Insurance Contract

Question 1

Voidable Contract

Answer 1

A voidable contract allows one party the option of breaking the agreement because of an act or omission of an act (a breach) by the other party. The party with the right to void the contract may instead choose to have the contract enforced

Question 2

void ab initio

Answer 2

void from the beginning

Question 3

Binder

Answer 3

A binder is a temporary contract in property insurance, and is often used before the issuance of the formal insurance policy. The binder must meet all the requirements for a legal contract. It is distinguished by its temporary nature (often 30 days or less).

Question 4

Conditional receipt

Answer 4

A conditional receipt can provide temporary coverage, contingent on an applicant’s ability to present evidence of insurability.

Life insurance agents give applicants a conditional receipt when the applicants submit a premium payment with the application. With one common type of conditional receipt, if evidence of insurability exists, coverage begins from the date of the receipt. Evidence of insurability always includes, but is not limited to, good health

Question 5

Unilateral contract

Answer 5

In unilateral contracts, only one party makes an enforceable promise. Insurance contracts are unilateral in that only the insurer makes a binding promise. The insured can cancel the policy at any time without recourse, while the insurer is limited to specific situations (such as failure of the insured to pay premiums) when it may cancel a policy.

Question 6

Bilateral Contract

Answer 6

Contracts in which both parties make enforceable promises are called bilateral contracts. Insurance is not considered a bilateral contract.

Question 7

Subrogation

Answer 7

Subrogation is the legal substitution of one person in another’s place. Subrogation is supported by the theory that if a person must pay a debt for which another is liable, such payment should give the person a right to collect the debt from the liable party.

Question 8

Contract Offer and Acceptance

Answer 8

Deals begin when one person makes a proposal to exchange something of value with another person. The proposal to make an exchange is called the offer. The offer must be reasonably definite and communicated clearly. If the second person agrees to the exchange, this is called acceptance. The acceptance must be unconditional, unequivocal, and communicated clearly.

Question 9

Consideration of contract

Answer 9

The value exchanged between the parties to the contract is the consideration. The consideration is what each party gives to the other. Consideration may take a tangible form, such as money, or it may take the form of a promise to do something or not to do a particular activity. There must be an exchange of consideration to have a valid contract.

In an insurance contract, the consideration the insurer gives is a contingent promise to pay the insured; that is, the insurer agrees to make payment only if a covered loss occurs. If such an event does not occur, the insurer need not make payment. In return for the insurer’s promise, the insured gives two things - money and a promise to follow the provisions and stipulations in the insurance contract.

Question 10

Capacity to enter a contract

Answer 10

Not every person legally has the capacity to enter into a contract.

State law defines the period of minority as ending at age 18. If a 13-year-old were to enter into a contract, it would be voidable at the youngster’s option. If a minor chose not to void the contract, the youngster could ratify or affirm it when reaching age 18.

Many state laws allow older minors (often beginning at age 15) to make binding agreements for insurance in specific instances. Insurance companies also must be qualified to enter into contracts. They must have a license to operate in each state in which they do business.

The unauthorized insurer would be subject to fines and penalties by the courts if an insured were injured because of having dealt unknowingly with an unqualified insurer.

Question 11

Legal Purpose

Answer 11

A contract must have a legal purpose, an end or intention permitted by law. Contracts having an antisocial purpose are legally unenforceable.

Question 12

Principles of Indemnity

Answer 12

Indemnity means the insured should be restored to the same financial position occupied before the insured’s loss. Any departure from this rule should be on the side of under-compensation. Insurers enforce the principle of indemnity through the insurable interest requirement, actual cash value settlements, and the operation of subrogation clauses.

Question 13

Exception to Indemnity

Answer 13

The three exceptions to the rule that insurance contracts are contracts of indemnity are:

life insurance
replacement-cost insurance, and
valued insurance.
Life insurance- Because the economic value of a human life cannot be measured precisely before death, life insurance cannot be a contract of indemnity. One could not be put in exactly the same financial position occupied before a loss because that position cannot be foretold.

Replacement-cost insurance- is written when the insurer promises to pay an amount equal to the full cost of repairing or replacing the property without deduction for depreciation.

If an insured loses an old, run-down building to a fire and a new building is built, the insured is obviously better off after the loss. Replacement-cost coverage is a typical feature of homeowners’ insurance policies and is also found in other property contracts.

