Offer and Acceptance

A contract (agreement) involves a meeting of the minds.
To be legally enforceable, a contract must be made with a definite,
unqualified proposal (offer) by one party and the acceptance of
its exact terms by the other. In many cases, the offer of an insurance
contract is made by the applicant when the application is submitted
with the initial premium. The insurance company accepts the offer
when it issues the policy as applied for.When an offer is answered
by a counteroffer, the first offer is void.

Consideration

For a contract to be enforceable, the promise or promises it contains must be supported by consideration.
Consideration can be defined as the value given in exchange for the promises sought. In an insurance contract,
consideration is given by the applicant in exchange for the insurer's promise to pay benefits. It also consists of the
application and the initial premium. This is why the offer and acceptance of an insurance contract are not complete
until the insurer receives the application and the first premium. The Consideration clause also contains information
such as the schedule and amount of premium payments.

Legal Purpose

To be legal, a contract must have a legal purpose. This means that the object of the contract and the reason the
parties enter into the agreement must be legal. A contract in which one party agrees to commit murder for money
would be unenforceable in court because the object or purpose of the contract is not legal. Insurance contracts are
always considered to possess a legal purpose.

Competent Parties

To be enforceable, a contract must be entered into by competent parties. With a contract of insurance, the parties
to the contract are the applicant and the insurer. The insurer is considered competent if it has been licensed or
authorized by the state(s) in which it conducts business. The applicant, unless proven otherwise, is presumed to
be competent with three possible exceptions:

► Minors
► The mentally infirm
► Those under the influence of alcohol or narcotics

Each state has its own laws governing the legality of minors and the mentally infirm entering into contracts of insurance.
These laws are based on the principle that some parties are not capable of understanding the contract they agree to.

The elements just discussed must be contained in every contract for it to be enforceable by law. In addition to these,
insurance contracts have distinguishing characteristics that set them apart from many other legally binding
agreements. Some of these characteristics are unique to insurance contracts. Let's review these distinctions.

Aleatory

Insurance contracts are aleatory. This means there is an element of chance and potential for unequal exchange of
value or consideration for both parties. An aleatory contract is conditioned upon the occurrence of an event.
Consequently, the benefits provided by an insurance policy may or may not exceed the premiums paid. For
example, an individual who has a disability insurance policy will collect benefits if she becomes disabled. However,
if no disability strikes, benefits are not paid. Both insurance and gambling contracts are typically considered aleatory contracts.

Adhesion

Insurance contracts are contracts of adhesion. This means that the contract has been prepared by one party (the
insurance company) with no negotiation between the applicant and insurer. In effect, the applicant "adheres" to the
terms of the contract on a "take it or leave it" basis when accepted. Any confusing language in a contract of
adhesion would be interpreted in favor of the insured. The purpose is to correct any advantage that may result for
the party who prepared the contract. A policy of adhesion can also be described as one which the
insurance company can modify.

Unilateral

Insurance contracts are unilateral. This means that only one party (the insurer) makes any kind of enforceable
promise. Insurers promise to pay benefits upon the occurrence of a specific event, such as death or disability. The
applicant makes no such promise. In fact, the applicant does not even promise to pay premiums. The insurer cannot
require the premiums to be paid. Of course, the insurer has the right to cancel the contract if premiums are not paid.

Personal Contract

Life insurance is a personal contract or personal agreement between the insurer and the insured. The owner of
the policy has no bearing on the risk the insurer has assumed. For this reason, people who buy life insurance policies
are called policyowners rather than policyholders. Policyowners actually own their policies and can give them away
if they wish. This transfer of ownership is known as assignment. To assign a policy, a policyowner simply notifies the
insurer in writing. The company will then accept the validity of the transfer without question. The new owner is
granted all of the rights of policy ownership.

Conditional

An insurance contract is conditional. This means that the insurer's promise to pay benefits depends on the occurrence
of an event covered by the contract. If the event does not materialize, no benefits are paid. Furthermore, the insurer's
obligations under the contract are conditioned on the performance of certain acts by the insured or the beneficiary.
For example, the timely payment of premiums is a condition for keeping the contract in force. If premiums are not
paid, the company is relieved of its obligation to pay a death benefit.

Valued or Indemnity

An insurance contract is either a valued contract or an indemnity contract. A valued contract pays a stated sum
regardless of the actual loss incurred. Life insurance contracts are valued contracts. If an individual acquires a life
insurance policy insuring her life for $500,000, that is the amount payable at death. There is no attempt to value
actual financial loss upon a person’s death.

An indemnity contract, however, is one that pays an amount equal to the loss. Contracts of indemnity attempt to
return the insured to their original financial position. Fire and health insurance policies are examples of indemnity
contracts. An insured that owns a $50,000 fire insurance policy and suffers a $5,000 loss due to fire will be able to
collect up to $5,000, not $50,000.

