Insurance Contract Principles

A property or liability insurance policy is a “personal contract,” a “conditional contract,” a “unilateral contract,” a “contract of adhesion,” a “contract of indemnity,” and a contract which requires that the person insured have an insurable interest at the time of the insured-against contingency.

Further: An Insurance Contract is one of Uberrima fides. This is a Latin phrase meaning “utmost good faith” (or translated literally, “most abundant faith”). It is the name of a legal doctrine which governs insurance contracts. This means that all parties to an insurance contract must deal in utmost good faith, making a full declaration of all material facts in the insurance proposal. Under utmost good faith contracts if there is a violation it is categorized as a material misrepresentation, a breach of a warranty, or a concealment. Insureds can also go after insurers for a breach of utmost good faith. Normal business contracts are “good faith contracts” and can result in contract enforcement, monetary damages or both. If the contract cannot be performed or is unconscionable, the contract can be set aside. This contrasts with the legal doctrine of caveat emptor (let the buyer beware). Caveat emptor does not come into play in insurance contracts. The buyer does have an obligation to read the contract and if is not understood to ask the sales agent to explain. It is best to get the explanations in writing.

Personal Contract

Property and liability insurance policies cover persons and not property or operations. Although the terms “insured my house” or “insured my motorcycle” are used commonly, they are not technically correct. The contract between the insurer and the insured is a personal contract between an insuring entity and a person(s) based upon their financial, “insurable interest”, in the object or liability being insured. In other words, the question of whether payment is due upon the occurrence of a contingency, and how such payment will be measured, depends upon economic loss suffered by the person(s). For example, if a person sells her home and gives a contract covering the home to the new owner and a loss occurs, the insurer will not pay the new owner since there is no privity of contract. The insurer will not pay the old owner because there is no insurable interest.

Conditional Contract

Property and liability insurance policies are said to be “conditional contracts” because the obligation of the insurer to perform is conditional upon an event happening. Compare this to entering into a contract to build a house. Both parties must perform. Build and payment. This is not conditional.

Unilateral Contract

Only one party is legally bound to contractual obligations after the premium is paid to the insurer. Only the insurer has made a promise of future performance, and only the insurer can be sued for breach of contract. However, in order for an insured to collect, the insured must perform according to the contract. If the insured does not perform then the insurance company does not have to perform. This is mainly covered in a section called “Duties after a loss” found in insurance contracts.

Contract of Adhesion

Property and liability insurance policies are said to be “contracts of adhesion” because the insurer and insured parties are generally of unequal bargaining power where the insured party cannot negotiate the terms of the contract and must take the offer of the insurer as made. The contract can be modified by endorsing the contract using pre-approved language. It also must be noted that the language in insurance contracts are generally approved by state law. And for life insurance, if the language does not meet insurance code minimums, the minimum is automatically read into the contract. Importantly, the rule of law regarding “contracts of adhesion” is that any ambiguities are resolved against the WRITER of the contract. The writer of the contract most of the time is the insurance company. However, large companies can write their own “manuscript” policies and place them in a broker's hands for bids. In this case ambiguities are constructed against the writer – the insured in this case.

Contract of Indemnity

Property and liability insurance policies are said to be “contracts of indemnity” because the purpose of insurance is to indemnify the insured—that is, to make good a loss that the insured has suffered. The principle of indemnification is that the insured should not profit from the policy. This does not preclude that the insured will suffer some loss. In fact, many policies include a deductible which guarantees that the insured will pay part of each loss himself.

Insurable Interest

Insurable interest is one wherein economic loss would be suffered from an adverse occurrence to the person(s) insured.

A person can only collect in property casualty if the insured has insurable interest at the time of the loss. Many times a person can buy a valid contract but there is no insurable interest yet. An example is before buying a house you have to show up with a contract or a binder proving that the house is insured to receive the mortgage – thus, one may insure property where there is not insurable interest in anticipation of such. One can only collect at the time of loss if insurable interest then exists.

In life insurance, one only needs insurable interest at the time the policy is taken – no continuing insurable interest is required. Controversial areas include corporate-owned life insurance, investor-owned life insurance and viatical settlements.