Question 14

Valued Insurance Policy

Answer 14

A valued insurance policy is an exception to the rule of indemnity. Valued policies pay the limit of liability whenever an insured total loss occurs. The value of the insured property is agreed to before the policy is written. If a total loss occurs, it may cause more or less damage than the stated amount. Nevertheless, the stated amount will be paid.

Question 15

Insurable Interest

Answer 15

If individuals could insure property or a life in which they had no financial interest, insurance would become gambling. A policyholder would not be indemnified but enriched by a loss. Such contracts of insurance were written for a time in England. The fraud and murder associated with them caused laws to be passed in the eighteenth century prohibiting the issuing of insurance policies in which the policyholder lacked interest in the loss.

Question 16

Owner of Life Insurance

Answer 16

In most situations, the person being insured will be the owner of the contract. For estate planning purposes, a spouse or a trust may be the owner. In business situations, the company or the partners could be the owner of the life insurance contract.

Question 17

Beneficiary of Life insurance

Answer 17

The beneficiary is the party receiving the funds at the insured’s death. It is the beneficiary who must demonstrate the insurable interest at the time of application. The insurer needs to know that the person who will be receiving the death benefit has an adequate relationship to the person being insured.

Most often, the primary beneficiary is the spouse. Some divorce agreements now require that life insurance be maintained to provide for the children, naming the ex-spouse as beneficiary for the benefit of the children. To minimize estate taxes, the insured’s estate should not be named as beneficiary.

Question 18

Actual Cash Value

Answer 18

Actual Cash Value (ACV) means replacement cost at the time of loss, less depreciation.

Actual Cash Value is one of the strategies used to implement the principle of indemnity. The insured can only recover the amount of the loss, even if the face value of the policy was higher because the property was over-insured.

Defining Actual Cash Value
Replacement Cost − Depreciation = Actual Cash Value

Question 19

Replacement Cost

Answer 19

Replacement cost means the dollar amount required to rebuild a similar structure meeting the building code requirements in effect at the time of original construction. Replacement cost of a building does not equal fair market value of the property, because market value would include the value of the land and its location. Location can be an important factor in property value but not in replacement cost.

Question 20

Depreciation

Answer 20

Depreciation is calculated as a percentage. The numerator is the number of years the structure was in use. The denominator is an estimate of the useful life of the structure.

Question 21

Functional Replacement

Answer 21

Sometimes insurers do not use an actual cash value provision in their policies. In cases where the replacement cost of a building is greater than its market value, as is often the case with older, inner-city structures, insurers provide coverage based on replacement cost with modern construction techniques. Insurers call this provision functional replacement.

Functional replacement allows wallboard to be substituted for plaster walls, plastic pipes for copper pipes, and plywood for hardwood.

Question 22

Discharge of contracts

Answer 22

Contracts can be discharged on the grounds of the following conditions:

performance
condition precedent
condition subsequent
rescission
reformed
Performance- In the normal course of events, insurance contracts end by performance; that is, each party does what it has agreed to do. The insurer renders payment if a loss occurs or stands ready to do so if none occurs. In most cases, no loss occurs. The insurer still performed as required by standing ready to pay legitimate claims. Insureds discharge their duties by paying premiums and abiding by the conditions of the contract.

Condition Precedent- A condition precedent is something that must be done by one party to activate the other party’s duty to perform. For example, policyholders must continue to pay premiums in order to keep the policy in force.

Condition Subsequent- A condition subsequent must be fulfilled by the insured after the insurer has become liable in order to avoid releasing it from liability. For example, after an accident the insured must cooperate with the insurer and the insured must do nothing to jeopardize the insurer’s right to recover from a responsible third party.

Rescission- Insurance contracts also may be ended by rescission. Rescission is an agreement (contract) by both parties to end a contract. All the requisites of a contract are required. If rescission is mutual, both parties voluntarily relinquish their rights and duties under contract. If one party feels it was the victim of fraud, it may ask the court to rescind the contract. Rescission is a well-recognized equitable remedy from English common law.

Reformed- If mistakes have been made in a policy, the policy may be reformed; that is, the policy may be corrected so one party cannot take advantage of the other party’s mistake.

Question 23

Smokers policy

Answer 23

Applicants for life insurance are sometimes tempted to lie about their cigarette smoking because the premiums are so much lower for non-smokers. If the insured dies within the contestable period, and the insurance company discovers the person smoked, the company will rescind the contract and the only payment to the survivors will be the return of premiums.

Question 24

Insurable Interest

Answer 24

Property insurance requires an insurable interest when the loss actually occurs.

Life insurance requires an insurable interest only at the inception of the insurance policy.