Legal Concepts Of Insurance Contract Chapter 3

Question 1

Unilateral Contract

Answer 1

Only one party (the insurer) makes any kind of enforceable promise. Insurers promise to pay benefits upon the occurrence of a specific event, such as death or disability.

(The applicant does not even promise to pay premiums but insurer has right to cancel contract for nonpayment.)

Question 2

Personal Contract

Answer 2

A personal agreement between the insurer and the insured.

This means it is actually the owner (person) of the property who is insured, not the property itself and the contract is not transferable to another person (except for life insurance, which is)

Question 3

Assignment of life insurance

Answer 3

Life insurance allows transfer of ownership through assignment. The policyowner who wishes to assign a life insurance policy must simply notify the insurance company in writing and the company with accept the transfer without question and the new policy owner with assume all the rights granted in the policy. Life insurance contract are NOT personal contracts.

Question 4

Conditional Contract

Answer 4

Insurance contracts are conditional.

A condition is a requirement specified in the contract which limits the rights provided by the contract. Conditions must be upheld by the insured to qualify for indemnification and the insurers promise to pay benefits depends on the occurrence of an event covered by the contract. No event, no payment.

Example 1: timely payment of premiums is a condition for keeping contract in force. If premiums are not paid, company is relieved of obligation to pay a benefit.

Example 2: Notice/Proof. The insurer will not pay the benefits if the insured does not notify the company of the loss or cannot prove the loss occured.

Question 5

What are two types of insurance contract?

Answer 5

Valued Contracts or Indemnity Contract

Question 6

Valued Contract

Answer 6

Pays a stated sum regardless of the actual loss incurred.

Example: Life insurance. There’s no attempt to value actual financial loss upon a person’s death.

Question 7

Indemnity Contract

Answer 7

Also called reimbursement contract. Pays an amount equal to the loss. Specified that insurance should restore an individual to the same or a similar financial position in which they existed prior to the loss.

Examples: property, casualty, & health insurance policies.

Question 8

Insurable Interest

Answer 8

The relationship between parties that justify one having an legally enforceable insurance policy on the another.

For someone other than the party insured to be the policy owner, they must have a financial interest in the insured, meaning the applicant (person acquiring the contract) must be subject to financial or economic loss upon the death, illness or disability of the person being insured; to have an Insurable interest in the life of another, the individual must have a reasonable expectation of benefitting from the other person’s continued life.

Examples: insurable interest is within a husband & wife, parent & child, business partners or a business’s key employee, debtor/creditor, or a niece/nephew who lived within the individuals household.

A person would NOT have insurable interest in the life of their mail carrier since there is no expectation of benefitting from the mail carriers continued life.

Question 9

Key point on Insurable Interest in life and health insurance:

Answer 9

Insurable interest is only required at the time of the application & does not have to continue throughout the duration of the policy nor does it have to exist at the time of the claim.

Example: a married couple take out insurance policies on one another’s lives. There’s no issue if they later get divorced and choose to continue the policies. Even though insurable interest no longer exists, they can still collect the death benefit as long as policy is still active.

Question 10

Insurable Interest in Property and Casualty insurance:

Answer 10

An insurer must prove they have legitimate interest in preserving the property they seek to insure when the policy is purchased as well as when a loss occurs.

Example: Bob owns a house. Bill owns a house next door. They can each purchase their own homeowners policies but they would not be allowed to purchase a policy on each other’s properties bc they each only have insured interest in their own homes.

Question 11

Stranger Originated Life Insurance (STOLI) aka Investor Originated Life Insurance (IOLI)

Answer 11

Life insurance arrangements used to circumvent state insurable interest statutes where investors persuade individuals (typically seniors) to take out new life insurance, naming the investors as beneficiaries.

Generally, investors loan money to the insured to pay the premiums for a defined period based on the life insurance policy’s contestability period. Eventually, the insured assigns ownership to the investors, who begin to make the premium payments on behalf of the insured. When the insured dies, the investor will receive the death benefit. In return, the senior receives a financial incentive: typically an upfront payment, a loan, or a small continued interest in the policy’s death benefit.

