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.

2) Consideration
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
  • Minor
  • 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.


Contract Characteristics

Related Articles
  1. Insurance

    Exploring Advanced Insurance Contract Fundamentals

    Understanding your contract can help you protect our family's financial security.
  2. Insurance

    What Happens If Your Insurance Company Goes Bankrupt?

    When insurance companies go bankrupt or face financial difficulty, it's bad news for policy holders.
  3. Insurance

    The History Of Insurance In America

    Insurance was a latecomer to the American landscape, largely due to the country's unknown risks.
  4. Insurance

    Do You Need Casualty Insurance?

    Find out how different types of coverages can protect you and which policy is right for you.
  5. Financial Advisor

    All About Impaired Risk Annuites and Insurance

    What are impaired risk insurance products and understanding life insurance rate classes, table ratings and flat extra premiums.
  6. Insurance

    Term Life Insurance: Everything You Need to Know

    Term life insurance is an affordable way to financially protect your loved ones after your death. Here's what you need to know before purchasing a policy.
  7. Insurance

    Insurance Coverage: A Business Necessity

    Don't go to work without this policy in place - especially if your work is in your home.
Frequently Asked Questions
  1. What are Common Examples of Monopolistic Markets?

    Discover what causes real instances of market monopoly, how it persists and where monopoly privilege is most common in the ...
  2. What is the gold standard?

    The gold standard is a monetary system where a country's currency or paper money has a value directly linked to gold, but ...
  3. What's the most expensive stock of all time?

    The most expensive publicly traded stock of all time is Warren Buffett’s Berkshire Hathaway.
  4. What is a "socially responsible" mutual fund?

    As the name suggests, socially responsible mutual funds invest exclusively in socially responsible investments.
Trading Center