The Insurance Contract

An insurance policy is a legal contract. Understanding contract law basics is essential for the P&C exam.

Four Elements of a Valid Contract

ALL contracts, including insurance policies, must have these four elements:

1. Offer and Acceptance

There must be an agreement between the parties.

In Insurance:

• Offer: The completed application for insurance
• Acceptance: The insurer's underwriting approval and policy issuance

The applicant offers to buy insurance; the insurer can accept or reject the offer.

2. Consideration

Definition: Something of value exchanged between the parties.

Both parties must give something up — the insured gives money, the insurer gives a promise.

3. Competent Parties

Both parties must have legal capacity to enter a contract.

Parties who are NOT competent:

• Minors (under 18)
• Persons under influence of alcohol or drugs
• Mentally incompetent individuals

4. Legal Purpose

The contract must be for a lawful purpose, not against public policy.

Requirements:

• Must be supported by insurable interest
• Cannot encourage illegal ventures
• Cannot be a wagering contract

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Five Unique Characteristics of Insurance Contracts

Insurance policies have special characteristics that distinguish them from other contracts:

1. Contract of Adhesion

Definition: One party prepares the contract; the other party can only "take it or leave it."

In Insurance:

• The insurer writes the policy
• The applicant cannot negotiate or modify terms
• It's "adhesion" because the applicant adheres to existing terms

Legal Consequence: Courts interpret any ambiguity in favor of the insured because the insured had no bargaining power over the wording.

2. Aleatory Contract

Definition: One party may receive significantly more value than they give.

In Insurance:

• Insured pays $1,000 in premiums
• House burns down
• Insurer pays $300,000 claim

This unequal exchange is the essence of insurance — unlike most contracts where equal value is exchanged.

Contrast: Most contracts are "commutative" — parties exchange roughly equal value.

3. Unilateral Contract

Definition: Only ONE party makes a legally enforceable promise.

In Insurance:

• Insurer promises to pay claims if covered events occur
• Insured does NOT promise to pay premiums (can cancel anytime)

The insurer cannot sue the insured for failing to pay future premiums — they can only cancel the policy for non-payment.

4. Conditional Contract

Definition: The insurer's duty to pay depends on conditions being met.

Two Main Conditions:

1. A covered loss must occur
2. The insured must comply with policy conditions (pay premium, report claims timely, cooperate with investigation)

5. Personal Contract

Definition: The contract is between the insurer and the specific insured person.

Implications:

• Cannot be transferred without insurer consent
• Coverage follows the person, not necessarily the property
• Assignment of policy benefits requires insurer approval

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Contract Characteristics Summary