5.

INSURANCE CONTRACTS

Insurance Contracts

An insurance contract is a document representing the agreement between an insurance

company and the insured.

Central to any insurance contract is the insuring agreement, which specifies the risks that are
covered, the limits of the policy, and the term of the policy.

Specifications of an insurance contract

All insurance contracts specify:

1. Conditions

These are requirements of the insured, such as paying the premium or reporting a loss;

2. Limitations

These specify the limits of the policy, such as the maximum amount that the insurance
company will pay;

3. Exclusions

These specify what is not covered by the contract.

Determinants of the contents of an insurance contract

The contents of an insurance contract depends on:

1. the type of policy,

2. what the insurance applicant wants,
3. how much he is willing to pay.

Features of Insurance Contract

There are four requirements for any valid contract, including insurance contracts:

1. offer and acceptance,

2. consideration,
3. competent parties, and
4. legal purpose.

Insurance contracts have an additional requirement that they be in legal form.

Insurance contracts are regulated by the law, so insurance contracts must comply with these
requirements.

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The state may stipulate that only certain forms may be used for certain types of insurance or
that the contract must have certain provisions.

Additionally, contracts must be approved by the state insurance department before they can be
used, to ensure that they comply with regulations.

If a contract lacks any of these essential elements, then it is a void contract that will not be
enforced by any court.

For instance, most contracts signed by a minor are void contracts because they are not legally
competent.

A voidable contract is one that can be nullified by a party if the other party breaches the
contract, or because material information was omitted or false in the contract. The party with
the right to void can also choose to enforce it, instead.

For instance, insurance companies can often void a contract because the applicant provided
false information on the application.

Thus, if someone was in an auto accident, and that person previously filled out the insurance
application stating that he had no speeding tickets, when, in fact, he had, then the insurance
company can void the contract and not pay the claim.

Although most contracts can be oral, most are written, especially insurance contracts, because
of their complexity.

1. Offer and acceptance

In insurance, the offer is typically initiated by the insurance applicant through the services of
an insurance agent, who must have the authority to represent the insurance company, by filling
out an application for insurance.

Sometimes the application for insurance can be filed directly with the insurance company
through its website.

How the offer is accepted will depend on whether the insurance is for property, liability, or life
insurance.

For property and liability insurance, the offer is the application for insurance and the payment
of the 1s t  premium, or the promise to do so.

In most personal lines of insurance, the agent can, in most cases, accept the offer for the
company, binding the company to the contract.

A binder is a temporary contract that can be oral or written that binds the insurance company
to the contract immediately until it has a chance to examine the application, and issue a formal
policy. Through the binder, the insurance becomes effective immediately.

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Most binders are written and include general information, such as the type and amount of
insurance, the name of the parties, and the time during which the binder is effective. However,
once a formal policy is issued, then the terms of the policy override the binder.

This is particularly true for oral binders, for once a written policy is issued, the parole
evidence rule makes the written policy determinative where there is any conflict between the
oral and written agreement.

If a mistake was made in the policy, such as mistyping the wrong policy value, then the
contract can be reformed by correcting the mistake to prevent unjust enrichment of either
party.

However, some agents cannot bind the insurance company, in which case, the insurance
company must receive and accept the application, or it can reject it. The insurance is not
effective until the company accepts the application.

In life insurance, the agent never has the power to bind the company. In most cases, the
applicant fills out the application and pays the 1s t  premium.

The applicant is then given a conditional premium receipt — the most common type of
receipt is the insurability premium receipt.

If the applicant is insurable according to the company's underwriting standards, then the life
insurance becomes effective from the date of the application, or, in some cases, from the date
of the medical examination.

However, if the premium is not paid when the application is filled out, then the insurance will
not become effective until the policy is delivered and the premium is paid, and the applicant is
in good health when the policy is delivered.

Some companies require that the applicant not receive any medical treatment between the
application and the delivery of the policy; otherwise the policy will not become effective.

Thus, a conditional receipt is like a binder, but differs from it because coverage is conditional
upon the health of the applicant, occupation, and other factors.

A binder does not require the payment of a premium to become effective —  often the insurer
needs the time to determine what the premium will be.

Contract of adhesion 

While the insurance applicant is usually considered the one making the offer, the insurance
company dictates the terms of the contracts.

