THE MISADVENTURES OF ERNIE AND OLIVER: CONTRACTS (Excerpted & Edited)

Ernie and Oliver had no insurance experience when they decided to buy an agency. What are the odds that these two gentlemen will be slapped with an E&O claim early in this misadventure? How about a little E&O review? It can't hurt, right?

In our first E&O installment, we'll discuss the basics of contracts, the various parts of them and what they include.

In a typical insurance contract, the insurer agrees to pay for covered losses, provide a defense and perform any other listed services, while the insured agrees to pay the premium and fulfill all other policy requirements. The insurer has the legal ability to bind the agreement so long as it is licensed in the appropriate state. Contracts cannot be constructed for illegal activities like murder for hire or drug dealing.

Contracts come in many different forms. Let's look at some terminology.

Valid contract-one that includes all elements recognized by the courts and is legally binding

Void contract-one without legal effect; it's missing one or more elements, like consideration or offer and acceptance

Voidable contract-one that can be broken by one or more parties for a legal reason; this also includes contracts that lack genuine assent and those involving minors

Unenforceable contract-one that won't be upheld by the courts, typically because of a rule of law; perhaps the statute of limitations has expired

Term. A word or phrase used to describe a thing or to express a concept, especially in a particular kind of language or branch of study. You still with us? Just checking.

Principle of indemnity. This states that the insurer will pay to replace what has been lost or damaged, restoring the insured to his or her status prior to the loss; this is the cornerstone of insurance.

Replacement cost coverage pays to replace the lost or damaged property with property composed of materials of like kind and quality; this coverage does not include a deduction for depreciation.

Insurable interest. This is the financial interest of an individual or business in the value of the subject of the contract; at the time of loss the holder of this interest must clearly prove a personal stake in the item being insured. Some reasons for requiring a business or individual to have an insurable interest in a contract:

• Without it, the policy becomes a wager or gambling contract and is against the public interest
• Decreases moral hazard
• Helps measure the amount of the financial loss