1. What is the nature of an Insurance Contract?

ANSWER. The life insurance contract has distinguishing features with the contract law. An offer and acceptance, legal capacity, valid consideration and a lawful agreement are sufficient for any contract to be valid. Apart from these requirements the insurance contract has some more characteristics like

❑ Adhesion

❑ Conditional

❑ Unilateral

❑ Aleatory

❑ Personal.

2. Give a brief note on;

❑ Adhesion contract

❑ Valued policy

❑ Unilateral contract

❑ Conditional contract

❑ Aleatory contract

❑ Personal contract

ANSWER:  Adhesion Contract: A contract of adhesion means that the insured must accept the entire contract, with all its terms and conditions which are fixed by the insurer. It is highly specialized and technical in nature and prevents it from being a bargaining contract.

 Valued Policy: Unlike property insurance, life insurance contract is a valued policy which means the insurer agrees to pay a stated sum of money irrespective of the actual economic loss which is opposite to the contract of indemnity applicable to property insurance.

Unilateral Contract: Unlike commercial contracts which are bilateral in nature, insurance contracts are unilateral in nature. It means that only one party, the insurer, gives a legally enforceable promise and the insured cannot be legally forced to pay the premiums. But of course, the insurer is bound to accept them and provide protection to the insured when they pay premiums in timely manner.

Conditional Contract: An insurance contract is a conditional contract. The insurer’s obligation ‘to pay a claim depends upon the conditions which are inserted in the policy like payment of premiums, proof of death and in the case of property loss immediate notice of loss to the insurer, etc.

Aleatory Contract: Unlike a commutative contract, an insurance contract is aleatory. It means that the values exchanged may not be equal but involve the element of chance or an uncertain event. In this, one party may receive more in value than the other. The insured may receive more than the amount he paid in premiums when the loss occurs immediately after the acceptance of a policy. And the insurer may receive more in value if the loss does not occur to the insured when the policy was in force.

Personal Contract:  Property insurance is a personal contract between the insurer and the insured. In this, insurer insures the owner of property against loss but not the property. Insured property is indemnified if there is any loss, and it cannot be assigned to another party without the insurer’s consent. But life insurance can be assigned to any one because the assignment does not alter the risk.

2. What are the basic requirements of an Insurance Contract?

ANSWER. The basic requirements of an insurance contract are:

❑ Offer and acceptance.

❑ Consideration.

❑ Competent parties.

❑ Legal purpose.

Offer and acceptance: An agent merely solicits or invites the prospective insured to make an offer. The applicant for insurance makes the offer, and the company accepts or rejects the offer. This accepting procedure is different for property, liability insurance and life insurance. In property insurance, the offer and acceptance can be oral or written and the agents have the power to bind their companies through the use of a binder which is a temporary contract. But in life insurance, the agent does not have the power to bind the insurer. The application for life insurance is always in writing and it should be approved by the insurer before it is in force.

Consideration: It refers to the value that each party gives to the other. The insured’s consideration is payment or a promise to pay the premium and an agreement to abide by the conditions in the policy. The insurer’s consideration is the promise to do certain things which are specified in the contract.

Competent parties: Insane persons, intoxicated persons and minors are not legally competent to enter into insurance contracts.

Legal purpose: All illegal activities which are contrary to the public interest are not enforceable. A contract should have a legal purpose.

3. Describe the basic parts of an Insurance Contract:

ANSWER. Insurance contracts generally can be divided into

❑ Declarations

❑ Definitions

❑ Insuring agreement /Operative clause

❑ Exclusions

❑ Conditions

❑ Miscellaneous provisions.

Generally, most of the insurance contracts contain these parts:

Declarations: In the declaration part information regarding property or activity to be insured by the insurer is presented. It is useful for underwriting and rating purposes. It is generally found on the first page of the policy. In property insurance, the declaration page contains information regarding the identification of the insurer, name of the insured, location of the property, period of protection, amount of insurance, amount of the premium, etc. In life insurance, the declaration page contains the insured’s name, age, premium amount, issue date and policy number.

Definitions: Insurance contracts generally contain a page of definitions. They are in either quotation marks or in bold face type. For example, the insurer is always referred to as “we” “our” or “us” and the insured is referred to as “you” and “your”. These definitions make easy to determine the coverage under the policy.

