurance Contracts
There are certain special characteristics inherent in the insurance contract that make it different from other contracts. It is important for a person dealing with insurance to understand such characteristics. The following describes these distinct characteristics, each with examples:
Aleatory Contracts: By their nature, insurance contracts are aleatory, effective based on an uncertain event. For example, the insurance company will pay only when an occasion, say an accident or a natural disaster, occurs. The uncertainty of the event is the very inherent nature of the agreement in every insurance policy.
Contracts of Adhesion: Generally, all contracts of insurance are contracts of adhesion. The term simply implies that one party to the contract the insurer drafts the contract and another—the insured—has little to no possibility of bargaining the terms of the contract; the latter just has to take it the way it is. For example, when you purchase a car insurance policy, you usually accept the terms dictated by the insurer without argument over them.
Unilateral Contracts: A unilateral contract is a type of contract in which one party is obliged to make a legally binding promise. For example, in a case of insurance, the company assures payment on specified kinds of losses once the insured provides his premium. The claimant’s paying of the premium cannot compel the insured into a claim; one may fail to do this and simply lose if premiums have not been paid.
Personal Contracts: Being a personal contract is one of the features of an insurance contract—it is taken by or purchased in the name of an individual and cannot be transferred to another individual. For example, a life insurance policy taken by or in the name of one person cannot be transferred to another person.
Conditional Contracts: These contracts are conditional, that is, the insurer’s obligation of paying is based on the insured fulfilling specific conditions. For example, a claim has to be lodged, while documentation has to be proven to be paid for loss by an insured.
Valued or Indemnity Contracts: Any insurance contract can either be valued or indemnity contracts. Value contracts pay a determined sum under a particular event, no matter the real loss, for example, a life insurance policy. On the other hand, indemnity contracts reimburse the real sum lost, for example, health insurance covering medical expenses.
Contracts of Utmost Good Faith: Contracts of this nature are those that majorly influence the insurance parties to use good faith in their conduct and dealings. Failure of such may eventually lead to misrepresentation and non-disclosure. Such instances include the acknowledgment of health information by the applicant during the time of applying for health insurance. Failure to do this will eventually lead to the non-maintenance of claims or even policy cancellation.
Warranties: A warranty is in a sense a form of insurance whereby a certain promise is made by the assured regarding the observance of certain stated conditions. For example, it can be not to sail in some dangerous zone in the case of a marine policy. The policy may be vitiated if there is a breach of warranty.
Representations: These are basically the statements that an applicant makes during the application process. Of course, they have to be true as far as the insured knows. For example, on an auto insurance application, you may represent that you have never had a previous accident when applying for auto insurance. If this is false, then the insurer may deny coverage.
Concealment: It means willful hiding of material information. As is well known, if an applicant conceals the basic information about a pre-existing health disorder in the insurance proposal form, an insurer may avoid the policy or repudiate claims on this very ground. Thus, absolute honesty and full disclosures at the very threshold are necessary in order to keep an insurance contract alive.
Knowing these features makes it possible to understand the complexities in, and the responsibilities of an insurance agreement. Further reading about other aspects of Insurance contracts is contained in the publications “Introduction to Insurance Contracts” and “Essential Elements of an Insurance Contract”.
Agent Authority in Insurance
Insurance agents are, in simple terms, representatives of the insurance companies to the policyholder. It is of the paramount importance of both the agent and the policyholder to have an idea on the types of authorities that an agent is vested for transactions and communication to be right and legal. There are three main major types of authority an agent may have: express, implied, and apparent. Let us look at each type through elaborating examples to explain the same:
1. Express Authority
Express authority is the authority which is expressly given to the agent through the insurance company. That is, this kind of authority is vested in the agreement of the agency. It stipulates what the agent is and is not allowed to carry out on behalf of the insurance company.
Example of Express Authority: For example, an insurance company may grant its agent express authority to collect premiums from its customers. Such an authority shall also have been clearly provided within the agreement entered into with the agent. Nothing would seem to misguide the parties on the agent’s capability of performing such a task.
Implied authority is assumed to be present in the agency contract in confirmation of what is needful of carrying out the express authority. This, therefore, allows the agent to take up tasks that are reasonably requested in his execution of duties, even if sometimes these tasks are not necessarily mentioned in the contract.
Example of Implied Authority: For instance, if an agent is expressly authorized to sell insurance policies, then it follows that such an agent can, of course, make quotes to potential clients; where necessary fully describing the terms and conditions of various policies.
