Insurance Contracts

to be a legal contract an insurance policy must have three elements:

Offer= application for insurance submitted to the insurer with the initial premium payment Acceptance= Consideration= Value to the contract consisting of the insurer's promise to pay benefits in the event of a covered loss, and the insured's payment for the policy.

Other Legal Concepts

Insurance contracts are defined by other legal concepts that extend beyond the nature of the contract.

Legal Characteristics of Insurance Contracts

While they are based on the common elements of all contracts, insurance contracts have additional characteristics that define them. Insurance contracts are: -contracts of adhesion -aleatory -personal -unilateral -conditional

Featured characteristics and concepts of insurance contracts:

-Contract of adhesion= drafted by one party and is offered to consumer on a take it or leave it bases. The other party has little chance to bargain terms, price or other elements; he or she must "adhere" to its provisions. --Ambiguities in a Contract of Adhesion -Contracts are often written in language that may be difficult to understand. Because applicants for insurance have no input in the drafting of the insurance contract's language, courts have ruled that ambiguities in the contract must be interpreted to the benefit of the policyowner. -aleatory= one party may receive a benefit that is out of proportion to the consideration he or she is giving. Receiving the disproportionately large benefit depends on whether a chance event occurs --Contracts can be either aleatory or commutative. Most are commutative. This means each party to the contract expects to receive from the other party something of equal value to what he or she is giving. -conditional= benefits are only payable if specific conditions are met. --Insurance policies are conditional, which means their continuation depends on certain actions of the policyowner. --For instance, the contract will stay in force on the condition that the owner continues to pay premiums. The contract will pay out its benefits on the condition that certain information, such as proof of death or proof that medical costs were incurred, is supplied. --Regardless of the condition or conditions that apply to an insurance contract, every condition must generally be satisfied before the legal right to the benefit is created. If a condition is not satisfied, then the insurer is normally not obliged to pay the promised benefit -personal= between an insurer and insurered on the context of property insurance --Most insurance policies are personal contracts between the insurer and the policyowner. That is, the agreement between these two parties is personal and cannot be transferred to a third party without the insurer's consent. Health insurance is a personal contract that cannot be transferred or assigned to another party. --Life insurance is different. Though it is personal property that takes the form of a contract, life insurance is not a personal contract in the legal sense. As property, it can be transferred by the owner to anyone without permission from the insurer. The policyowner may be required to inform the insurer of such actions, but the insurer cannot object. -unilateral= one sided; --In many contracts both parties make legally binding promises, and each party can sue to make the other party keep a promise. That is, they are bilateral. --In a unilateral contract, only one party makes an enforceable promise. Insurance contracts are unilateral; only the insurer makes an enforceable promise. The policyowner must pay required future premiums to keep the policy in force, but there is no legally binding requirement for the owner to pay premiums. A policyowner can terminate his premiums at will, with no legal repercussions. When that happens the insurer is released from its promise to pay the benefit, and, at the end the premium grace period, the contract expires. ---unilateral contract=the insurer makes a promise that can be enforced. ---Grace Period= Period after the premium due date during which a policyowner can pay the premium on an insurance policy lapses. Grace periods are usually 31 days. -interpretation= unclear policies are interpreted in the favor of the policy owner -reasonable expectations= -representations, not warranties -indemnity contract= pays the actual amount that was lost -valued contract= pay a stated amount -waiver= voluntarily relinquishing a known right. -estoppel= prevents a party from enforcing a right after giving it up, when another party relied on the relinquished right

Elements of a Legal Contract

A contract is an agreement that is enforceable at law. It has five basic elements: -offer -acceptance -consideration -competent parties -legal purpose A contract involves a binding promise for which the law creates a duty of performance. The party making the promise is known as the promisor, and in insurance transactions that is the insurance company. The party to whom the promise is made is known as the promisee, which is the applicant (i.e., future policyowner) in all insurance transactions. -Promisor=party who has the "duty to perfrom." Is the party who makes the promise. -Promisee=In a contract, the party to whom the promisor makes a promise.

