Merritt Personal Lines Manual: 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.

• 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.
• Age. References to an insured person's age may be found in premium and benefit provisions. For the purposes of determining life insurance premiums and values, any reference to an insured's age means the age as of the nearest birthday.
• Agreement. When an offer made by one party has been accepted by the other, with mutual understanding by both, an agreement exists.
• 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.
• 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.
• Concealment. The failure to disclose a material fact.
• Conditional. 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.
• 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.
• 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.
• Fraud. Deceit, trickery or misrepresentation with the intent to induce another to part with something of value or surrender a legal right.
• 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.
• Material Fact. 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.
• 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.
• Owner. The owner of a policy is the person who makes the contract with the insurance company. The owner has various rights and obligations (such as designating a beneficiary and making premium payments).
• Parties to the Contract. When a life insurance policy is issued, a number of parties may be involved with respect to contractual obligations and benefits. Obviously, the insurance company is a party to the contract, in exchange for the premium payment, it has agreed to pay certain benefits if the insured dies. Since the insurance will pay a benefit if the insured dies, it is also obvious that the person insured is a party to the contract. But there may be other parties.
• Payee. The payee is the person entitled to benefit payments under the policy. Usually, this is a designated beneficiary.
• 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.
• Policy Date and Due Date. The policy date is usually the original effective date. It is treated as an anniversary date and used to determine premium due dates and other dates. The due date is simply the date on which all premium payments, after the first payment, become due.
• Proceeds. Proceeds are any moneys payable as a death benefit. If a policy has an original face amount of $100,000 and dividends have been used to buy $5,000 of additional insurance, then the proceeds equal $105,000 at that point in time. On the other hand, if the policy owner has borrowed $50,000 against the policy, the proceeds would be only $55,000.
• 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.
• 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.
• 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 affected by an agent, adjuster, company, employee or company official and it can be done either orally or in writing.
• 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.