Contract law In general, an insurance contract must meet four conditions in order to be legally valid: it must be for a legal purpose; the parties must have a legal capacity to contract; there must be evidence of a meeting of minds between the insurer and the insured; and there must be a payment or consideration.
To meet the requirement of legal purpose, the insurance contract must be supported by an insurable interest (see further discussion below); it may not be issued in such a way as to encourage illegal ventures (as with marine insurance placed on a ship used to carry contraband).
The requirement of capacity to contract usually means that the individual obtaining insurance must be of a minimum age and must be legally competent; the contract will not hold if the insured is found to be insane or intoxicated or if the insured is a corporation operating outside the scope of its authority as defined in its charter, bylaws, or articles of incorporation.
The requirement of meeting of minds is met when a valid offer is made by one party and accepted by another. The offer is generally made on a written application for insurance. In the field of property and liability insurance, the agent generally has the right to accept the insured’s offer for coverage and bind the contract immediately. In the field of life insurance, the agent generally does not have this power, and the contract is not valid until the home office of the insurer has examined the application and has returned it to the insured through the agent.
The payment or consideration is generally made up of two parts—the premiums and the promise to adhere to all conditions stated in the contract. These may include, for example, a warranty that the insured will take certain loss-prevention measures in the care and preservation of the covered property.
Warranties In applying for insurance, the applicant makes certain representations or warranties. If the applicant makes a false representation, the insurer has the option of voiding the contract. Concealment of vital information may be considered misrepresentation. In general, the misrepresentation or concealment must concern a material fact—defined as a fact that would, if it were known, cause the insurer to change the terms of the contract or be unwilling to issue it in the first place. If the agent of the insurer asks the applicant a question the answer to which is a matter of opinion and if the answer turns out to be wrong, the insurer must demonstrate bad faith or fraudulent intent in order to void the contract. If, for example, in answer to an agent’s question, the applicant reports no history of serious illness, in the mistaken belief that a past illness was minor, the court may find the statement to be an honest opinion and not a misrepresented fact.
A basic principle of property liability insurance contracts is the principle of subrogation, under which the insurer may be entitled to recovery from liable third parties. In fire insurance, for example, if a neighbour carelessly sets fire to the insured’s house and the insurance company indemnifies the insured for the loss, the company may then bring a legal action in the name of the insured to recover the loss from the negligent neighbour. The principle of subrogation is complemented by another basic principle of insurance contract law, the principle of indemnity. Under the principle of indemnity a person may recover no more than the actual cash loss; one may not, for example, recover in full from two separate policies if the total amount exceeds the true value of the property insured.
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