Formation of a Life and Health Insurance Contract
The formation of a life or health insurance contract differs from the formation of other insurance contracts because the life or health producer usually does not have the authority to bind the insurer.
Insurance policies are legal contracts and are subject to the general law of contracts. This is a distinct body of law that is separate from criminal law (crimes against society) and tort law (legal liability issues usually involving damages for negligence). A contract is a legal agreement between two or more parties promising a certain performance in exchange for a valuable consideration. Under the law, the following elements are necessary for the formation of a valid contract:
- Agreement (offer and acceptance)
- Competent parties
- Legal purpose
Agreement (Offer and Acceptance)
There can be no contract without the agreement or mutual assent of the parties. A common intention on all terms of the contract is essential to an agreement and no essential terms of the contract may be left unsettled. Further, the intention of the parties to a contract must be communicated to one another.
The parties to an insurance contract are the insurance company and the applicant, who may become the insured or may name another person to be insured. Unless otherwise indicated, it is assumed that the applicant is the prospective insured.
An offer is a proposal that creates a contract if accepted by another party according to its terms. If an applicant gives the insurer a completed application and pays the first premium, the application is an offer. If the policy is issued as applied for, the insurer accepts the offer.
There is no offer if the applicant sends the application to the insurance company without payment of the premium. Such an application is merely an invitation to the company to make an offer. The insurance company makes an offer by issuing the policy. The applicant accepts it by paying the first premium.
An acceptance must be unconditional and unqualified. If an insurance company, after receiving an application and premium payment, issues a policy with more restrictive coverage than that applied for, the company has made a counter offer.
For example, a counter offer occurs if an applicant applies for a standard health insurance policy, pays the premium, and receives a policy containing an exclusionary endorsement for specified physical conditions. The applicant must decide whether to accept the policy as modified. If he or she accepts the policy, there is a contract. If he or she rejects the modified policy, there is no contract, and the applicant is entitled to a return of his or her premium.
Each party to the contract must give valuable consideration. In the insurance contract, the value given by the insurer consists of the promises contained in the policy contract. The consideration given by the insured consists of the statements made in the application and the payment of the initial premium.
The consideration may consist of any of the following:
- A monetary payment
- An act
- A forbearance from action
- The creation, modification, or destruction of a legal right
- A return promise
It is important to know that part of the applicant's consideration consists of the statements in the application. A great deal of importance is placed on the representations in the application because the insurance company's entire decision of whether to contract is based on its evaluation of the information in the application.
For a contract to be binding, both parties must have the legal capacity to make a contract. To have the legal capacity to make insurance contracts, an insurance company must have authority under its charter to issue contracts and be authorized by the state to issue contracts. The company's representative must also be licensed by the state.
To be valid, a contract must be for a legal purpose and not contrary to public policy. An insurance contract is not against public policy where an insurable interest exists.
Parts of the Insurance Contract
Although it is not a legal requirement that all contracts be in writing, insurance contracts always are because of their complex nature. The number of pages that make up an insurance contract varies because of the types of insurance and the individual risks being insured, but all life/health insurance contracts contain four basic parts:
- Policy face (Title page)
- Insuring clause
Policy Face (Title Page)
The policy face is usually the first page of the insurance policy. It includes the policy number, name of the insured, policy issue date, the amount of premium and dates the premium is due, and the limits of the policy. The policy face also includes the signatures of the secretary and president of the issuing insurance company. In addition, there are generally clauses required by law to give the insured information on his or her right to cancel, and a warning to the insured to read the policy carefully.
The insuring clause generally also appears on the policy face. It is a statement by the insurance company that sets out the essential element of insurancethe promise to pay for losses covered by the policy in exchange for the insured's premium and compliance with policy terms.
This section spells out in detail the rights and duties of both parties. Conditions are provisions that apply to the insured and insurer. For example, the conditions include the reinstatement provision, suicide clause, payment of claim provision, and similar standard policy provisions.
In this section, the company states what it will not do. The exclusions are a basic part of the contract and a complete knowledge of them is essential to a thorough understanding of the agreement. Certain risks must be excluded from insurance contracts because they are not insurable.