Utmost Good Faith

Insurance is a contract of utmost good faith. This means both the policyowner and the insurer must know all material
facts and relevant information. There can be no attempt by either party to conceal, disguise, or deceive. A consumer
purchases a policy based largely on the insurer and agent’s explanation of the policy’s features, benefits,
and advantages. Insurance applicants are required to make a full, fair and honest disclosure of the risk to the
agent and insurer. Concepts related to utmost good faith include warranties, representations, and concealment.
These represent grounds through which an insurer might seek to avoid payment under a contract.

Warranty

A warranty in insurance is a statement made by the applicant that is guaranteed to be true in every respect. It
becomes part of the contract and, if found to be untrue, can be grounds for revoking the contract. Warranties are
presumed to be material because they affect the insurer's decision to accept or reject an applicant.

Representation

A representation is a statement made by the applicant that they consider to be true and accurate to
the best of the applicant's belief. It is used by the insurer to evaluate whether or not to issue a policy. Unlike
warranties, representations are not a part of the contract and need be true only to the extent that they are material
and related to the risk. Statements made by applicants for insurance are considered to be representations and not
warranties. A false statement made by an applicant that would influence an insurer in determining whether or
not to accept the risk is considered a material misrepresentation.

Concealment

The issue of concealment is also important to insurance contracts. Concealment is defined as the failure by the
applicant to disclose a known material fact when applying for insurance. If the purpose for concealing information is
to defraud the insurer (that is, to obtain a policy that might not otherwise be issued if the information were revealed),
the insurer may have grounds for voiding the policy. Again, the insurer must prove concealment and materiality.

In most cases, life insurers have only a limited period of time to uncover false warranties, misrepresentations, or
concealment. After that time period passes (normally two years from policy issue), the contract cannot be voided
or revoked for these reasons.

Insurable Interest

Another element of a valid insurance contract is insurable interest. Insurable interest is a component of legal purpose. This means that the person acquiring the contract (the applicant) must be subject to loss upon the death, illness, or disability of the person being insured. To have "an insurable interest" in the life of another person, an individual must have a reasonable expectation of benefiting from the other person's continued life. A policy obtained by a person not having an insurable interest in the insured is not valid and cannot be enforced. Thus, insurable interest must exist between the applicant and the individual being insured. When the applicant is the same as the person to be insured, there is no question that insurable interest exists. Individuals are presumed to have insurable interest in themselves.

It is important to note that insurable interest must only exist at the time of the application of a life or health insurance
contract. It doesn't have to continue throughout the duration of the policy nor does it have to exist at the time of claim.

Stranger-Originated Life Insurance (STOLl)

Stranger-Originated Life Insurance (STOLI) transactions are life insurance arrangements where investors persuade individuals (typically seniors) to take out new life insurance, naming the investors as beneficiary. This is sometimes
called Investor-Originated Life Insurance (IOLI). These arrangements are used to circumvent state insurable interest statutes.

Generally, the investors loan money to the insured to pay the premiums for a defined period (usually two years
based on the life insurance policy's contestability period).

Eventually the insured assigns ownership to the investors, who receive the death benefit when the insured dies. In
return, the seniors receive financial incentives. This normally includes: an upfront payment, a loan, or a small
continuing interest in the policy’s death benefit. After the two year period, the investors make the premium
payments on behalf of the insured.

Contracts of insurance are binding and enforceable. As such, all
parties to the contract (the insurer and the applicant) are subject to
specific legal requirements. We discussed some of the more important
regulations that states impose on people who solicit and sell insurance.

Next, we will focus on the legal aspects of negotiating and issuing
contracts of insurance.

The Law of Agency

As noted earlier, an agent is an individual who is authorized by an insurer to sell its goods and services on its behalf.
An agent’s role involves the following duties:

► Describing the company’s insurance policies to prospective buyers and explaining the conditions under
which the policies may be obtained
► Soliciting applications for insurance
► Collecting premiums from policyowners
► Rendering service to prospects and to those who have purchased policies from the company

The authority of an agent to undertake these functions is clearly defined in a "contract of agency" (or agency
agreement) between the agent and the company. Within the authority granted, the agent is considered to be the
insurance company. The relationship between an agent and the company represented is governed by agency law.

Principles of Agency Law

By legal definition, an agent is a person who acts for another person or entity (known as the principal) with regard
to contractual arrangements with third parties. An authorized agent has the power to bind the principal to contracts
(and to the rights and responsibilities of those contracts). With this in mind, we can review the main principles of
agency law:

► The acts of the agent (within the scope of his authority) are the acts of the principal
► A contract completed by an agent on behalf of the principal is a contract of the principal
► Payments made to an agent on behalf of the principal are payments to the principal
► Knowledge of the agent regarding business of the principal is presumed to be knowledge of the principal

Agent Authority

Agent authority is another important concept of agency law. Authority is what’s given by an insurer to a licensee to
transact insurance on their behalf. Technically, only those actions for which an agent is actually authorized can bind
a principal. In reality, an agent's authority can be quite broad. There are three types of agent authority: express,
implied, and apparent.

