Special Characteristics of Insurance Contracts

Insurance contracts have unique characteristics that distinguish them from ordinary contracts. Understanding these special features is essential for the exam and for explaining insurance to clients.

Overview of Insurance Contract Characteristics

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Contract of Adhesion

An insurance policy is a contract of adhesion—meaning one party (the insurer) drafts the contract, and the other party (the applicant) must "adhere" to it on a take-it-or-leave-it basis.

Key Implications

• The applicant has no opportunity to negotiate terms
• The insurer uses standardized forms
• The applicant can accept or reject, but not change the contract

The Adhesion Rule

Because the insurer writes the contract, any ambiguities are interpreted in favor of the insured. Courts reason that since the insurer chose the language, any unclear provisions should benefit the party who had no say in drafting them.

Example

If a policy provision could reasonably be interpreted two different ways, the interpretation that favors the insured (provides more coverage) will be applied.

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Unilateral Contract

Insurance is a unilateral contract—only one party (the insurer) makes a legally enforceable promise.

How It Works

What This Means

• The insured can stop paying premiums at any time without legal penalty
• The insured cannot be sued for failing to maintain insurance
• However, if premiums aren't paid, coverage ends
• The insurer MUST pay valid claims as long as the policy is in force

Contrast with Bilateral Contracts

Most contracts are bilateral—both parties make enforceable promises. For example, in a sales contract, the seller promises to deliver goods and the buyer promises to pay. Insurance is different because only the insurer's promise is enforceable.

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Aleatory Contract

Insurance is an aleatory contract—meaning the values exchanged by each party may be unequal.

How It Works

• The insured might pay a few hundred dollars in premiums and receive nothing if no loss occurs
• Alternatively, the insured might pay one premium and then die, with beneficiaries receiving hundreds of thousands of dollars
• The exchange depends on chance—whether a covered event occurs

Example

Why This Matters

This unequal exchange distinguishes insurance from ordinary contracts where values exchanged are typically equal. It also distinguishes insurance from gambling—in insurance, the event insured against already exists as a risk; in gambling, risk is artificially created.

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Conditional Contract

Insurance is a conditional contract—the insurer's obligation to pay is contingent upon certain conditions being met.

Common Conditions

• Premium payment — Coverage requires premiums be paid
• Notice of loss — Insured must report claims promptly
• Proof of loss — Documentation of the loss must be provided
• Cooperation — Insured must cooperate in claim investigation
• Policy conditions — Various policy provisions must be followed

Example

If an insured fails to notify the insurer of a loss within the required time frame, the insurer may deny the claim—not because the loss didn't occur, but because a condition of the contract wasn't met.

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Utmost Good Faith (Uberrimae Fidei)

Insurance contracts are contracts of utmost good faith. Both parties are expected to deal honestly and not attempt to deceive, conceal, or misrepresent material facts.

Why This Standard Exists

Insurance requires a higher standard of honesty than ordinary contracts because:

• The insurer relies heavily on information provided by the applicant
• Much of the relevant information is known only to the applicant
• The insurer cannot independently verify everything

Key Concepts Related to Good Faith

Representations vs. Warranties

• Representation: A statement believed to be true to the best of the applicant's knowledge. Only material misrepresentations (those that would affect the insurer's decision) can void the policy.

• Warranty: A statement guaranteed to be absolutely true. Historically, any breach of warranty—even if immaterial—could void the policy. Today, most states require the breach to be material.

Concealment

Concealment is the failure to reveal known material facts. Unlike misrepresentation (saying something false), concealment involves staying silent about something important.

Example: An applicant who knows they have cancer but doesn't mention it on the application is guilty of concealment.

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Personal Contract

Life and health insurance are personal contracts—they cover a specific person and cannot be transferred to cover someone else.

What This Means

• The policy insures the named individual
• Coverage cannot be transferred to another person
• The policy can be assigned for value, but the covered person doesn't change

Assignment

While the coverage is personal, policy ownership can be assigned (transferred):

• Absolute assignment — Complete transfer of all rights
• Collateral assignment — Temporary transfer as security for a loan

Example: A policy owner can assign a life insurance policy to a lender as collateral. If the insured dies, the lender receives the amount owed, and any remainder goes to the beneficiary. But the policy still covers the original insured person's life.

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Indemnity Principle

The principle of indemnity states that insurance should restore the insured to the same financial position they were in before the loss—no better, no worse.

Application

Life Insurance Exception

Life insurance is a valued policy—it pays the face amount regardless of the actual "value" of the life lost. Human life cannot be objectively valued, so the amount is determined at policy issue.

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Key Takeaways

• Adhesion: Insurer writes the contract; ambiguities favor the insured
• Unilateral: Only the insurer's promise is enforceable
• Aleatory: Unequal exchange is possible (depends on chance)
• Conditional: Benefits depend on conditions being met
• Utmost good faith: Both parties must be honest; misrepresentation can void coverage
• Personal: Policy covers a specific person and cannot be transferred to cover someone else