Utmost Good Faith

An insurance contract requires that both the policyowner and the insurer act in utmost good faith. Under this concept, both parties are entitled to receive all the material facts related to the circumstances under which they enter into the contract. That is, each party has the right to expect complete, relevant, and accurate information. Failure to disclose critical information on the part of one party usually gives the other party the right to void the contract.

Quiz Questions

Question 1 What will result if an insured decides to stop paying premiums for his or her insurance policy? *The insurance company is released from its promise to pay benefits and the contract expires. The insurance company must return all premiums that have been paid if no claims have been made under the policy. The insured has breached the terms of the contract. The insurance company can require the insured to continue paying the premiums. An insurance contract is a unilateral contract, which means that only one party-the insurer-makes a promise that can be enforced. The insured must only pay the first premium. The insurer cannot require the policyowner to pay more premiums. However, if the policyowner does not pay any required premiums, the insurer is released from its promise to pay the benefit and the contract expires. Question 2 What are statements made in a life insurance application? conditional promises unconditional promises *representations warranties An applicant's statements on an application for insurance are considered representations and not warranties. A representation is a statement made at the time the contract was formed but not guaranteed by the maker to be true. A misrepresentation on the application allows the insurer to end the contract only if the misrepresentation was material. Question 3 What are statements that are guaranteed to be true called? petitions declarations *warranties representations A warranty is a statement that its maker guarantees to be true in all ways. If a warranty is found false, the other party has the right to end the contract, even if the statement was not important to the contract's formation. However, statements made by insurance applicants on the application are deemed to be representations, not warranties. Question 4 An applicant for an insurance policy submits an application without the first premium. Which of the following is correct? The applicant has made an offer to the insurer. The insurer may not make a counteroffer to the applicant. *The applicant has invited the insurer to make an offer. The insurer has made an offer to the applicant. When an applicant submits an application without the first premium, the applicant has invited the insurer to make an offer. In contrast, when an applicant submits an application to the insurer with the first premium payment, the applicant has made an offer that the insurer may or may not accept. Question 1 The fact that a health insurance contract generally cannot be transferred to a third party without the insurer's consent makes it what type of contract? unilateral conditional *personal aleatory Most insurance policies are personal contracts between the insurer and the policyowner. This means that the policyowner cannot transfer the agreement without the insurer's consent. Life insurance is an exception. The owner of a life insurance policy can do what he or she wants with the policy, such as using it as collateral on a loan or transferring it to a third party. Question 2 Which of the following statements about utmost good faith in insurance contracts is correct? Only the insurer must act in utmost good faith. Only the insured and the beneficiary must act in utmost good faith. *Both the insured and insurer must act in utmost good faith. Only the insured must act in utmost good faith. An insurance contract requires that both the insured and the insurer act in utmost good faith. Under this concept, both parties can expect complete, relevant, and accurate information. If one party fails to disclose critical information, the other party usually can void the contract. Question 3 Which of the following contract characteristics is unique to insurance contracts but not all contracts? competent parties consideration *unilateral legal purpose All legally enforceable contracts must be made between parties that are legally competent. In an insurance transaction, the applicant is deemed competent (unless proven otherwise) when he or she applies for a policy. The insurer must also be authorized by the state to issue a policy. Question 4 Sandra and David orally agree that Sandra will pay David $25,000 to set fire to her ex-husband's house and the house burns to the ground. Which of the following statements is correct? David can void the contract if he changes his mind about setting fire to the house. The contract is unenforceable because it is not in writing. The contract is unenforceable because the consideration will be paid after the act is performed. *The contract cannot be enforced because its purpose is illegal. Because the purpose of Sandra and David's contract is illegal, it is not enforceable. Whether or not David can void the contract is irrelevant, since the contract is not for a legal purpose.