Let's take a look at each.

1. Express authority. Express authority is the authority a principal deliberately gives to its agent. Express
authority is granted by means of the agent’s contract, which is the principal’s appointment of the agent to act on its
behalf. For example, an agent has the express authority to solicit applications for insurance on behalf of the company.

2. Implied authority. Implied authority is the unwritten authority that is not expressly granted, but which the
agent is assumed to have in order to transact the business of the principal. Implied authority is incidental to
express authority because not every single detail of an agent's authority can be spelled out in the agent’s contract.
For example, an agent's contract may not specifically state that he can print business cards that contain the
company's name, but the authority to do so is implied.

3. Apparent authority. Apparent authority is the appearance or assumption of authority based on the actions,
words, or deeds of the principal. It can also exist because of circumstances the principal created. For example, by
providing an individual with a rate book, application forms, and sales literature, a company creates the impression
that an agency relationship exists between itself and the individual. The company will not later be allowed to deny
that such a relationship existed.

► The significance of authority (whether express, implied, or apparent) is that it ties the company to the acts and
deeds of its agents. The law will view the agent and the company as one and the same when the agent acts within
the scope of his authority.

► An insurer may be liable to an insured for unauthorized acts of its agent when the agency contract is unclear about the authority granted.

Agent as a Fiduciary

Fiduciary is another legal concept which governs the activity of an agent. A fiduciary is a person who holds a
position of financial trust and confidence. Agents act in a fiduciary capacity when they accept premiums on behalf
of the insurer or offer advice that affects a person’s financial security.

Brokers versus Agents

Unlike agents, brokers legally represent the insureds. A broker (or independent agent) may represent a number of
insurance companies under separate contractual agreements. A broker solicits and accepts applications for
insurance and then places the coverage with an insurer.

Professional Liability Insurance (E&O)

Just as doctors should have malpractice insurance to protect against legal liability arising from their professional
services, insurance agents need errors and omissions (E&O) professional liability insurance. Under this insurance,
the insurer agrees to pay sums that the agent legally is obligated to pay for injuries resulting from professional
services that he rendered or failed to render.

In addition to the principles of contract and agency law, there are other legal concepts that apply to insurance and
the power of agents. These include waiver, estoppel, parol evidence rule, void vs voidable contracts, and fraud.

Waiver

A waiver is the voluntary giving up of a legal, given right. If an insurer fails to enforce (waives) a provision of a
contract, it cannot later deny a claim based on a violation of that provision.

Endorsement

An endorsement is a written form attached to an insurance policy that alters the policy's coverage, terms, or conditions. Sometimes called a rider.

Estoppel

The concepts of waiver and estoppel are closely related. Estoppel is the legal impediment to one party denying the
consequences of its own actions or deeds if such actions or deeds result in another party acting in a specific manner
or if certain conclusions are drawn. In other words, it is the loss of defense.

Parol Evidence Rule

Parol evidence is oral or verbal evidence, or that which is given verbally in a court of law. The parol evidence rule
states that when parties put their agreement in writing, all previous verbal statements come together in that writing
and a written contract cannot be changed or modified by parol (oral) evidence.

Reasonable expectations

"Reasonable expectations" is a legal principle that reinforces the rule that ambiguities in insurance contracts should be interpreted in favor of the policyholder. It also states that an insured is entitled to coverage under a policy that a sensible and prudent person would expect it to provide.

Void versus Voidable Contracts

The terms void and voidable are often incorrectly used interchangeably. A void contract is simply an agreement
without legal effect. In essence, it is not a contract at all, for it lacks one of the elements specified by law for a valid
contract. A void contract cannot be enforced by either party. For example, a contract having an illegal purpose is
void, and neither party to the contract can enforce it. An insurer may also void an insurance policy if a
misrepresentation on the application is proven to be material.

A voidable contract is an agreement which, for a reason satisfactory to the court, may be set aside by one of the
parties to the contract. It is binding unless the party with the right to reject it wishes to do so. Say that a situation
develops under which the policyholder has failed to comply with a condition of the contract: the policyholder ceased
paying the premium. The contract is then voidable, and the insurance company has the right to cancel the contract
and revoke the coverage.

Forms

The insurance carrier is responsible for assembling the policy forms for the insured person(s).

Fraud

In the event of fraud, insurance contracts are unique in that they run counter to a basic rule of contract law. Under
most contracts, fraud can be a reason to void a contract. With life insurance contracts, an insurer has only a limited
period of time (usually two years from date of issue) to challenge the validity of a contract. After that period, the
insurer cannot contest the policy or deny benefits based on material misrepresentations, concealment, or fraud.