CHARACTERISTICS OF THE INSURANCE CONTRACT

Insurance contracts have some unique characteristics that are not found in other types of contracts. The following are a number of important elements that the student of insurance should understand.

Aleatory—This has to do with the fact that performance depends upon an uncertain future event. The insurer and insured may not give and receive equal dollar value. For instance, a man purchased a $100,000 whole life policy and made one premium payment of several hundred dollars. He died shortly thereafter of an accident. The insurer paid out more than it received. Conversely, a man may have purchased a 20-year term contract and made his premium payments for 20 years. As he did not die during the 20-year period, the insurer did not have to pay a death benefit. In this case, the insured paid more for the contract.

Adhesion—The insurance company has the contract drawn and offers it to the policyowner who “adheres” to its terms. Due to this, if there were a dispute over the meaning of ambiguous language in the contract, a court normally would side with the policyowner. After all, it was the company’s fault for having unclear language in the contract.

Unilateral—Contracts may be either unilateral or bilateral. An exchange of a promise for a promise makes a bilateral contract; an exchange of an act for a promise makes a unilateral contract. Life policies are unilateral contracts or one-sided contracts. Only one party is obligated to perform under the contract. That party is the insurer. The insurer is obligated to pay the death benefit as long as premiums have been paid. However, the policyowner does not have to continue making payments. The policyowner has the right to surrender a policy or allow it to lapse.

Utmost good faith—Essentially, this means the parties to a contract are dealing with each other openly and honestly with no attempts to misrepresent, deceive, or conceal material information. The insurer is relying on the applicant making truthful representations. The applicant is relying on the agent’s and insurer’s statements as to the benefits, features, and advantages of the policy.

Personal contract—Insurance policies are said to be personal contracts as they are a personal agreement between the insurer and the policyowner. Except for life insurance and some marine coverages, insurance is not transferable to another person without the insurer’s approval. For instance, if you sell your house, you cannot give your homeowner’s policy to the new buyer. However, in the case of life insurance, it is different. The policyowner may assign ownership of the life policy to another person without the insurer’s approval.

Executory—Insurance policies are executory in nature as the promised performance of the insurer will not take place until a future date. In life policies a death benefit would not be paid to a beneficiary until the death of the insured person.

Conditional—Insurance policies are conditional as certain conditions must be met to make the contract enforceable. In life insurance, the insurer would need to receive the death certificate of the insured person before paying the proceeds to the beneficiary.

California Insurance Code

The following text is based on the California Insurance Code (CIC) and relates to some of the topics covered in this chapter. In order to fulfill the Department of Insurance requirements, some of this material is repeated in other sections of the course, especially in the Code and Ethics portion.

Shall: Shall is mandatory. There is no choice.

May: May is permissive. There is a choice to do or not to do something.

(CIC 16)

Person: “Person” means any person, association, organization, partnership, business trust, limited liability company, or corporation. (CIC 19)

Insurer: Any person capable of making a contract may be an insurer, subject to the restrictions of the code. Any person, association, organization, partnership, business trust, limited liability company, or corporation capable of making a contract may be an insurer. (CIC 19, 150)

Claimant: Any person who asserts a right of recovery under a surety bond, an attorney, any person authorized by operation of law to represent the claimant, or any of the following persons properly designated by the claimant: an insurance adjuster, a public adjuster, or any member of the claimant’s family. (Title 10, CCR 2695.2(c)

Notice of Legal Action: Notice of an action commenced against the insurer with respect to a claim, or notice of action against the insured received by the insurer, or notice of action against the principal under a bond, and includes any arbitration proceeding. (Title 10, CCR 2695.2(o)

Proof of Claim: Any documentation in the claimant’s possession submitted to the insurer that provides any evidence of the claim and that supports the magnitude or the amount of the claimed loss. (Title 10, CCR 2695.2(s)

Application: The written statements on a form by a prospective insured about himself. These statements are used to decide on the applicant's underwriting classification and premium rate.

Adverse Selection: An insurance company insuring too many poor risks. Insurers need a profitable distribution of exposures--a balancing of preferred risks with poor risks to average out the risks.

