The Key Elements of an Insurance Contract

Buying insurance usually forms the backbone of anyone’s financial plan, offering some reassurance of financial stability should the “worst” happen.

Life insurance, health insurance, automobile insurance, home or renter’s insurance are all necessary facts of life for most people.

Any type of insurance is purchased by contract, where the rights and responsibilities of both the insured and the insurance company are clearly outlined. Here we will examine all of the components in an insurance contract that make it a legally binding document for both parties.

Read: Why Life Insurance Should Be Part of Your Financial Plan

Key Elements of the Contract

Offer and Acceptance

When a prospective insured goes to buy an insurance policy, they must fill out an application provided by the insurance company. If they are shopping online, they will complete a digital application. If they are working with an agent or broker, then he or she may fill this out for the customer.

The application is legally known as an offer, where the insured offers to make premium payments of a certain dollar amount in return for insurance coverage up to specific limits. Acceptance occurs when the insurance company formally issues the policy, or when the agent or broker issues a certificate of temporary coverage.

Legal Consideration

This represents the dollar value of the premiums that the insured agrees to pay and the dollar limit of the coverage that the insurer will provide in return. If the insurance company receives a claim that is covered in the policy, then the insurer will pay this claim.

Competent Parties

Insurance contracts are only valid if both parties are of sound mind and body, referred to legally as “competent parties.” The insured must be at least the legal age of majority and the insurance company must be licensed in the state in which the insured lives.

Free Consent

Both parties in any insurance contract must enter into the contract with free consent, which means it is on their own volition. There cannot be any fraud, misrepresentation, intimidation or coercion involved when the contract is signed. The contract also cannot be signed as a result of an error.

Read: 25 Key Personal Insurance Terms You Should Know and Understand

Legal Purpose

All insurance contracts are required to obey the laws of the land. They must adhere to all state-specific laws that apply to the contract and cover only legal activities. A business that deals in criminal activity would not be covered according to the tenant of legal purpose. Any agreement that is made outside of those laws is null and void.

Insurable Interest

The insured has an insurable interest when they benefit financially from the person or thing being insured. The insured will then experience a financial loss if the item or person being insured either dies or is damaged or lost. Prospective insureds cannot get coverage on something in which they have no insurance interest.

Utmost Good Faith

This phrase “utmost good faith” means that both parties in any insurance contract have acted without any type of deception, omission or other form of misrepresentation and that all pertinent facts have been disclosed by both parties.

Material Facts

Material facts are the factors that affect the risk that is being taken. They consist of the factors that the insurance company needs to know about in order to decide whether to insure the risk or reject it. If an insured applies for life insurance, then the insurer will need to know all about the insured:’

• Age.
• Height.
• Weight.
• Health.
• Occupation.

For car insurance, the insurer needs to know:

• The insured’s age.
• Driving record.
• the kind of car that is being insured.

Full and True Disclosure

This means that both parties are required to completely disclose all material facts pertinent to the insurance policy. There can be no omissions, misrepresentations or twisting of the facts when filling out the application or providing the policy.

Duty of Both the Parties

Both the insured and the insurer have a legal obligation, or duty to disclose all material facts accurately and correctly. The insured does this when they fill out the application, and the insurance company does this by adhering to all of the laws and rules that apply to it.

Principle of Indemnity

The principle of indemnity applies to most types of insurance policies. It means that the insurance company will compensate the insured with a cash settlement if a covered loss occurs. The idea is that the insured will be in the same position financially that they were in before the loss occurred.

Conversely, the insured cannot receive greater compensation than the amount of the loss. The insurance company is only required to cover the actual monetary value of the loss and no more.

Doctrine of Subrogation

Subrogation allows the insurer to pursue reimbursement from a third party that caused the covered insurance loss. For example, if another driver crashes into the insured’s car and totals it, then the insured’s insurance company will repay the insured for the loss and then pursue reimbursement from the other driver’s insurance company.

Warranties

Warranties are all of the respective promises that are laid out in the insurance contract. They delineate the specific conditions that can trigger a claim and also outline the actions that will be taken by the insurance company as a result of the claim.

Conditions

Conditions are the elements that determine whether a claim will be paid out. Paying the policy premiums is the most obvious condition that must be met. But many other conditions can also apply to an insurance policy. Most insurance policies have geographic limits for their coverage in addition to the specific circumstances detailing what the insured must do in order to be paid. Failing to meet these conditions relieves the insurer of the burden of paying the claim.

If the insured fails to notify the insurer of a loss or refuses to provide the requested information to the insurance company (such as a medical exam or property inventory) then the insured has breached the contract and will not be reimbursed for the loss.

Read: Your Complete Guide to Home Inventories

Limitations

Limitations outline the parameters of the insurance coverage being provided. They list the maximum amounts that will be paid for a given type of loss along with any conditions that would allow the insurance company to pay less or require it to pay more (i.e. a life insurance policy may be required to pay out twice the amount of the death benefit if the insured dies in a car crash).

Exclusions

Exclusions are exceptions to the conditions under which the insurance company will pay a claim. For example, a death caused by war or natural disaster is usually excluded by most life insurance companies.

Proximate Cause

Proximate cause refers to the actual manner in which a loss was sustained. The insurance company needs to know why a loss occurred so that it can determine whether the cause was an insured peril.

For example, if the belongings in an insured’s house were destroyed due to a flood, (the proximate cause) then the homeowner’s insurance company would not pay out for damages unless they were insured for flood loss under the policy, had added a flood rider or bought a separate policy covering floods.

