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There are 4 requirements for any valid contract, including insurance contracts—offer and acceptance, consideration, competent parties, and legal purpose. If a contract lacks any of these essential elements, then it is a void contract that will not be enforced by any court. For instance, most contracts signed by a minor are void contracts because are not legally competent. A voidable contract is one that can be nullified by a party if the other party breaches the contract, or because material information was omitted or false in the contract. The party with the right to void can also choose to enforce it, instead. For instance, insurance companies can often void a contract because the applicant provided false information on the application. Thus, if someone was in an auto accident, and that person previously filled out the insurance application stating that he had no speeding tickets, when, in fact, he had, then the insurance company can void the contract and not pay the claim. Although most contracts can be oral, most are written, especially insurance contracts, because of their complexity.
In insurance, the offer is typically initiated by the insurance applicant through the services of an insurance agent by filling out an application for insurance.
How the offer is accepted will depend on whether the insurance is for property or liability, or for life insurance. For property and liability insurance, the offer is the application for insurance and the payment of the 1st premium, or the promise to do so. In most personal lines of insurance, the agent can, in most cases, accept the offer for the company, binding the company to the contract. A binder is a temporary contract that can be oral or written that binds the insurance company to the contract immediately until it has a chance to examine the application, and issue a formal policy. Through the binder, the insurance becomes effective immediately. Most binders are written and include general information, such as type and amount of insurance, the name of the parties, and the time during which the binder is effective. However, once a formal policy is issued, then the terms of the policy override the binder. This is particularly true for oral binders, for once a written policy is issued, the parole evidence rule makes the written policy determinative where there is any conflict between the oral and written agreement. If a mistake was made in the policy, such as mistyping the wrong policy value, then the contract can be reformed by correcting the mistake to prevent unjust enrichment of 1 of the parties.
However, some agents cannot bind the insurance company, in which case, the insurance company must receive and accept the application, or it can reject it. The insurance is not effective until the company accepts the application.
In life insurance, the agent never has the power to bind the company. In most case, the applicant fills out the application and pays the 1st premium. The applicant is then given a conditional premium receipt—the most common type of receipt is the insurability premium receipt. If the applicant is insurable according to the company’s underwriting standards, then the life insurance becomes effective from the date of the application, or, in some cases, from the date of the medical examination.
However, if the premium is not paid when the application is filled out, then the insurance will not become effective until the policy is delivered and the premium is paid, and the applicant is in good health when the policy is delivered. Some companies require that the applicant does not receive any medical treatment between the application and the delivery of the policy; otherwise the policy will not become effective.
Thus, a conditional receipt is like a binder, but differs from it because coverage is conditional upon the health of the applicant, occupation, and other factors. A binder does not require the payment of a premium to become effective—often the insurer needs the time to determine what the premium will be.
While the insurance applicant is usually considered the one making the offer, the insurance company dictates the terms of the contracts. The insurance applicant must accept the contract of adhesion totally or not at all. Because of differing legal definitions and rulings provided by different courts in the past and because of requirements imposed by state governments and their agencies, an insurance contract has to be carefully worded to be legally effective and to provide coverage in the way that it was intended. This is why insurance contracts are largely standardized. Another reason is because insurance companies can only calculate competitive premiums based on actuarial studies, and these studies are based on certain limitations and underwriting guidelines. Thus, most insurance contracts cannot be negotiated. However, the insured can request specific riders and exclusions to the policy. A rider (aka endorsement) is an amendment or addition to the basic policy that allows the policy to be tailored in acceptable ways for individual situations. An exclusion is a loss not covered by the contract.
Because insurance contracts are generally not negotiable, the courts have created case laws to benefit the insured. The first law is that where there is an ambiguity in a contract, the ambiguity is construed against the maker of the contract, which, in insurance, is the insurance company. Thus, if the terms of a contract are not specific, then the terms are interpreted in a way that would most benefit the insured. Another case law that has developed is the principle of reasonable expectations, which requires that any exclusion or other qualification be conspicuous; otherwise, the insured is entitled to coverage that he reasonably expects.