Rate: The cost per unit of insurance. Rate making is the process of calculating a premium so that it is adequate, reasonable, and not unfairly discriminatory or inequitable.

Premium: The amount the insured is charged for the insurance protection and is normally paid on a monthly, quarterly, semi-annual, or annual basis.

Earned and unearned premium: Earned premium is premium the insurer is entitled to keep as it is for a period of time the insurer covered the insured with protection. Unearned premium is premium the insurance company needs to return to the insured if the policy is terminated and the insured paid premium for a period of time extending past the termination date.

Grace Period: Period after the date the premium is due during which the policy stays in force and the insured can pay the premium without penalty.

Policy defined: The written instrument, in which a contract of insurance is set forth, is the policy. (CIC 380)

Rider: An endorsement to an insurance policy that modifies clauses and provisions of the original policy, adding or excluding coverage.

Required contents: A policy shall specify:

(a) The parties between whom the contract is made.

(b) The property or life insured.

owner thereof.

(d) The risks insured against.

(e) The period during which the insurance is to continue.

(f) Either:

(1) A statement of the premium, or

(2) If the insurance is of a character where the exact premium is only determinable upon the termination of the contract, a statement of the basis and rates upon which the final premium is to be determined and paid. (CIC 381)

The financial rating of the insurer is not required to be specified in the insurance policy.

Parties to the contract: Any person capable of making a contract may be an insurer, subject to the restrictions imposed by the code. (CIC 150) Any person except a public enemy may be insured. (CIC 151)

If the insured has no insurable interest, the contract is void. (CIC 280) The measure of insurable interest in property is the extent to which the insured might be damnified by loss or injury thereof. (CIC 284) An interest in property insured must exist when the insurance takes effect, and when the loss occurs, but need not exist in the meantime; an interest in the life or health of a person insured must exist when the insurance takes effect, but need not exist thereafter or when the loss occurs. (CIC 286)

Fraud: Fraud is a dishonest act whether it transpires due to such occurrences as concealment, misrepresentation, or violation of a material warranty. Under most contracts, fraud is a reason to void a contract. With life insurance contracts, an insurer has two years from the date of issuance of a policy to challenge the validity of a contract.

Concealment: Concealment is defined as the neglect to communicate that which a party knows and ought to communicate. Whether or not concealment is intentional or unintentional, the injured party has the right to rescind the insurance contract. Rescission means the contract is made null and void. All parties to a contract shall communicate in good faith all information believed to be material to the contract.

Each party to the contract must: (1) communicate in good faith with one another; (2) disclose all facts of which the party has knowledge and which are of importance to the contract; and (3) identify all facts that the party cannot warranty and of which the party has no means to ascertain.

It is not necessary to disclose to the other party: (1) information which the other party already has knowledge; (2) information which, in the exercise of ordinary care, the other ought to know, and of which the party has no reason to suppose him ignorant; (3) information to which the other party waives communication; and (4) information that is excluded by a warranty and not material to the risk; (5) information that is expected from insurance and not material to the risk; (6) information based on personal judgment. (CIC 330-333)

Materiality: Materiality is to be determined not by the event, but solely by the probable and reasonable influence of the facts upon the party to whom the communication is due, in forming his estimate of the disadvantages of the proposed contract, or in making his inquiries. (CIC 334) If a party to the contract misrepresents information, the injured party may rescind the contract.

Each party to a contract of insurance is bound to know all the general causes open to inquiry that may affect either the political or material perils contemplated. The right to information of material facts may be waived either by the terms of insurance or by neglect to make inquiries as to such facts where they are distinctly implied in other facts which are communicated. Information regarding the nature or amount of one’s insurable interest need not be communicated unless in response to an inquiry. An intentional and fraudulent omission on the part of one insured to communicate information of matters proving or tending to prove the falsity of a warranty entitles the insurer to rescind. (CIC 335-338)

Representation: A representation is a statement to the best knowledge and belief of the party making the statement. A representation can be written or oral. The language of a representation is to be interpreted by the same rules as a contract in general. A representation as to the future is a promise, unless it is merely a statement of belief or an expectation. A representation cannot qualify an express provision in a contract of insurance, but it may qualify an implied warranty. (CIC 354) A representation may be made at the time of, or before, issuance of the policy. A representation may be altered or withdrawn before the insurance is effected, but not afterwards. (CIC 355) The completion of the contract of insurance is the time to which a representation must be presumed to refer.

