A contract is a legally enforceable agreement between two or more parties. For a contract to be valid, several essential elements must be present. The parties entering into the agreement must be legally competent and possess the capacity to contract. The agreement must be made for a lawful purpose and entered into in good faith. In addition, there must be a mutual agreement, consisting of an offer made by one party and acceptance by another. Finally, the contract must involve consideration, which is the exchange of something of value between the parties.
Insurance policies possess several unique contractual characteristics. One of these characteristics is that insurance policies are contracts of adhesion. This means that the insurer drafts the policy and presents it to the applicant largely on a take-it-or-leave-it basis, with little opportunity for the insured to negotiate the terms. As a result, if a policy provision is ambiguous or subject to more than one reasonable interpretation, courts generally interpret the ambiguity in favor of the insured. Insurance policies are also aleatory contracts. In an aleatory contract, the value exchanged by the parties may be unequal because performance depends on the occurrence of an uncertain event. The insured pays a relatively small premium in exchange for the insurer's promise to provide benefits if a covered loss occurs. Depending on whether a loss occurs and its severity, the amount paid by the insurer may be significantly greater or less than the premium received.
Information provided by an applicant on an insurance application is generally considered a representation. A representation is a statement that the applicant believes to be true and accurate at the time it is made. Representations differ from warranties, which are statements or promises that are guaranteed to be true. A misrepresentation occurs when an applicant provides false or inaccurate information. When a representation or misrepresentation influences the insurer's decision to accept the risk, determine premium rates, or issue coverage, it is considered material. Material misrepresentations and the breach of a warranty may give the insurer the right to void the policy or deny coverage.
Insurance contracts are designed to provide financial protection when a covered accident or occurrence results in a loss. An accident is a sudden, unexpected, and unintended event, while an occurrence includes an accident as well as continuous or repeated exposure to the same generally harmful conditions that cause injury or damage over time. When multiple insurance policies apply to the same loss, the policy that responds first is known as primary insurance. Any policy that provides coverage only after the limits of the primary policy have been exhausted is known as excess insurance. When a covered loss occurs, insurance is intended to restore the insured to approximately the same financial position occupied before the loss. This concept is known as the principle of indemnity, which seeks to compensate for the loss without allowing the insured to profit from it.
To obtain insurance coverage, an individual or organization must have an insurable interest in the property, person, or exposure being insured. An insurable interest exists when the insured would suffer a financial or economic loss if a covered event were to occur. In property and casualty insurance, the insurable interest generally must exist at the time of the loss, although the insurer will typically require evidence of that interest before issuing coverage. While the insurer is completing the underwriting process and preparing the policy, it may issue a binder, which is a temporary insurance contract that provides coverage for a specified period. Once the policy is issued, evidence that insurance coverage is in force is often provided through a certificate of insurance, which summarizes the types and limits of coverage in effect on the date the certificate is issued.
Although property and casualty insurance policies vary by insurer and coverage type, most follow a similar organizational structure. Understanding the major sections of a policy helps insureds determine what is covered, what is excluded, and what responsibilities apply under the contract. The Declarations identify key information about the policy, including the named insured, the insured property or business, the location of the insured risk, the policy period, and any applicable limits of insurance and deductibles. The Insuring Agreement contains the insurer's promise to provide coverage and describes the perils, causes of loss, or events covered by the policy. The Conditions section outlines the rights, duties, and obligations of both the insured and the insurer. The Exclusions section identifies losses, perils, property, or circumstances that are not covered by the policy. Many policies also include Additional Coverages, which provide certain supplemental benefits automatically and without an additional premium. If the insured wishes to modify the policy, add coverage, change limits, or alter policy provisions, an endorsement may be attached to the policy. Endorsements amend the original contract and may increase or decrease coverage, often resulting in an adjustment to the premium.
Property and casualty insurance policies contain a number of standard conditions that govern how coverage operates and define the rights and responsibilities of both the insurer and the insured. One common provision is the Liberalization clause, which automatically extends coverage improvements to existing policyholders when the insurer broadens coverage without charging an additional premium. In such cases, the enhanced coverage applies without the need to issue an endorsement. Another important condition is Subrogation, which gives the insurer the right to recover claim payments from a third party responsible for a covered loss. After compensating the insured, the insurer may pursue reimbursement from the party whose actions caused the damage.
When more than one insurance policy provides coverage for the same loss, the Other Insurance condition determines how the insurers will share responsibility for the claim. One common method is pro rata liability, under which each insurer pays a portion of the loss based on the ratio that its policy limit bears to the total limits of all applicable insurance. Another method is contribution by equal shares. Under this approach, each insurer contributes an equal amount toward the loss until the claim is fully paid or an insurer has exhausted its policy limit. If one insurer reaches its limit, the remaining insurers continue sharing the unpaid portion of the loss according to the policy provisions.
If the insured and the insurer are unable to agree on the amount payable for a covered loss, the dispute may be resolved through arbitration. Arbitration is a formal dispute resolution process in which neutral arbitrators review the facts and evidence presented by both parties and make a determination regarding the claim.
The Duties in the Event of Loss condition outlines the responsibilities of the insured after a covered loss occurs. One of the insured's first obligations is to provide the insurer with a notice of loss, which informs the insurer that a loss has taken place. The insured may also be required to submit a sworn proof of loss within a specified time period. This document provides detailed information about the claim, including the nature and extent of the damage, supporting documentation, and an inventory of damaged, destroyed, or stolen property. In addition, the insured must take reasonable steps to protect the property from further damage and must cooperate with the insurer throughout the investigation, evaluation, and settlement of the claim.
A policy that is terminated before the end of its policy term is considered cancelled. When a cancellation occurs, the treatment of premiums depends on the type of cancellation involved. Under a flat cancellation, the policy is treated as though it never existed. No coverage is provided, and the insurer returns the entire premium paid by the insured. Under a pro rata cancellation, which typically occurs when the insurer cancels the policy, the insurer retains only the earned premium for the period during which coverage was in force and refunds the unearned premium to the insured. Under a short-rate cancellation, which typically occurs when the insured requests cancellation, the insurer retains the earned premium and also deducts a portion of the unearned premium as a cancellation charge or administrative fee.
A policy is considered nonrenewed when it is not continued for an additional policy term after reaching its expiration date. In a nonrenewal situation, coverage remains in force until the end of the current policy period but does not continue beyond that date unless a new policy is issued or the existing policy is renewed.