Return of Premium

In the event that you overfund or overpay your insurance premiums, then the return of premium clause will guarantee the return of any excess premiums paid, or else credit the excess to the next insurance period.

Declarations Page

The declarations page is generally the first page or two of your policy. It is basically a snapshot of your coverage, and you can find the answers to most of your basic coverage questions in it. The information includes the name of the insured, the type of coverage provided, basic coverage limits and applicable sublimits, deductible amounts, and the policy period (see An Intro to Insurance Sublimits to learn more about them and how you can fill these gaps in your coverage).

If your policy covers property, such as your home or vehicle, then it will also be listed on the declarations page alongside the property value and any necessary identifying information, such as a vehicle’s VIN number. As for health insurance policies, this section might be called a summary of benefits and will include information about your premiums, maximum benefit limits, deductibles, copay, and coinsurance (to find out how these work, see All the Ways You Pay: Premiums, Deductibles, Co-pays, and Coinsurance).

Schedules

Occasionally, you may need a policy that covers multiple items. If you cover several vehicles or multiple pieces of property under the same policy, the declarations page may not offer sufficient space to list them all. In this case, your insurance provider will attach a schedule listing all your covered property and applicable limits for each item.

You will typically find schedules just after the declarations page. If you need to verify coverage of a certain item and don’t see it listed in the declarations, look through your policy in case the property schedule has been inserted elsewhere.

Insuring Agreement

The insuring agreement is also found near the front of your policy. It simply outlines the basics of the insurance contract and the responsibilities of both you and your insurance company. The primary responsibility of the insurance company is to pay claims on your behalf for losses suffered due to covered perils and defend you in the case of lawsuit (see Insurance and Lawsuits to find out what happens when you are sued). Your chief responsibility is to pay the agreed premium and truthfully report losses in a timely manner.

In a property policy, the insuring agreement also indicates the type of policy you have, either all-risk or named perils. Named perils policies only provide coverage for losses brought about by causes specifically listed in the policy document. Conversely, all-risks policies provide coverage for all causes of loss, except those specifically excluded in the policy.

Policy Coverage

While the declarations page provides a snapshot of your limits and covered property, the policy coverage section provides a much more detailed explanation of how and when your coverage applies. It outlines the type of coverage provided and how deductibles, limits and sublimits apply to covered losses. If you have a question about your policy that looking at the declarations page cannot answer, the policy coverage section should be your next stop.

In a named perils policy, each covered peril is outlined specifically. In an all-risks policy, the policy coverage section includes boilerplate wording outlining applicable coverage for “any covered loss.” Perils not covered by an all-risks policy are specified in the following section.

In health insurance policies, this section lists your covered services and the applicable in and out-of-network costs. It may also include specific limitations or requirements for coverage to apply, such as obtaining a referral from an approved provider before seeking specialist care.

Exclusions

Most policies have exclusions, though they differ by coverage type, the state in which the policy was issued, and the insurance company that issued it.

For homeowner’s policies, the most common exclusions are war, earthquake, acts of terrorism, water damage, and neglect (to learn more about water damage exclusions, see 5 Water Damage Home Insurance Scenarios: Are You Covered?).

Auto policies often contain exclusions limiting coverage for vehicles not listed on the policy; damage intended by the insured; or vehicles used for commercial purposes, such as delivery services. In many cases, you may elect to pay an additional premium to have certain exclusions removed.

Health insurance policies may include exclusions or limitations regarding pre-existing conditions or claims that arise due unapproved medical costs. Common exclusions include services provided in relation to the commission of a felony and experimental treatments.

If you have questions about a specific cause of loss, check your policy’s exclusions to make sure your coverage isn’t limited.

Conditions

In addition the insuring agreement, most policies also contain a section that outlines specific conditions that the insured must meet for claims to be paid. Common ones include timely reporting of claims, submitting official proof of loss forms, and cooperating with the company’s investigation of your claim. For example, property and auto policies generally also require that the insured take any necessary and practical steps to ensure no additional damage is done to covered property after a loss.

Endorsements

There are a number of life events that can cause your insurance needs to change. If you need to alter your existing coverage prior to the policy’s expiration, your insurance company will issue an endorsement amending your policy. If you make many changes in a single year, the policy you have at the end of your policy term may only bear a passing resemblance to the one you originally purchased.

Common endorsements include adding or deleting vehicles or property from a policy, removing certain exclusions, and increasing or decreasing policy limits. Most endorsements will affect your premium, either increasing it for an increase in coverage or reducing it for a decrease in a coverage reduction. Any premium change will be pro-rated based on the remaining days in the policy period.

If you spot an error in your policy regarding covered property, services, or causes of loss, read through this section before contacting your insurer. It may be that an endorsement has amended the error.

Glossary

As you review your policy documentation, you may notice several terms printed in bold. These terms are likely defined in a glossary included in your policy. Some portions of your contract might feel like a dense forest of insurance jargon. The glossary is a great resource if you ever feel lost while reading one of those passages.

Conclusion

Insurance contracts are complex legal documents that have been created by attorneys. They are used to establish an agreement between an insured and the insurance company and ensure that both parties act in an honest and fair manner.

We’ve laid out the basics for you here, but insurance contracts are often complicated for the average person to decipher. Consult your financial advisor or insurance agent for more information on insurance contracts and how they can affect you.