Life insurance and some health insurance contracts usually have entire contract clauses that require the attachment of any statements, including the application, made by the insured to the contract itself, to prevent any disputes later. Entire contract clauses also prevent incorporation by reference, which is alluding to other written works, such as the corporate bylaws, that the insurance applicant probably hasn't read.
Property insurance contracts are personal contracts between the insured and the insurer. Property insurance covers the insured for the financial losses of property damage or loss, not the property itself. If the insured sells the property, the insurance does not transfer with it. The insurance cannot be assigned to anyone else without the insurer’s consent.
However, the beneficiaries of most insurance contracts can be changed without the consent of the insurer, but the insurer must be notified.
Consideration is the value that the parties to a contract give to each other—it is the reason why the contract is agreed to. In insurance contracts, the insurer promises to pay for covered losses that the insured suffers, and the insured promises to abide by the contract and pay the premium. Most contracts are bilateral contracts where the promises that each party makes are enforceable by the other party through legal proceedings. However, insurance contracts are unilateral contracts where only the insurer makes a legally enforceable promise to pay for covered losses. The company cannot sue the insured for breach of contract. However, insurance contracts are also conditional contracts—if the insured fails to pay the premium, or fails to abide by the contract, then the insurer is not obligated to pay for any of the insured’s losses.
Most contracts are commutative contracts—the amount of consideration given by both parties are usually fairly equal. Thus, a contract to purchase real estate usually requires a payment equal to its value. Insurance contracts are, however, aleatory contracts, because the insurance company only has to pay if certain events occur. If they don’t occur, the company never has to pay, even if the insured has paid premiums for decades. However, if a covered loss does occur, then the insurance company may have to pay much more than it has collected in premiums. Thus, aleatory contracts are characterized by unequal consideration.
The parties to the contract must be legally competent to agree to them. Most adults have legal capacity to agree to contracts, unless they are intoxicated, mentally ill, or mentally retarded. The key requirement is that the parties must know what they are agreeing to—a meeting of the minds; otherwise, there could be no agreement. To protect minors, the law does not give them legal capacity to agree to contracts except where specified by law.
An insurance company has legal capacity if it is licensed to sell insurance in that particular state, and is acting within the scope of its charter.
All contracts must have a legal purpose to be enforceable by the courts, and, of course, most insurance contracts do.
The performance required of most insurance contracts is for the insured to pay premiums and perform any other duties that are required of the contract, while the insurer's main duty is to pay for losses, if any occur. In most cases, aside from the payment of the premium by the insured to the insurer, neither party needs to perform until a loss occurs, but when a loss does occur, then the insured must initiate performance before the insurer is required to do anything.
Insurance contracts require the insured to perform specific things or requires certain conditions, both before and after a loss, which the law sometimes categorizes as condition precedent and condition subsequent. If the insured fails to perform these duties or satisfy these conditions, then the insurance company may be relieved of its obligation to pay the claim.
A condition precedent is either a condition that must be satisfied or something that the insured must do before a loss occurs and before the insurer will perform, which, in most cases, is paying the claim. A common condition precedent requires the insured to notify the insurer of any loss; otherwise the insurer has no duty to perform. Another example: to collect disability insurance, the insured must submit proof of disability to his insurer.
A condition subsequent is a condition that must be fulfilled after an event that required an act of the insurer. For example, if the insurance company wants to exercise its subrogation rights and sue a 3rd party for the insured's cause of loss, then the insurer may require the insured to testify in court.
Insurance contracts can be ended by mutual agreement—recission. The insured can terminate the contract by not paying the premium. If the insurance company has evidence of fraud, it can ask a court to rescind a contract unilaterally. However, life insurance policies usually have an incontestable clause which prevents an insurer from canceling a life insurance policy after a 1 or 2 year period. The initial period gives the insurance company time to check the facts in the application, and possibly rescind the contract if it detects fraud. However, after this period, the life insurance cannot be canceled by the company for any reason other than nonpayment of the premium.
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