Insurance Contracts

A contract is a legally binding agreement creating rights and duties for those who are parties to it. If one party to the contract fails to perform its duties without a legal excuse, attorneys say the contract is breached. If a contract is breached or if disputes arise between the parties about the interpretation of the contract, the issues may be settled by a court. Courts can enforce their judgments and settle contractual disputes using a variety of remedies. For example, a court can require performance of the original contract by the breaching party or it can direct that the injured party be compensated for damages caused by the breach.

A valid contract is one a court will enforce. We describe the elements of a valid contract shortly. Two other categories of contracts are voidable and void contracts. A voidable contract allows one party the option of breaking the agreement because of an act or omission of an act (a breach) by the other party. The party with the right to void the contract may instead choose to have the contract enforced. A good insurance example of a voidable contract is one in which the insured has attempted to defraud the insurer. After the insurer establishes the insured's fraud, it will be released from its contractual obligations. At the insurer's option, the contract can be set aside or voided.

If, however, an insurer breaches the contract by refusing to pay a valid claim, its insured can go to court to force the insurer to perform. If a court believes an insurer denied the claim in bad faith, the insurer may be penalized for amounts substantially greater than the original amount of damages sustained by the insured.

A void contract is one a court will not enforce because it lacks one or more features of a valid contract. For example, assume an insurance contract is purchased for an illegal purpose, insuring property with the intent of committing the fraud of arson. A court would not enforce such a contract's provisions after discovering the illegal purpose. Likewise, if an incompetent person (such as a person, declared legally insane) was to enter into an insurance contract, this contract would be considered, in legal Latin, void able initial, void from the beginning. In legal terms, the court is saying that a contract never existed.

ELEMENTS OF A VALID CONTRACT

All valid contracts must have the following four elements: offer and acceptances sideration, capacity, and legal purpose.

OFFER AND ACCEPTANCE

Deals begin when one person makes a proposal to exchange something of value another person. The proposal to make an exchange is called the offer. If the sec person agrees to the exchange, this is called acceptance. The offer must be reasonably definite and communicated clearly. The acceptance must be unconditional, unequivocal, and communicated clearly.

All parties to a contract must agree to exactly the same terms. There must be a meeting of the minds. To create a contract, one party makes an offer to another party to do something or not to do something. The second party may accept or reject this offer or may make a counteroffer. When one party makes an offer and the second party accepts it without qualifications, a necessary requirement for a contract is met.

The offer and acceptance may be oral or in writing. Both forms are recognized by law. In property insurance, as we noted, most states allow oral insurance binders and contracts, but they are usually put in writing as soon as possible to provide protection for both the insured and insurer.

When purchasing insurance, an individual ordinarily completes an application and in doing so makes an offer to purchase insurance. If the insurer accepts the offer, it agrees to insure the applicant. It should be noted that insurance agents, though soliciting new business, legally are not offering to sell insurance. Technically, it is said they are inviting the insured to make an offer. If the insurer issues a policy, that indicates acceptance.

CONSIDERATION

The value exchanged between the parties to the contract is the consideration. consideration is what each party gives to the other. Consideration may take a tangible form such as money, or it may take the form of a promise to do something or not to do it. There must be an exchange of consideration to have a valid contract.

In an insurance contract, the consideration the insurer gives is a contingent promise to pay the insured. That is, the insurer agrees to make payment only if a covered loss occurs. If such an event does not occur, the insurer need not make payment. In return for the insurer's promise, the insured gives two things money and a promise to follow the provisions and stipulations in the insurance contract.

Most insurance contracts are unilateral contracts. That is, only the insurer makes an enforceable promise. The insured does not promise to pay the premiums and cannot be sued for failure to do so. Insureds, however, cannot collect for losses if they do not pay premiums because timely payment of the premium is a condition of the contract. Contracts in which both parties make enforceable promises are called bilateral contracts.

CAPACITY

Not every person legally has the capacity to enter into a contract. As a general rule, for reasons of social welfare, minors, the insane, and the intoxicated cannot enter into a binding agreement. The purpose of this rule is to keep people from taking advantage of parties who presumably do not have the capacity to understand the agreement they are making.

State law defines the period of minority as ending at age 18. If a 13 year old were to enter into a contract, it would be voidable at the youngster's option. If a minor chose not to void the contract, the youngster could ratify or affirm it when reaching age 18.

Although as a general rule minors can disaffirm contracts, they cannot do so when contracting for a necessary good or service. In most instances, insurance contracts have not been held to be necessary. When minors own and operate motor vehicles, own property, or have dependents, however, insurance may be considered a necessary purchase. Many state laws allow older minors to make binding agreements for insurance in specific instances.

Insurance companies also must be qualified to enter into contracts. They must have a license to operate in each state in which they do business. If an insured were injured because of having dealt unknowingly with an unqualified insurer, the insured could look to the court for a remedy. The unauthorized insurer would be subject to fines and penalties.

LEGAL PURPOSE

A contract must have a legal purpose, a function or intention permitted by law, Contracts having an antisocial purpose are legally unenforceable. No court will aid the parties to such a contract. An insurance policy purchased as a gamble on a famous per. son's life or on any life in which the contract owner has no legal interest is an example of an unenforceable contract. If a person attempted to collect proceeds from contracts where an insurable interest was lacking, a court would hold the contract void, as we explain later when describing the doctrine of insurable interest.