Consideration

Consideration is anything of value that a party gives to another party. This exchange of consideration demonstrates each party's commitment to honor the terms of the agreement. It is a required element of every valid contract. With insurance contracts the applicant's consideration is the initial premium payment. If paid with the application, coverage may become effective the date the application was submitted. If paid after the application is submitted, coverage would not become effective until the first premium is paid to the insurer (or the insurer's agent). The insurance company's consideration is its good faith promise to pay benefits when and as defined in the policy.

Fraud

Fraud is willful deception with the intent to gain something of value. Under contract law, fraud is a reason for voiding a contract and can be done at any time. However, particularly in the case of life insurance contracts, the insurer must discover the fraud within a limited time after the contract is signed. (This period is usually two years after the date of policy issue.) After this period passes, the insurer loses the chance to void the contract. Fraud is often an act of concealment or misrepresentation. But, not all such acts are considered fraud. The key to deciding whether fraud has occurred is whether the applicant expected something of value in return for the deception.

Acceptance

Simply extending an offer doesn't result in a contract unless the offeree accepts the offer. If the offeree does not accept every term of the offer, the offeree effectively rejects the offer. However, the offeree can make a counteroffer. For example, suppose that Moe submits to XYZ Insurance Company an application for $3 million of life insurance coverage. The company, in reviewing the application and the risk that Moe poses, decides it cannot insure Moe for that amount. Instead, it offers to insure Moe under a policy for $500,000. XYZ Insurance Company has effectively made a counteroffer to Moe. Moe can accept or reject the counteroffer. When an insurer issues a policy on a basis other than as applied for, the insurer has rejected the applicant's offer and has made a counteroffer.

Concealment

Concealment is the deliberate withholding of material facts when applying for insurance. If the concealed facts would have changed the insurer's decision to offer the insurance policy, then the insurer has grounds to void the insurance contract

Offer

1 of 3 elements of a contract. To be valid, the offeror must express a willingness to enter int an agreement in a way that the offeree understands that saying yes to the offer will result in an agreement. Can be written or verbal. (offeror= The party making the offer.) (offeree= the party to whom an offer is made.) The first step in the formation of a legal contract is usually the offer. An offer can be written or verbal. Regardless of how it is made, the offeror makes the offer to the offeree. In the typical insurance transaction, the applicant is the offeror who makes an offer to buy insurance through a signed application plus the initial premium. The insurance company (offeree) reviews the application and decides whether it wants to accept the offer. If the insurer accepts the application and issues a policy as applied for, then this means the insurer has accepted the offer and the policy becomes a written contract between the parties. If the insurer does not accept the application "as applied for," it may make a counteroffer by offering a policy with different terms (e.g., a rated policy or a policy that limits benefits or excludes certain conditions from coverage through the use of riders). It is then the applicant's responsibility to accept or reject the counteroffer. The initial premium plays an essential role in the offer. If a premium deposit does not accompany the application, the role of offeror and offeree is reversed. The applicant has not made an offer but has merely invited the insurer to make an offer. The policy does not become a contract until the applicant accepts the company's offer by paying the initial premium.

Representations and Warranties

Under the insurance laws of most states, an applicant's statements on an insurance application are considered representations and not warranties. This distinction is important. It bears directly on the insurer's ability to rescind (withdraw) a policy based on untrue statements. A representation is a statement that is believed to be true to the best of the maker's knowledge, even though in fact it may not be true. Statements made by an insurance applicant are deemed to be representations. For example, an applicant for life insurance may answer "no" to the question "Do you have heart disease?", believing it to be a truthful response. If the insured were to die shortly thereafter of a heart attack, the insurer could not rescind the contract. Even though the insured almost certainly had heart disease when the policy was applied for, the fact that he truthfully answered "no" to the heart disease question prevents the insurer from voiding the contract. This rule does not permit applicants to lie. Willful misrepresentation is fraud and is grounds for voiding the contract if discovered by the insurer during the policy's contestability period. In contrast to a representation, a warranty is a statement the maker guarantees to be true in all ways. In the case of a life insurance policy, the insurer makes warranties that become part of the contract. --Representation=A statement made at the time a contract is formed. This statement persuades a party to enter into the contract. Statement that is true to the best knolwedge of the person making that statement. --Fraud=The deliberate act to deceive with the intent to gain something of value --Warranty=A statement guaranteed by the maker to be true in all ways.