The insurance applicant must accept the contract of adhesion totally or not at all.

Because of differing legal definitions and rulings provided by different courts in the past and
because of requirements imposed by state governments and their agencies, an insurance

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contract must be carefully worded to be legally effective and to provide coverage in the way
that it was intended. This is why insurance contracts offered to the public are standardized.

Another reason is because insurance companies can only calculate competitive

premiums based on actuarial studies, and these studies are based on certain limitations and
underwriting guidelines.

Thus, most insurance contracts cannot be negotiated. However, the insured can request
specific riders and exclusions to the policy.

A rider (aka endorsement) is an amendment or addition to the basic policy that allows the

policy to be tailored in acceptable ways for individual situations.

An exclusion is a loss not covered by the contract.

Because insurance contracts are generally not negotiable, the courts have created case laws to
benefit the insured.

The first law, applicable to contracts generally, is that where there is an ambiguity in a

contract, the ambiguity is construed against the maker of the contract, which, in
insurance, is the insurance company.

Thus, if the terms of a contract are not specific, then the terms are interpreted in a way that
would most benefit the insured.

Another case law that has developed is the principle of reasonable expectations, which
requires that any exclusion or other qualification be conspicuous; otherwise, the insured is
entitled to coverage that he reasonably expects.

Life insurance and some health insurance contracts usually have entire contract clauses that
require the attachment of any statements, including the application, made by the insured to the
contract itself, to prevent any disputes later.

Entire contract clauses also prevent incorporation by reference, which is alluding to other

written works, such as the corporate bylaws, that the insurance applicant probably hasn't read.

Personal contracts

Property insurance contracts are personal contracts between the insured and the insurer.

Property insurance covers the insured for the financial losses of property damage or loss, not
the property itself. If the insured sells the property, the insurance does not transfer with it.

The insurance cannot be assigned to anyone else without the insurer's consent.

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If property and liability contracts could be freely assigned, then someone who presents a low
risk for the covered loss could buy a policy and sell it or give it to someone with a higher risk,
rendering the premium inadequate to cover the greater loss exposure.

For instance, a parent could buy automobile insurance for himself, then decide to assign the
policy to his teenage child, who generally would have to pay a higher rate, since teenagers
have a higher accident rate than other groups.

On the other hand, life insurance policies can be freely assigned, because the person insured
remains the same. Indeed, many people who have acquired a terminal illness have sold their
life insurance policies to 3r d  parties to get money to treat their illness or to provide care.

Beneficiaries can be changed, because changing beneficiaries does not change the insured risk,
so there is no consequence to the insurer if the policy owner changes the beneficiaries, but the
insurer must be notified before the change has any legal effect. This is to protect the insurance
company from paying the wrong person or from being forced to pay twice.

2. Consideration 

Consideration is the value that the parties to a contract give to each other — it is why the
contract is agreed to.

In insurance contracts, the insurer promises to pay for covered losses that the insured suffers,
and the insured promises to abide by the contract and pay the premium.

Most non-insurance contracts are bilateral contracts where the promises that each party
makes are enforceable by the other party through legal proceedings.

However, insurance contracts are unilateral contracts, where only the insurer makes a legally
enforceable promise to pay for covered losses.

The company cannot sue the insured for breach of contract. However, insurance contracts are
also conditional contracts — if the insured fails to pay the premium, or fails to abide by the
contract, then the insurer is not obligated to pay for any of the insured's losses.

Most non-insurance contracts are commutative contracts — the amount of consideration

given by both parties are usually fairly equal. Thus, a contract to purchase real estate usually
requires a payment equal to its value.

Insurance contracts are, however, aleatory contracts, because the insurance company must pay
only if certain events occur. If they don't occur, the company never has to pay, even if the
insured has paid premiums for decades.

However, if a covered loss does occur, then the insurance company may have to pay much
more than it has collected in premiums.

Thus, aleatory contracts are characterized by unequal consideration.

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3. Competent Parties

The parties to the contract must be legally competent to agree to them.

Most adults have legal capacity to agree to contracts, unless they are intoxicated, mentally ill,
or mentally retarded.

The key requirement is that the parties must know what they are agreeing to — a meeting of
the minds; otherwise, there could be no agreement.

To protect minors, the law does not give them legal capacity to agree to contracts except
where specified by law.

