Legal Aspects of Insurance

Question 1

Contract

Answer 1

A contract is a legally binding agreement creating rights and duties for those who are parties to it. If one party to the contract fails to perform its duties without a legal excuse, the contract is breached. If a contract is breached or if disputes arise between the parties about the interpretation of the contract, the issues may be settled by a court. Courts can enforce their judgments and settle contractual disputes using a variety of remedies.

Question 2

Voidable Contract

Answer 2

A voidable contract allows one party the option of breaking the agreement because of an act or omission of an act (a breach) by the other party. The party with the right to void the contract may instead choose to have the contract enforced.

Question 3

Void Contract

Answer 3

A void contract is a contract that a court will not enforce because from its beginning it lacked one or more features of a valid contract.

Question 4

Binder

Answer 4

A binder is a temporary contract in property insurance, and is often used before the issuance of the formal insurance policy. The binder must meet all the requirements for a legal contract. It is distinguished by its temporary nature (often 30 days or less).

Question 5

Conditional Receipt

Answer 5

A conditional receipt can provide temporary coverage, contingent on an applicant’s ability to present evidence of insurability.

Question 6

Four Elements of a Valid Contract

Answer 6

Offer and acceptance

Consideration

Capacity

Legal purpose

Question 7

Consideration

Answer 7

The value exchanged between the parties to the contract is the consideration. The consideration is what each party gives to the other. Consideration may take a tangible form, such as money, or it may take the form of a promise to do or not to do a particular activity. There must be an exchange of consideration to have a valid contract.

Question 8

Unilateral Contracts

Answer 8

In unilateral contracts, only one party makes an enforceable promise. Insurance contracts are unilateral in that only the insurer makes a binding promise. The insured can cancel the policy at any time without recourse, while the insurer is limited to specific situations (such as failure of the insured to pay premiums) when it may cancel a policy. The insured does not promise to pay the premiums and cannot be sued for failure to do so. Insureds cannot collect for losses if they do not pay premiums, because timely payment of the premium is a condition of the contract.

Question 9

Bilateral Contracts

Answer 9

Contracts in which both parties make enforceable promises are called bilateral contracts. Insurance is not considered a bilateral contract.

Question 10

Legal Purpose

Answer 10

A contract must have a legal purpose, an end or intention permitted by law. Contracts having an antisocial purpose are legally unenforceable. No court will aid the parties to such a contract. An insurance policy purchased as a gamble on a famous person’s life or on any life in which the contract owner has no legal interest is an example of an unenforceable contract. If a beneficiary attempted to collect proceeds from contracts where an insurable interest was lacking, a court would hold the contract void.

Question 11

Indemnity

Answer 11

Indemnity means the insured should be restored to the same financial position occupied before the insured’s loss.

Question 12

Three exceptions to the rule that insurance contracts are contracts of indemnity are:

Answer 12

Life insurance

Replacement-cost insurance

Valued insurance.

Question 13

Replacement Cost Insurance

Answer 13

Replacement-Cost Insurance is written when the insurer promises to pay an amount equal to the full cost of repairing or replacing the property without deduction for depreciation.

Question 14

Valued Insurance Policy

Answer 14

A valued insurance policy is an exception to the rule of indemnity. Valued policies pay the limit of liability whenever an insured total loss occurs. The value of the insured property is agreed to before the policy is written. If a total loss occurs, it may cause more or less damage than the stated amount. Nevertheless, the stated amount will be paid.

Question 15

Actual Cash Value

Answer 15

Actual Cash Value (ACV) means replacement cost at the time of loss, less depreciation.

Question 16

Actual Cash Value Formula

Answer 16

Replacement Cost - Depreciation = Actual Cash Value (ACV)

Question 17

Functional Replacement

Answer 17

Sometimes insurers do not use an actual cash value provision in their policies. In cases where the replacement cost of a building is greater than its market value, as is often the case with older, inner-city structures, insurers provide coverage based on replacement cost with modern construction techniques. Insurers call this provision functional replacement.

Question 18

Subrogation

Answer 18

Subrogation is the legal substitution of one person in another’s place. Subrogation is supported by the theory that if a person must pay a debt for which another is liable, such payment should give the person a right to collect the debt from the liable party.

Question 19

Discharge of Contracts

Answer 19

Performance

Condition precedent

Condition subsequent

Rescission

Reformed

Question 20

Condition Precedent

Answer 20

A condition precedent is something that must be done by one party to activate the other party’s duty to perform. For example, policyholders must continue to pay premiums in order to keep the policy in force.

Question 21

Condition Subsequent

Answer 21

A condition subsequent ends an existing duty of immediate performance.

Question 22

Recision

Answer 22

Insurance contracts also may be ended by rescission. Rescission is an agreement (contract) by both parties to end a contract.