Contractual Elements of Insurance

Insurance policies are contracts and as such, are governed by the many elements of contract law. While this blog will certainly not prepare you for the bar exam, it hopes to provide some understanding of the legal aspects of insurance policies. 

One element of a valid insurance contract is known as Insurable interest. Insurable interest requires that somebody must potentially suffer a financial or economic hardship in the event of a loss due to an accident, sickness or death of the insured person. This insurable interest must exist between the person buying the policy and the person being insured by the contract. Obviously, a spouse has an insurable interest in the life or health of their mate. Each person also has an unlimited insurable interest in their own life. However, it’s easy to see that problems might arise if insurance contracts could be written involving two strangers. You might be very good friends with your neighbor up the street, but unless he/she is your business partner, an insurable interest most likely does not exit between the two of you. With this being the case, a life or health insurer would probably decline to offer a policy in such a situation.

The principle of indemnity is also an important element of insurance. To indemnify means to compensate for a loss, or to make one whole again. Based on this principle, insurance is designed to restore an insured to the same physical or financial condition that existed prior to the loss, without profit or gain. Insurers are usually reluctant to underwrite a situation where somebody profits from the misfortunes of the insured party.

In order to be an enforceable contract, there are also four essential factors that must be present. The parties entering the contract must be competent so minors, mentally incompetent individuals, and those under the influence of drugs or alcohol are unable to form a binding contract. Likewise, insurance cannot be issued for an illegal activity. Intentional, illegal acts such as arson or murder are good examples of this requirement. There must be an offer (usually accomplished by the purchaser submitting an application) and an acceptance (usually taking the form of an approved application). Finally, the contract is considered binding when consideration is exchanged. The insured’s consideration is the payment of the premium, while the insurance company complies via its promise to indemnify in the event of a loss.

If you would like to learn more about these and other wise financial planning moves, please contact us through our Level 5 Financial LLC website or via phone at 719-323-1240.  This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice.  You should consult your own tax, legal and accounting advisors before engaging in any transaction.

Certified Financial Planner