Legal Elements of Insurance
Elements of a Contract
As we’ve said, an insurance policy is a legally binding contract between two parties. One party
is the insured person or organization and the other is the insurance company. An insurance
policy describes the rights and obligations of both parties.
It is important to understand the following legal terms that relate to insurance.
Agreement. When an offer made by one party has been accepted by the other, with
mutual understanding by both, an agreement exists.
Legal Purpose. For a contract to be valid it must not be for an illegal subject or
contrary to public policy. Insurance does not cover intentional loss or criminal acts for
this reason.
Consideration. The exchange of values on which a contract is based. In insurance,
the consideration offered by the insured is usually the premium and the statements
contained in the application. The consideration offered by the insurer is the promise to
pay in accordance with the terms of the contract.
Competency. This is one of the elements that must be present in order to have a legal
contract. It relates to the fitness or ability of either of the parties to the contract. An
example of incompetency would be a mental incapacity.
Legal Contract Principles Important to Insurance
Aleatory Contract. A contract in which the number of dollars to be given up by each party is
not equal. Insurance contracts are of this type, as the policyholder pays a premium and may
collect nothing from the insurer or may collect a great deal more than the amount of the
premium if a loss occurs.
Contract of Adhesion. This is a characteristic of a unilateral contract which is offered on a
“take it or leave it” basis. Most insurance policies are contracts of “adhesion,” because the terms
are drawn up by the insurer and the insured simply “adheres.” For this reason ambiguous
provisions are often interpreted by courts in favor of the insured.
Conditional Contract. There are conditions which must be met by both parties before the
contract is legally enforceable. In an insurance contract conditions for both the insurer and
insured are spelled out in the policy form.
Personal. A personal contract is between two specific parties and generally cannot be
transferred to other parties, unless under conditions specified in the contract. Insurance policies
are usually not transferable unless the insurer agrees to do so.
Unilateral Contract. A contract such as an insurance policy in which only one party to the
contract, the insurer, makes any enforceable promise. The insured does not make a promise but
pays a premium, which constitutes the insured’s part of the consideration.
Utmost Good Faith. Acting in fairness and equity with a sincere belief that the act is not
unlawful or harmful to others. The insurance contract requires that each party is entitled to rely
upon the representations of the other without attempts to conceal or deceive
Other Legal Principles Important in Insurance Law
Concealment. The failure to disclose a material fact.
Materiality. In insurance, it refers to a fact which is so important that the disclosure of it
would change the decision of an insurance company, either with respect to writing coverage,
settling a loss, or determining a premium. Usually, the misrepresentation of a material fact will
void a policy.
Fraud. Deceit, trickery or misrepresentation with the intent to induce another to part with
something of value or surrender a legal right.
Waiver. The act of giving up or surrendering a right or privilege that is known to exist. In
property and liability fields, it may be effected by an agent, adjuster, company, employee, or
company official, and it can be done either orally or in writing.
Estoppel. The legal principle whereby a person loses the right to deny that a certain condition
exists by virtue of having acted in such a way as to persuade others that the condition does exist.
For example, if an insurer allows an insured to violate one of the conditions of the policy, the
insurer cannot at a later date void the policy because the condition was violated. The insurer has
acted in such a way as to lead the insured to believe that the violation did not void the coverage.
Warranty. A statement made on an application for most kinds of insurance that is warranted
as true in all respects. If untrue in any respect, even though the untruth was not known to the
applicant, the contract may be voided without regard to the materiality of the statement. By
contrast, statements in life and health applications are not warranties except in cases of fraud,
and the trend in more recent court decisions in other lines has tended to modify the doctrine of
warranty to an application only when the statement is material to a risk or the circumstances of a
loss.
Representation. A statement made on an application for insurance that the applicant
represents as correct to the best of his or her knowledge and belief.
Misrepresentation. The use of oral or written statements that do not truly reflect the facts
either by an insured on an application for insurance or by an insurer concerning the terms or
benefits of an insurance policy.