An insurance company has legal capacity if it is licensed to sell insurance in that particular
state, and is acting within the scope of its charter.

4. Legal Purpose

All contracts must have a legal purpose to be enforceable by the courts, and, of course, most
insurance contracts do.

Parts of an insurance contract

Insurance contracts can be divided into the following parts:

a) Declarations
b) Definitions
c) Insuring agreement
d) Exclusions
e) Conditions
f) Miscellaneous provisions

All insurance contracts do not necessarily contain all the six parts but the classifications provide
a convenient framework for insurance contracts analysis.

a) Declarations

These are statements that provide information about the property or activity to be insured.

This section (declaration) is usually found on the first page and contains information on the
identity of the insurer, name of the insured, location of property, period of protection, amount of
insurance, amount of premium e.t.c.

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In life insurance, declaration normally contains the insured’s person name, age, premium
amount, issue date and policy number.

b) Definitions

The definition define clearly the meaning of key words or phrases so that coverage under the
policy can be determined more easily.

Key words or phrases have quotation marks (“….”) or are bolded which are then defined.

c) Insuring agreements
i) Named-perils policy
ii) All-risks coverage

The insuring agreement summarizes the major promises of the insurer.

There are two basic forms of an insuring agreement in property liability insurance.

Under a named-perils policy, only those perils specifically named in the policy are covered.

Under an all-risk policy, all perils are covered except those specifically excluded.

All-risk coverage is generally preferable to named-perils coverage, because the protection is

broader. If a loss is not excluded it is then covered.

Further the burden of proof is placed on the insurer to deny claim. To deny claim the insurer
must proof that the loss is excluded. In order to avoid unreasonable expectations the term all
risks has been replaced with risk of direct loss to property.

However, this is interpreted to mean all losses are covered except those excluded. Life insurance
is an example of an all risk policy with a major exclusions being suicide.

d) Exclusions

i) Excluded losses

ii) Excluded property

An exclusion is a policy provision that eliminates coverage for some type of risk.

Exclusions narrow the scope of coverage provided by the insuring agreement.

In many insurance policies, the insuring agreement is very broad. 

Insurers utilize exclusions to carve away coverage for risks they are unwilling to insure.

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There are two major types of exclusions

A contract may also exclude certain losses in property insurance for instance, professional
liability may be excluded

A contract may exclude or place limitations on the coverage of certain property. In home owners
policy for instance, cars may be excluded.

Reasons for exclusions

i) Some perils are considered uninsurable – A given peril may substantially depart from the
requirements of an insurable risk discussed previously.
ii) Exclusions are also used because extraordinary hazards are present- a hazard is a condition
that increases the chance or severity of loss.
As such personal car and a passenger service vehicle (PSV) should not be charged similar
premiums.
iii) Exclusions are also necessary because coverage can be better be provided by other contracts.
This avoids duplication of coverage and to limit coverage to policy best designed to provide it
e.g. a car is excluded from home owner’s policy.
iv) Certain property is excluded because of moral hazard or difficulty in determining or
measuring the amount of loss.
A homeless policy may limit coverage of money to say Ksh. 15,000/= to avoid unlimited
coverage which would increase fraudulent claims.
v) Exclusions may also be used because coverage is not needed by the typical insured party. -
Most homeowners do not own planes.

To cover planes as part of homeowners’ policy would be grossly unfair to majority that does not
own planes.

e) Conditions

These are provisions in the policy that qualify or place limitations on the insurer’s duty to
perform insurance contract terms.

If these conditions are not met the insurer can refuse to pay the claim. Common policy
conditions include notifying the insurer when loss occurs, protecting the property after loss,
preparing an inventory of damaged items e.t.c.

f) Miscellaneous provisions

These include requirements if loss occurs, subrogation, cancellation e.t.c.

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PERSONAL AUTO POLICY INSURANCE

Personal automobile insurance covers private passenger vehicles. It provides protection against
economic loss to an insured from bodily injury or property damage to others (liability) arising
from the operation, maintenance, or use of a covered automobile.

Coverage may also be purchased for damage to vehicles owned by you (Collision and Other than
Collision).

Auto insurance is one of the most important insurances that a consumer must think about. It
obviously falls under the category of property insurance, and one's automobile is often the most
expensive and necessary pieces of property that one owns.