Insuring Agreement: It is the most important part in the contact. It summarizes the major promises and conditions to fulfil the promises by the insurer. In property and liability insurance there are two forms of an agreement.

1). Named peril policy and

2). All risk coverage.

In the named peril policy, the policy covers only the specified perils, whereas under an all-risk coverage policy the policy covers all losses except those losses specifically excluded. All risks coverage is preferable to named perils coverage because of its broad coverage and also as the burden of proof to deny the payment is placed on the insurer unlike the insured in the named peril policy. Life insurance is an example of all risks policy, it covers all causes of death with some exceptions like suicide, aviation, war, etc.

Exclusions: There are three types of exclusions in an insurance contract:

a). Excluded perils [Example the peril of war is excluded in disability income policy]

b). Excluded losses [Example Professional liability losses are excluded from personal liability section of homeowners policy]

c). Excluded property [example Cars and planes in a homeowners policy]

MAIN REASONS FOR THESE EXCLUSIONS ARE:

❖ Some perils are uninsurable like wars.

❖ Some perils are predictable declines [wear and tear and inherent vice].

❖ Some perils are extraordinary hazards [in cars and cabs – cabs are more prone to accidents than car].

❖ To avoid duplication of coverage [ ex. A car is excluded under homeowners policy because car is covered under the personal auto policy].

❖ To avoid moral hazard – If unlimited amount of money were covered fraudulent claims could increase.

❖ Finally exclusions are used because the coverage is not needed by the typical insured.

Conditions: To meet promises by the insurer, the conditions section imposes certain duties on the insured. If the policy conditions are not met, the insurer can refuse to pay the claim.

Miscellaneous Provisions: In property and liability insurance, miscellaneous provisions refer to cancellation, subrogation, and assignment of the policy; and in life insurance, grace period, reinstatement of a lapsed policy and misstatement of age, etc. Most of the policy owners make a common mistake of not reading policies and understanding the contractual provisions that appear in the policies which lead to controversies in the settlement. To avoid this, study of basic parts of insurance contract would be useful.

4. Identify the major types of exclusions typically found in insurance contracts. Why are exclusions used by insurers?

ANSWER. EXCLUSIONS are basic part of any insurance contract. There are three types of exclusions in the insurance contract.

a). Excluded perils [ ex. The peril of war is excluded in disability income policy]

b). Excluded losses [ ex. Professional liability losses are excluded from personal liability section of homeowners policy]

c). Excluded property.

 5. Define the term conditions in an insurance contract. What is the significance of the conditions section to the insured?

ANSWER. The conditions section is an important part of an insurance contract. The CONDITIONS are provisions in the policy that qualify or place limitations on the insurer’s promise to perform. So, the conditions section imposes certain duties on the insured. If the policy conditions are not met, the insurer can refuse to pay the claim.

6. How do you construct an insurance contract?

ANSWER. Generally speaking, the construction of the insurance contract as to its validity will be governed by the law and usages of the place where the contract is made. Like any other legal contract, the construction of an insurance contract also depends on the agreement between competent parties, resulting from an offer and acceptance, must comply with legal requirements as to form and have for its purpose a legal object. There must be a valuable consideration, an insurable interest and the contract must be made with full knowledge of material facts and be free from fraud, mistake and misunderstanding. And policy forms are necessarily general in character, since they are drawn to meet a general situation and not with reference to particular cases. But because of ambiguity in the wording and varying circumstances surrounding the loss, the chance of disputes as to the interpretation may occur.

To avoid this there are certain legal principles underlying the interpretation of the application, as well as of policy provisions, that are kept in mind by the courts as guiding principles in their efforts to interpret the contract.

Example.

1). Courts consider fire insurance is a contract of indemnity whereas life insurance is not a contract of indemnity though the principle of indemnity is a fundamental legal principle of an insurance contract.

2). In the case of contract of adhesion and endorsement, generally the courts will give the benefit of the doubt to the insured on the ground that the contract is not a bargaining contract.

3). Finally, it is the purpose of the law and function of the court to enforce the contract when there is no conflict or ambiguity between the two competent parties insured and the insurer.

7. Describe the schedule of an insurance policy.

ANSWER. Life insurance policies are generally two types;

❑ Narration type and

❑ Scheduled type.

