An insurance policy is a contract. Contracts are agreements that are enforceable by law. We have contracts in insurance to allow two parties, typically an insurance company and an insured, to reach a mutual agreement to bind each other to certain promises- such as the insurer covering a particular risk of loss, and the insured agreeing to pay a premium (cost) for this protection. However, in order for a contract to be valid and enforceable, it must contain certain fundamentals.
To be Legally Binding an insurance contract must have the following five elements:
1) Offer and Acceptance
To be legally enforceable, a contract must be made with a definite, unqualified offer by one party and the acceptance of its exact terms by the other party.
The Offer- with many insurance contracts, the offer is made when the applicant submits the application with the initial premium.
The Acceptance- the acceptance is confirmed when the insurance company accepts the offer and issues a policy. The company may counteroffer and then the applicant has the choice to accept or reject the new terms.
No Initial Premium- When the applicant does not submit an initial premium with the application, the role of offer and acceptance is reversed. The insurer can respond by issuing a policy (the offer) that the applicant can accept by paying the planned premium when the policy is delivered.
In order for an insurance contract to be legally binding, there must be an exchange of value. Consideration is the value given in exchange for the services sought after.
The submission of the completed application (offer) plus the payment of the initial premium (consideration) to the insurance company generally creates a binding contract provided that the application passes the underwriting process.
3) Legal Intent
The subject of the insurance contract must be of legal purpose and/or a legal business entity in order for the contract to be enforceable. A contract whereas one party agrees to commit a crime for payment of services would not be enforceable in court because the subject matter is not of legal content.
4) Competent Parties
To cement a valid contract, the parties involved (individuals, groups, or businesses) must be capable of entering into a contract per the law. For an insurance contract, the insurer (insurance company) is considered competent if it is licensed or approved by the state or states in which it conducts business.
The applicant is presumed to be a competent party, unless one of these exceptions apply:
- Mentally Incompetent
- Under the influence of alcohol or drugs
If one of the parties is not competent, then the contract is voidable by the incompetent party.
5) Legal Form
Contracts must also follow the laws and guidelines of state regulations. For example- not all contracts are required to be in written form, but state laws might mandate a written contract to make it binding.
State Insurance Regulation attempts to accomplish the following (MAPS):
- Maintain competition
- Available coverage to all that want and need it
- Protect policy owners against insurer mistreatment
- Save the solvency of insurers
If an insurance contract lacks one of the five characteristics of a valid contract above, the contract will not posses legal effect and cannot be enforced by either party.
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