Indemnity vs. Valued Contracts

Insurance contracts may be either indemnity contracts or valued contracts. A contract of indemnity is one under which the benefit payable cannot be greater than the actual loss the contract owner incurs or the face amount of the policy, whichever is less. The insured's recovery under an indemnity policy is limited to his or her actual loss. Medical expense insurance policies are indemnity contracts. Life insurance policies by their very nature are not contracts of indemnity. They are valued contracts that guarantee payment of a stated sum regardless of the perceived "worth" of the insured. A life insurance contract issued for $1 million in coverage pays that amount upon the insured's death without regard for the insured's value or need for the money. -Indemnity= An insurance contract in which the payment of a loss is limited to the insured's actual loss. -Valued Contracts= A life or health insurance policy that pays a stipulated sum in the contract. All life insurance policies are valued contracts, as are accidental death & dismemberment health policies. A valued contract is the opposite of a reimbursement contact.

Waiver and Estoppel

Two related principles that affect insurance contracts and their enforceability are: -waiver (when a party to a contract gives up a right that this party knows he or she holds.) -estoppel (When a party to a contract gives up a right without intending to do so.) Waiver is when one party to a contract gives up a right that the party knows he or she holds. This applies to agents of the party, too. For example, an insurance company has the right to cancel a policy if the premium is received beyond its grace period. If one of its agents routinely accepts a late premium payment from a policyowner with no warning of cancellation by the insurer, the insurer is deemed to have waived its right to cancel the policy due to late premium payments by the policyowner. The flip side to a waiver is the concept of estoppel, which is the legal inability to abandon a decision or action once made or taken. With estoppel, a party gives up a right by its actions, whether it intended to or not, and more important, it is subsequently prevented from exercising that right. Estoppel effectively limits a party's right to change his or her mind. In the example above, the insurer would be estopped from canceling the policy for a late premium because it had effectively waived its right to do so by allowing its agent to collect it late in the past

Reasonable Expectations

The long-term success of the insurance industry is based on reasonable expectations that promises made by the insurer will be respected when the time comes. The doctrine of reasonable expectations can also impact an insurer's liability. For example, an agent's failure to deliver to the insurer a life insurance application and premium payment (and thus failure to get agreed-upon coverage) can result in an insurer's unintended liability should the applicant die shortly thereafter.

Legal Purpose

For a contract to be enforceable, it must serve a legal purpose. As long as it is legal, the purpose of the contract can be anything the parties choose. For obvious reasons, a murder-for-hire "contract" between two parties is unenforceable (as well as a felony). Insurance is presumed to serve a legal purpose in all jurisdictions.

Competent Parties

For a contract to be valid, all parties must be deemed legally competent. A contract that involves one or more incompetent parties is not enforceable. To be considered legally competent, a person must be -mentally sound, -of legal age, and -not under the influence of drugs or alcohol. Most states stipulate a certain minimum age for a person to be deemed legally competent to purchase an insurance contract. In some states the age is as low as 14 or 15 years. The insurance company's competency is based on its authority to do business in a state. Except in the case of surplus insurance, a policy issued by a non-admitted insurer would be deemed invalid. Also, insurers may only issue policies that are approved by the state's insurance regulatory authority; non-approved policies are deemed invalid

Key Points:

If the insurer accepts the application and issues a policy as applied for, then this means the insurer has accepted the offer. When an insurer issues a policy on a basis other than as applied for, the insurer has rejected the applicant's offer and has made a counteroffer. The applicant's consideration is the initial premium payment. The insurance company's consideration is its good faith promise to pay benefits when and as defined in the policy. Courts have ruled that ambiguities in the contract must be interpreted to the benefit of the policyowner. Health insurance is a personal contract that cannot be transferred or assigned to another party. Life insurance is not a personal contract in the legal sense. An applicant's statements on an insurance application are considered representations