General Rules of (Insurance) Contracts

The parties to the contract must be legally competent and capable of contracting.

The insurance company is a legal entity capable of contracting through its authorized agents. The individual entering into the contract with the insurance company must also be legally capable. As a result, and as an example, an insurance policy offered to and accepted by a child is not legally enforceable.

The contract must be based on an offer made by one party and an acceptance of that offer on the same terms by the other party.

As an example, an individual requests coverage from an insurance company and the company accepts the risk.

There must be equal knowledge by both parties of all material and relevant facts.

The insured must not conceal or misrepresent any material fact when submitting the risk to the company.

In addition, the insured must comply with any and all warranties and representations made when the policy is issued and throughout the time the policy is in force.

Warranty is a provision in a policy that requires existence of a condition that reduces the risk of loss.

The insured might warrant that the premise is protected by a burglar alarm or that an automatic sprinkler system is maintained in proper working order. On the other hand, a warranty might provide for the nonexistence of a condition that increases the risk of loss. Examples of this include a requirement that the premise not be used for any manufacturing purposes or that a vehicle not be driven beyond a 50-mile radius. In general, a warranty in an insurance policy requires strict compliance on the part of the insured.

Any breach of the warranty conditions voids the insurance policy.

A contract must be based on a valuable consideration.

For the insured, the consideration is the premium payment, although failure to pay a premium does not automatically invalidate a policy. The policy remains in force until cancelled in accordance with the terms of the policy.

For the insurance company, the consideration is its promise to pay for covered losses or to honor other obligations made in the policy.

A contract must be legal in form.

When an insurance policy is issued, it is legal in form and sometimes includes requirements and conditions mandated by the state.

A contract must be for a legal purpose.

Insurance cannot be for a purpose such as gambling, for the benefit of an improper insurable interest, or for a fraudulent purpose.

The Insurance Contract

The insurance contract is an agreement where one party obligates itself to make good the financial loss or damage sustained by a second party when a designated event occurs. The event must be fortuitous and happen by accident. The named insured must have insurable interest at the time of loss. One final point is that in order for any contract to be considered insurance, there must be a risk of loss.

FORTUITOUS EVENT

An occurrence largely beyond the control of any involved party; happening by chance; accidental; for example: fire, lightning, windstorm, explosion, or flood.

INSURABLE INTEREST

In order to recover from a loss to property, the holder must have an insurable interest in the property at the time of the event or occurrence. An insurable interest is any right, title, or interest in property where the holder of that right, title or interest sustains financial loss if the property is damaged or destroyed. Any lawful and substantial economic interest in the safety or preservation of the property from loss, destruction or damage also constitutes an insurable interest.

An entity does not have to be the property owner to have an insurable interest in it. Examples include, but are not limited to, mortgagees, trustees, vendors, lessees and bailees. Insurable interest for any entity must exist at the time the loss occurs.

RISK OF LOSS

If property could never be destroyed, there is no risk of loss. If property must necessarily disintegrate or be destroyed, there is no risk of loss. Between these two extremes is the exposure of risk that can be insured.