Insurance contract law and its unique characteristics

What makes an insurance policy a contract

An insurance policy is a legal contract, so it must meet the same four tests as any other enforceable contract. Many exam questions turn on remembering them.

1. Agreement (offer and acceptance). In most cases the applicant makes the offer by submitting a signed application with the first premium. The insurer accepts by issuing the policy as applied for. If the application is sent without the premium, the roles reverse: the insurer's issuance of the policy is the offer, and the applicant accepts by paying the premium when the policy is delivered. If the insurer issues the policy on different terms, such as a higher rate, that is a counteroffer, and the applicant accepts it by taking the policy and paying.
2. Consideration. Each side gives something of value. The insured's consideration is the premium and the statements in the application. The insurer's consideration is its promise to pay if a covered loss occurs.
3. Competent parties. Both parties must have legal capacity. The insurer must generally be authorized to do business in the state (narrow exceptions exist, such as excess lines coverage placed through a licensed excess line broker); the applicant must generally be an adult of sound mind who is not impaired by drugs or alcohol when signing.
4. Legal purpose. The contract cannot be against public policy. A policy without insurable interest, or one meant to profit from a crime, fails this test.

State insurance law defines the insurance contract itself as an agreement under which the insurer must confer a benefit of money value on the insured or beneficiary when a fortuitous event happens, an event largely beyond either party's control, in which that person has a material interest that would be harmed. That definition is why insurable interest and chance are built into every policy.

The unique characteristics

Insurance contracts also have features that ordinary commercial contracts usually lack.

• Aleatory. The values exchanged are unequal and depend on chance. One small premium may buy a very large claim payment, or no payment at all.
• Adhesion. The insurer drafts the contract and the applicant takes it or leaves it, with no bargaining over wording. So any ambiguity is interpreted in favor of the insured.
• Unilateral. Only the insurer makes a legally enforceable promise. The insured cannot be sued for stopping premium payments; the policy simply lapses.
• Conditional. The insurer pays only if the insured meets certain conditions, such as paying premiums, giving prompt notice of loss and proving the loss.
• Utmost good faith. Each side relies on the honesty of the other. The applicant must disclose material facts, and the insurer must deal fairly.
• Personal contract. Property and casualty coverage insures a person, not the thing, so it generally cannot be assigned without the insurer's consent. Life policies, by contrast, are generally freely assignable.

Representations, warranties and concealment

A representation is a statement the applicant believes to be true to the best of their knowledge. A warranty is a statement guaranteed to be literally true, a stricter standard than a representation; in New York, though, a breach of warranty generally voids coverage only if it materially increases the risk of loss. For life, accident and health policies and annuities, the law treats all statements made by or for the applicant as representations, not warranties. A misstatement allows the insurer to rescind only if it is material, meaning the insurer would have declined the risk or charged more had it known the truth. Concealment is deliberately withholding a material fact; fraud is an intentional misstatement made to deceive. Either can make the contract voidable.

The entire-contract rule

A life, accident or health policy must contain the entire contract. Nothing can be incorporated by reference unless a copy is endorsed on or attached to the policy when issued; the exception is a table or schedule of rates, premiums or other payments on file with the superintendent. The application cannot be used as evidence unless a true copy was attached when the policy was issued. The policy can be changed, or a right waived, only in a writing signed by a person the insurer names in the policy. That is why an agent cannot change policy terms. No one other than the applicant may insert anything into or alter the written application without the applicant's written consent. The one exception is for the insurer's own insertions made for administrative purposes only, marked clearly so that they are not ascribed to the applicant.

Waiver and estoppel

A waiver is the voluntary giving up of a known right. Estoppel stops a party from asserting a right it has already led the other side to believe it had given up. These doctrines often arise when an insurer accepts late premiums or overlooks a condition.

Exam tip: when a question asks who makes the offer, the default answer is the applicant, with the application and first premium. When the insurer changes the terms, the insurer has made a counteroffer.