Purpose of automobile insurance

 Personal auto insurance protects the insured and his or her family when operating or riding in
the automobile and covers any injury sustained in an auto accident.

 It pays for medical expenses and for lost work.

 Auto insurance protects the insured’s financial security in case of a lawsuit that results from
loss or injuries to other parties, following an accident involving a member of the family, a
friend or a relative that had been given permission, by the insured or the insured’s spouse, to
drive the car.

Personal auto coverage

The most common policy in force now is the personal auto policy. It breaks down the insurance
protection into four areas:

1. Liability Coverage
2. Medical Payments
3. Uninsured Motorist Coverage
4. Physical Damage to an Automobile

1. Liability Coverage

The liability portion of the auto insurance contract covers damages that the insured is responsible
for, by virtue of an accident. The policy will cover:

 The named insured

 Members of his or her family
 Any person using the covered auto

Automobile liability insurance is divided into two parts:

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Bodily Injury Liability Insurance

The bodily injury liability insurance is in case the insured causes an accident in which someone
else is hurt or killed.

Property Damage Liability Insurance

The property damage liability insurance is if the insured damages someone else’s property.

Usually, of course, the damaged property is someone else’s car; but other types of property like
buildings, lampposts, garage doors, and others are covered.

If the insured causes an accident which results in the death or injury of another, monetary
damages due to medical payments, lost wages, pain and suffering and loss of consortium are
covered.

2. Medical Payments Coverage

Medical Payments Coverage pays hospital bills, doctors’ bills, funeral expenses and other related
medical cost to the insured or to family members following an auto accident.

It makes no difference if the accident was the insured’s fault or not, nor does it matter whether
the insured or the covered family members were struck while occupying a vehicle or while
walking, etc.

The policy covers:

 The insured and family members of the insured

 Injuries while occupying the covered auto, including getting into and out of
 the car
 The insured and named family members while pedestrians
 Other persons while occupying the covered automobile

3. Uninsured/Underinsured Motorists Coverage

This auto insurance protection covers the insured and his or her family members and passengers
who are injured by a variety of incidents.

Some people drive without insurance despite the laws to the contrary.

The uninsured motorist provision covers the losses from their lack of responsibility. The policy
pays an amount that the insured could have collected had the uninsured driver carried the
minimum required coverage in that state.

This contractual promise is limited to the minimum.

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This protection extends to three situations:

 An uninsured or under-insured automobile under the state laws.

 Hit-and-run accidents.
 Insured autos with insurance companies that become insolvent.

4. Physical Damage Coverage

The physical damage section of the policy insures the covered automobile for damages due to
collision or any other peril, such as theft or weather.

The policy can cover all the physical damage to the car. This is usually provided under
comprehensive coverage, which is really coverage for all risks of physical damage.

Collision is a separate coverage item that includes damage to the auto from a collision with
another car or any other object.

The comprehensive coverage then would cover losses due to:

 Fire
 Theft
 Vandalism
 Storms
 Hitting animals
 Explosions

LIFE INSURANCE POLICIES

In a life insurance policy, the most common event is the death of the person who is insured—in
which case the payment is made to the beneficiary.

Depending on the type of policy, it sometimes may be the insured person attaining a certain age,
or the owner requesting to surrender the policy for its cash value, or to take that cash value out in
the form of monthly payments for a set number of years of the insured's life.

Reasons for purchasing life policies

People purchase life insurance for many reasons.

Some of them are discussed here:

1. Family protection – To provide financial security to surviving family members upon the
death of the insured.
2. Insurance to cover a particular need – Such as paying off a mortgage or consumer debt
upon the insured’s death.

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3. Business insurance – To compensate a company on the death of a key employee or to
provide a surviving partner the resources to buy out the deceased partner’s share of the
business.
4. To provide funds – To pay estate taxes or other final obligations necessary to settle a
deceased person’s estate.

Life insurance: An Asset

A reasonable way to approach life insurance is to think of it as an asset rather than a necessary
expenditure. In fact, life insurance is akin to investment in property.

Some of the advantages of buying life insurance are listed below:

1. It is a very secure asset

2. The policy owner need not worry about closely managing it
3. It is purchasable in any affordable amount
4. It provides a reasonable rate of return
5. Proceeds are payable immediately
6. The policy owner can choose his/her method of premium payment

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