When an insured has no personal knowledge of a fact, he may nevertheless repeat information which he has upon the subject, and which he believes to be true, with the explanation that he does so based on the information of others. He is not responsible for its truth, unless it proceeds from an agent of the insured, whose duty it is to give the information.

A representation is considered to be false when the facts fail to correspond with its assertions or stipulations. (CIC 358) If a representation is false in a material point, the injured party is entitled to rescind the contract from the time the representation becomes false. The materiality of a representation is determined by the same rule as the materiality of a concealment. All of the above provisions apply to the modification of a contract of insurance as well as to the original contract. (CIC 350-361)

Warranty: A warranty is a guaranteed truth. Warranties are either express or implied. A statement in a policy of a matter relating to the person or thing insured, or to the risk, as a fact, is an express warranty thereof. An implied warranty is a statement, not in writing, that insurable conditions exist. An implied warranty is included in the policy even though not specifically stated in it. A representation in an insurance contract qualifies as an implied warranty.

A particular form of words is not necessary to create a warranty. Every express warranty made at or before the execution of a policy shall be contained in the policy or in another instrument signed by the insured and made part of the policy. A warranty may relate to the past, the present, the future, or to any or all of these. A statement in a policy that imports that there is an intention to do or not to do a thing, which materially affects the risk, is a warranty that such act or omission will take place. (CIC 440-445)

If a loss insured against takes place and the performance of the warranty has become unlawful at the place of the contract or impossible, the omission to fulfill the warranty does not void the policy. If there is a violation of a material warranty, the wronged party may rescind the contract. The breach of an immaterial warranty will not void the policy unless the policy states that a violation of specified provisions will void it. A breach of warranty without fraud merely exonerates an insurer from the time that it occurs, or where the warranty is broken in its inception, prevents the policy from attaching to the risk. (CIC 447)

Opinion: Neither party to a contract of insurance is bound to communicate, even upon inquiry, information of his own judgment upon the matters in question. (CIC 339)

Misrepresentation: (CIC 780-784) A misrepresentation is a false oral or written statement made with the intent to defraud another. An insurer or an insurance licensee shall not cause or permit to be issued, circulated or used, any misrepresentation of the following:

(1) The terms of a policy issued by the insurer or sought to be negotiated by the person making or permitting the misrepresentation.

(2) The benefits or privileges promised thereunder;

(3) The future dividends, payable thereunder. (CIC 780)

Proof that an insurance licensee made false representations of one or more of these facts is a misrepresentation. These misrepresentations entitle the insured to void the contract.

Rescission: To rescind a contract is to terminate or void the contract. The policy is considered null and void from the beginning and treated as if it had never existed. As noted above, a wronged party has the right to rescind the contract when there has been a material concealment whether intentional or unintentional (CIC 331), an intentional and fraudulent omission proving the falsity of a warranty (CIC 338), a material false representation (CIC 359), or a violation of a material warranty or other material provision of a policy (CIC 447).

Cancellation, lapse, renewal, and non-renewal:

Cancellation is the termination of coverage by an insurer during a policy period. It does not mean the termination of the contract at the request of the policyholder.

Lapse refers to policy termination due to non-payment of the premium by the policyholder. A policy will lapse at the end of the grace period, which is a period of time after the premium due date, during which the policy remains in force without penalty.

Renewal refers to continued coverage under the policy for an additional period of time upon expiration of the current policy period.

Non-renewal refers to the giving of notice by the insurer to the policyholder that the insurer is unwilling to renew a policy.

Life policies are incontestable after being in force for two years. After this period of time, the insurer can cancel only for non-payment. Some term contracts are written as renewable which means the policyholder has the right to renew without proof of insurability, but premiums can be adjusted.

Disability contracts may be cancelled for non-payment and on the grounds of fraud on the part of the insured. Disability contracts can be written as non-renewable/cancelable, optionally renewable, conditionally renewable, guaranteed renewable, or non-cancelable