Question 12

Insurance Policy

Answer 12

A written contract in which one party promises to compensate another against loss that arises from an unknown event.

Question 13

Policy Rider (aka endorsement)

Answer 13

A legal attachment amending a policy to add additional benefits or reduce them and are often incorporated in policies by the attachment of either a benefit or an exclusion rider.

Question 14

Utmost Good Faith

Answer 14

Both the policyowner and the insurer must know all material facts and relevant info. There can be no attempt by either to conceal, disguise, or deceive.

Applicants are required to make full, fair, and honest of disclosure of risk to the agent and insurer. The insurer issues policies on the “faith” that the applicant was truthful.

Concepts related to warranties, representations and concealment represent grounds through which an insurer might seek to avoid payment.

Question 15

Reasonable Expectation

Answer 15

Legal principle that reinforces the rule that ambiguities in insurance contracts should be interpreted in favor of the policyholder & states that an insured is entitled to coverage under a policy that a sensible and prudent person would expect it to provide.

Question 16

Warranty (in regards to insurance)

Answer 16

A statement by the applicant that is guaranteed to be true in every respect which effects the insurers decision to accept or reject an applicant and becoming part of the contract; if found to be untrue, can be grounds for revocation of the contract. Can be express or implied and may relate to the past, the present or the future, or to any or all of these.

Question 17

Representation (in regards to insurance)

Answer 17

A statement made by the applicant that they consider to be true and accurate to the best of the applicants belief used by the insurer to evaluate whether or not to issue a policy.

Unlike warranties, representations are not part of the contract and need to be true only to an extent that they are material and related to the risk. Statements made by applicants are considered to be representations, not warranties.

A representation cannot qualify an express provision in a contract of insurance but it may qualify an implied warranty.

Question 18

Material Misrepresentation

Answer 18

A false statement made by an applicant that would influence an insurer in determining whether or not to accept the risk

Question 19

Concealment

Answer 19

The issue on concealment is crucial to insurance contracts. Is defined as the failure or neglect by the applicant to disclose a known material fact when applying for insurance.

Regardless if concealment is intentional or unintentional, if the purpose of concealment was to obtain a policy that might not be issued if the issue were to be revealed (defraud the insurer), the insurer may have grounds to void the policy. Regardless of intent, the injured party has the right to rescind the insurance contract.

Question 20

Rescission

Answer 20

Contract is made null and void.

Insurer must prove concealment and materiality.

Materiality: would the insurer have issued the exact same policy with the exact same terms if they had known the concealed facts at the time of application.

In most cases, insurers have a limited period of time to uncover false warranties, misrepresentations or concealment. After that period passes (typically 2 years from policy issue), the contact cannot be voided or revoked for these reasons.

Question 21

Void Contract

Answer 21

An agreement without legal effect. In essence it’s not a contract at all for it lacks one of the elements specified by law for a valid contract. It cannot be enforced by either party.

An insurer may void an insurance policy is a misrepresentation on the application is proven to be material.

Question 22

Voidable Contract

Answer 22

An agreement that, for a reason satisfactory to the court, may be set aside by one of the parties to the contract. It’s binding unless the party with the right to reject it wishes to do so.

Example: A policyholder stops paying the premiums. The contract is now voidable and the insurance company has the right to revoke the coverage.

Question 23

Cancellation

Answer 23

The voluntary act of terminating the insurance contract.

Question 24

Fraud

Answer 24

Under most contracts, fraud can be a reason to void a contract but insurance contracts are unique. An insurer only has a limited period of time ( usually 2 years from date of issue) to challenge the validity of a contract. After that, the insurer cannot contest the policy or deny benefits based on material Misrepresentation, concealment or fraud.

Question 25

Parole Evidence Rule

Answer 25

Parole Evidence is oral or verbal evidence or that of which is given verbally in a court of law. The legal principle of the parole Evidence Rule limits a contract to it’s written terms and minimizes the use of oral or written documents that are outside of the written policy.

Oral statements may not generally be used to counteract or nullify insurance contract provisions. In other words, oral statements made before the formation of a contract if not made part of the contract will not be admitted in court in the future if a litigious dispute arises.

