LOMA 280

Principles
of
Insurance

CHAPTER 3

The Insurance Contract

CHAPTER THREE 1
Chapter 3

Outline
The parties to an individual insurance contract are (1) the
insurance company and (2) the policyowner.

 insurance company
 the policyholder: the person that decides what types of
insurance coverage to purchase and negotiates the terms
of the insurance contract.

If a party to the contract does not carry out its promise, then
that party has breached the contract. Laws provide remedies
to innocent parties for losses resulting from breach of contract.

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Chapter 3

Outline
The following terms describe the legal status of a
contract.
valid
validcontract:
contract:satisfies
satisfiesall
alllegal
legalrequirements
requirementsand
and
isisenforceable
enforceableby
bylaw
law

void contract: does not meet one or more of the

legal requirements to create a valid contract and,
thus, is never enforceable.

voidable contract: a party has the right to avoid

contractual obligations under the contract without
incurring legal liability

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Chapter 3

Outline
The contract comes in variety of types
formal
formalcontract:
contract:one onethat
thatisisenforceable
enforceablebecause
because
the
theparties
partiestotothe
thecontract
contractmetmetcertain
certainformalities
formalities
concerning
concerningthe theform
formofofthe
theagreement;
agreement;generally
generallythe
the
contract
contractmust
mustbe beininwriting
writingand
andmust
mustcontain
containsome
some
form
formofofseal
sealtotobebeenforceable.
enforceable.For Forexp,
exp,aacontract
contract
for
forthe
thesale
saleofofland
landisisaaformal
formalcontract.
contract.
An insurance contract is an informal contract: one
that is enforceable because the parties to the
contract met requirements concerning the
substance of the agreement rather than the form of
the agreement; may be oral or written
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Chapter 3

Requirements for an Informal Contract

A legally enforceable informal contract must have:
 mutual assent  lawful purpose
 adequate consideration  contractual capacity

mutual assent: parties reach a meeting of the

minds about the terms of their agreement; parties
reach an agreement through a process of an offer
and acceptance, in which one party makes an offer
to contract and the other party accepts that offer
All parties must intend to be bound by contract
terms and make some outward expression of that
intent.
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Requirements for an Informal Contract

consideration:
consideration:something
somethingthatthatwill
willbebeofofvalue
valueand
and
legally
legallyadequate
adequatetotothe
theother
otherparty
partytotothe
thecontract
contract
The consideration given by an applicant for a life or
health insurance contract consists of the application
and the initial premium—the first premium paid for
an insurance policy. This consideration is given in
return for the insurer’s promise to pay the policy
benefit if the conditions stated in the policy occur. If
the initial premium is not paid, then no contract has
been formed. Renewal premiums—premiums
payable after the initial premium—are a condition
for continuance of the policy, not consideration for
the policy.
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Chapter 3

Requirements for an Informal Contract

A contract must be made for a lawful purpose—a
purpose that is not illegal or against the public good
—or it is void.
For example:
 Unless statutes have been enacted to the
contrary, gambling agreements are not
enforceable at law.
 One person cannot make a legally enforceable
agreement that requires another person to do
something that is in conflict with an existing law.

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Chapter 3

Requirements for an Informal Contract

 Individual life or health insurance policy: lawful
purpose is fulfilled by the presence of insurable
interest at the formation of the contract.
Only initial insurable interest is required for an
individual life or health insurance policy. Continuing
insurable interest is not required for the contract to
remain valid.

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Chapter 3

Requirements for an Informal Contract

contractual capacity: each party must have the legal
capacity to make a contract

 An insurer must have the legal capacity to issue the policy

and the applicant must have the legal capacity to purchase
the policy.
 Although every individual is presumed to have contractual
capacity, some people do not have full contractual capacity.
 In most jurisdictions, people who have limited contractual
capacity either (1) are minors or (2) lack mental capacity.
 Contracts entered into by individuals who do not have
contractual capacity are generally void or voidable.

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Requirements for an Informal Contract

minor: a person who has not attained the age of
majority—the age at which a person is given by law
the rights and responsibilities of an adult
 Contracts entered into by a minor are voidable
by the minor.
 In most countries, the age of majority is 18.
 In many jurisdictions, the age of majority for the
purpose of making life insurance contracts has
been modified by law to protect the insurer from
the possibility that minors will later use their lack
of legal capacity to void the contract.

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Chapter 3

Requirements for an Informal Contract

Two situations arise in which a person’s mental
capacity affects contractual capacity:
 Contracts entered into by a person who has
been declared insane or mentally incompetent
are usually void.
 Contracts entered into by a mentally impaired
person are generally voidable by that person. If
a mentally impaired person later regains mental
competence, he or she may either reject the
contract or require that it be carried out. The
other party to the contract does not have the
right to reject the contract and must carry out its
terms if required to do so.
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Requirements for an Informal Contract

Contractual capacity of Corporations
Organizations are generally presumed to have the
contractual capacity of a mentally competent adult.
An insurer acquires its legal capacity to enter into an
insurance contract by being licensed or authorized
to do business.
Should an unauthorized insurer issue a policy to a
person who is unaware of the insurer’s lack of legal
capacity, the policy may be enforceable against the
insurer. In some jurisdictions, the contract is void. In
other jurisdictions, the contract is voidable by the
policyowner.
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Chapter 3

Types of Contracts
bilateral
bilateralcontract:
contract:both
bothparties
partiestotothe
thecontract
contract
make
makelegally
legallyenforceable
enforceablepromises
promiseswhenwhenthey
theyenter
enter
into
intothe
thecontract
contract
An insurance contract is a unilateral contract
because only one party to the contract—the
insurance company—makes legally enforceable
promises when the parties enter into the contract.
As long as policy premiums are paid, the insurer is
legally bound by its contractual promises. The
purchaser of an insurance policy does not promise
to pay premiums and cannot be compelled by law to
pay the premiums.

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Types of Contracts
commutative
commutativecontract:
contract:aacontract
contractininwhich
whichthe
the
parties
partiesspecify
specifyininadvance
advancethe
therelatively
relativelyequal
equal
values
valuesthat
thatthey
theywill
willexchange;
exchange;most
mostcontracts
contractsfall
fall
into
intothis
thislike-for-like
like-for-likeexchange
exchangecategory
category
An insurance contract is an aleatory contract: one
party provides something of value to another party
in exchange for a conditional promise, a promise
to perform a stated act only if a specified, uncertain
event occurs—for example, the insured’s death (life
insurance) or illness/accident (health insurance)
If the specified event occurs, one party may receive
something of greater value than that party gave.

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Types of Contracts
bargaining
bargainingcontract:
contract:one
oneininwhich
whichthe
theparties
partiestotoaa
contract,
contract,as
asequals,
equals,set
setthe
theterms
termsand
andconditions
conditionsofof
the
thecontract
contract
An insurance contract is a contract of adhesion:
one party prepares the contract and the other party
must accept or reject as a whole, generally without
any bargaining between the parties
Even if negotiations occur between an individual or
a group policyholder and an insurer, the applicant
must accept the contract as written. Courts interpret
ambiguity in an insurance contract against the
insurer that constructed the contract.

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Chapter 3

End of Lesson 3

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