Legal Consideration

What Does Legal Consideration Mean?

Legal consideration refers to the exchange of something of value between parties in a legally binding contract. Typically, this involves money or currency exchanged for goods or services. For any contract to be valid, it must include consideration.

In the context of insurance, legal consideration includes the premiums paid by the insured, funds paid to a third party, and protection against lawsuits. The exchange of premiums represents a promise of indemnity, while the third party relinquishes the right to sue the insured. Thus, for the contract to be binding, each party must provide value to the agreement.

Even if a contract includes legal consideration and has been executed, certain factors can void it. For instance, a contract signed by a minor lacks legal consideration since minors cannot legally enter into contractual agreements. Similarly, contracts created for illegal purposes are deemed invalid.

The specific legal considerations in insurance contracts can vary. It is the responsibility of both the policyholder and the insurer to agree on the terms that best suit their needs.

Insuranceopedia Explains Legal Consideration

In the insurance industry, an insurance policy serves as evidence of a contract between the insured and the insurer. When a client submits an application and the insurer accepts it, five basic requirements for a legal contract must be met. Legal consideration is one of these key requirements, as illustrated in the following example:

Jan and John are taking out a mortgage to purchase a home, and the bank requires them to have fire insurance on the property. They submit an application to Fire Lines Insurance Ltd., agents of Fire Insurance Company Limited, the local insurance provider. This submission constitutes an offer to purchase insurance from Fire Insurance Company Limited.

In their application, Jan and John disclose all material facts about the property, enabling the underwriters to properly assess the risk. The insurance company can choose to accept the application, reject it, or accept it with certain conditions. After reviewing the application, the underwriters determine the risk is acceptable and agree to insure the property. This results in an agreement between the parties to create an insurance contract.

As part of the agreement, Jan and John are required to pay a premium—this represents their legal consideration. In return, the insurance company promises to indemnify them for damages specified in the policy—this represents the insurer’s legal consideration. With these exchanges, the requirement of legal consideration is fulfilled, and a policy is issued.