 IN THE NARRATION TYPE the contract contains continuous details in a long narration which is not popular in modern times.

SCHEDULED TYPE is popular in modern times.

It contains;

❖ Date of execution or operation

❖ Parties names

❖ Preamble or recitals [object of the deed]

❖ Operative clause or consideration [ insurer’s promise to pay the sum assured to the insured on the condition of scheduled payments]

❖ Covenants of title and conditions -covenants like

a). right to convey.

b). for freedom from encumbrances.

c). for further assurance and conditions like declaration of age insurable interest, valuable consideration, etc.

❖ Schedule or parcels [ accurate description of the property in property insurance and Benefit Schedule [particulars of the assured, the event insured, the sum assured, the payees, etc..] and payable schedule [particulars of the payment of dates of first premium, renewal premium etc. in life insurance.]

❖ Habendum [the quantity of the interest or estate of the assignee].

❖ Execution [prescribed articles for execution of the deed].

❖ Attestation of signature.

❖ Delivery unless a deed is delivered it will not be operative.

There should be a great care in drafting the policy. There should not be any ambiguity in the wording, and it should reflect the intention of the both the parties.

8. What is an endorsement or rider? If an endorsement conflicts with a policy provision, how is the problem resolved?

ANSWER. Insurance contracts generally contain endorsements and riders. The terms endorsements and riders are interchangeable.

Endorsements in property and liability insurance modify, extend or delete provisions found in the original policy. In life and health insurance, riders can be added that increase or decrease benefits, waive a condition of coverage present in the original policy or amend the basic policy. If an endorsement is contrary to a law or regulation, the policy is read and applied as if that endorsement did not exist.

9. Why do deductibles appear in insurance contracts? Identify some deductibles that are found in insurance contracts.

ANSWER. This provision is generally found in property, health and auto insurance contracts and not in life insurance contracts because the insured’s death is a total loss and deductibles reduce the face amount of insurance.

A deductible is a provision by which a specified amount is subtracted from the total loss payment that otherwise would be payable. Main purposes of these deductibles are.

❖ To eliminate small claims [expensive to handle and process].

❖ To reduce premiums [larger deductibles are preferable to smaller deductibles].

❖ To reduce moral and morale hazard [because of it insured may not profit out of loss and it encourages insured to be careful of his property] Deductibles in property insurance are two types:

1. Straight deductibles [applies to each loss]
2. Aggregate deductibles [all covered losses are added together till they reach a certain level for a particular period.]

Deductibles in health insurance generally are:

❖ Calendar year deductible [aggregate]

❖ Corridor deductible [it is a supplement plan to major medical expense plan]

❖ Elimination [waiting] period deductibles [disability income contract for the loss of work earnings]

10. What is Coinsurance? \

ANSWER. It is a contractual provision in commercial property insurance. Under this clause the insured must insure the property for a stated percentage of its insurable value [actual cash value or replacement cost] to collect in full for a partial loss. If this coinsurance is not met at the time of loss, the insured must share in the loss as a co-insurer. The co-insurance formula is.

 Amount of insurance carried/Amount of Insurance Required x loss = amount of recovery

Amount of insurance required is the actual cash value of the property x % coinsurance clause in the policy.

The precaution in applying this coinsurance formula is that the amount paid can never exceed the amount of the actual loss and should be limited to the face amount of the insurance. The main PURPOSE of co-insurance is to achieve equity in rating [ the insured who makes co-insurance receives a rate discount and who is under-insured is penalized through application of the coinsurance formula] But practical PROBLEMS IN  OPERATING COINSURANCE clause arise from changes in the actual cash value of the property due to inflation or with increase in inventory values with increase in stock , etc.

11. Describe a typical coinsurance clause [percentage participation clause] in a major medical policy?

ANSWER. Coinsurance in health insurance is technically known as Percentage Participation Clause. Under this the insured has to pay a certain percentage of medical expenses in excess of the deductibles.

 The PURPOSE to introduce this participation is;

1). To reduce premiums, and

2). To prevent overutilization of policy benefits like expensive medical services.

DISCLAIMER:  the FAQ presented here is only for sharing information with readers. In case of necessity do consult with professionals.

AUTHOUR: FCS Deepak P. SIngh [ B.Sc. FCS, LLB, AIII, CIAFP]/cs.deepakpsingh@gmail.com