Example: once an insurance producer delivers the insurance policy to the insured, the written contract (policy) supersedes anything discussed verbally during the application or sales process. Furthermore, only that which is written in the contract in enforceable.

Question 26

Waiver

Answer 26

Waiver is the voluntary surrendering (giving up) of a known right. A waiver is also defined as “the deliberate, voluntary, or intentional abandonment of a known right by the insurer.” It usually involves the conduct of an insurer or its sales representative, which intentionally relinquishes a defense against a claim.

Examples: Assume that a life insurer issues a policy that states that if the insured enters the military, the policy is void, insured joins the army and is killed during a battle. A company officer informs the insured’s beneficiary that since the insured died in defense of his country, the insurance company will waive its defense of military service death. Later the insurer denies the claim. However, they will have to pay the claim since the company officer’s communication (written or verbal) constitutes a waiver and prevents the insurer from denying the claim.

Another example of an insurer engaging in a waiver could be when it mistakenly accepts an incomplete application and issues a policy. If the insurer later attempts to rescind the policy or deny a claim because the application was incomplete, they will be prevented from doing so since they have engaged in a waiver. Their mistake prevents them from denying the claim or attempting to take back or rescind the policy. A waiver can also occur if an insurer fails to enforce a provision in the policy. If an insurer finds after it issues a policy that an individual lied about his health and the insurer does not inform him within a reasonable time that the contract is going to be void or rescinded, it has engaged in a “waiver by silence.”

If an insurer fails to enforce (waives) a provision of a contract, it cannot later deny a claim based on a violation of that provision.

Question 27

Estoppel

Answer 27

The legal principle of estoppel involves a broken promise. Estoppel prohibits an insurer from denying a claim due to specific actions (or inactions) by the insurer or its representatives. One party makes a false representation (i.e., an agent who states that the insured is fully covered). Another party relies on that statement (i.e., the insured). The insured then experiences financial harm (i.e., the insurer attempts to deny the claim). If these three elements are present, the insurer will be “estopped” or prevented from denying the claim.

For example, a producer makes a false representation to an applicant who relies on the statement. Later, harm is caused to the policyowner when a claim is denied because of this reliance. The insurer will then be “estopped” or prevented from denying the claim.

The concepts of waiver and estoppel are closely related.

Question 28

Insurance Agent

Answer 28

An individual authorized by an insurer to sell insurance products on behalf of the insurer. An agent’s role involves the following duties:

Describing the company’s insurance policies to prospective buyers and explaining the conditions under which the policies may be obtained;

Soliciting applications for insurance;

Collecting premiums from policyowners; and

Rendering service to prospects and to those who have purchased policies from the company.

The authority of an agent to undertake these functions is clearly defined in a contract of agency (or agency agreement) between the agent and the company. Within the authority granted, the agent is considered to be the insurance company. The relationship between an agent and the company represented is governed by agency law.

Question 29

Law Of Agency

Answer 29

As noted earlier, an insurance agent is an individual who is authorized by an insurer to sell insurance products on behalf of the insurer. An agent’s role involves the following duties:

Describing the company’s insurance policies to prospective buyers and explaining the conditions under which the policies may be obtained;
Soliciting applications for insurance;
Collecting premiums from policyowners; and
Rendering service to prospects and to those who have purchased policies from the company.
The authority of an agent to undertake these functions is clearly defined in a contract of agency (or agency agreement) between the agent and the company. Within the authority granted, the agent is considered to be the insurance company. The relationship between an agent and the company represented is governed by agency law.

Question 30

Principles of Agency Law

Answer 30

By legal definition, an agent is a person who acts for another person or entity (known as the principal) with regard to contractual arrangements with third parties. An authorized agent has the power to bind the principal to contracts (and to the rights and responsibilities of those contracts). With this in mind, we can review the main principles of agency law:

The acts of the agent (within the scope of his authority) are the acts of the principal.
A contract completed by an agent on behalf of the principal is a contract of the principal.
Payments made to an agent on behalf of the principal are payments to the principal.
Knowledge of the agent regarding the business of the principal is presumed to be knowledge of the principal.