Life insurance principles

Principles of Life Insurance

An insurance policy is a legal contract between the insurance company and the insured person and it must satisfy certain conditions to ensure that it is a valid contract.

In this chapter we will learn what the essential features of a valid contract are, including some unique principles that apply only to contracts of insurance.

Essentials of a valid contract of insurance

An insurance contract is an agreement, enforceable by law, between the insurance company and the insured

person; the insured person agrees to pay a premium to the insurance company and the insurance company agrees to pay a sum of money, on the happening of a specified event, to the insured person.

How do both parties enter into this legally binding agreement and what conditions must be satisfied by both parties to ensure that the contract is a valid one?

To answer these questions, we will first look at the essential features of a valid contract, and then we will move on to see how an insurance contract differs from other contracts.

Features of a valid contract

The following features are essential if a legal contract is to be valid:

Offer and acceptance

A contract comes into existence when one party makes an offer which the other party accepts unconditionally. It is easier to see how unconditional acceptance works by looking at an example. Let’s consider the following conversation:

Example:

ABC insurance company: ‘On the basis of your proposal form we can offer you cover, with a sum insured of Rs. XXXXX.’

Ganesh, the proposer (the person who wants to take out the insurance): ‘I accept.’

In this example, Ganesh’s acceptance does not alter any of the terms of ABC’s offer and the acceptance is said to be unconditional. A contract is formed, subject to the other essential elements being present.

Now, consider an alternative response by Ganesh:

Example:

ABC insurance company: ‘On the basis of your proposal form we can offer you cover, with a sum insured of Rs. XXXXX.’

Ganesh, the proposer (the person who wants to take out the insurance): ‘I accept, but I would like to increase the sum insured to Rs. YYYYY.’

In this case, a contract has not been formed as Ganesh has not unconditionally accepted the offer. Not until ABC accepts Ganesh’s counter-offer, without further conditions, is a contract formed.

Consideration

A contract must be supported by consideration in order to be valid. Consideration may be described as each person’s side of the bargain which supports the contract. Consideration in contract law is merely something of value that is provided and which acts as the inducement to enter into the agreement. The payment of money is a common form of consideration, although not the only form. In terms of insurance policies, we refer to the premium as the insured’s consideration.

Capacity to contract

Persons entering into contracts should be competent to do so. An individual is said to be competent to enter into a contract if they are:

• of the age of majority (age 18);

• of sound mind; and

• not disqualified, by law, from entering into contracts

According to this provision therefore, minors (those under the age of 18) cannot enter into insurance agreements. In addition, people who are legally considered to be of unsound mind and any person who has been barred by law cannot enter into an insurance contract. Any contracts entered into by the above people will be null and void.

Consensus ad idem

In simple terms this means both the parties to the contract must understand and agree upon the same thing, in the same sense. The proposer should have understood the features of the insurance policy in the same sense (manner) in which it was explained to them by the agent.

Legality of object or purpose

The objective of both the parties to the contract should be to create a legal relationship. The purpose of the contract should also be legal.

Example:

It is illegal for a husband to insure his wife’s life, and then to kill her and present it as a case of accidental death in order to benefit from the claim amount that he will receive as the legal beneficiary. Insurance cannot be used for illegal purposes or to derive monetary benefits from it.

Another example of an illegal act is a person who is heavily in debt, taking out life insurance for a large amount and then committing suicide so that their family can benefit from the claim money. Claims for death due to suicide in the first year are excluded by most life insurance companies.

Capability of performance

The contract must be capable of being performed by both the parties. For example, a person requesting life insurance for a very high amount should be capable of paying the premium required.

The agreement and its term must be certain and capable of performance and in a form that complies with the requirements of the laws of the land.

The policy document

In order that both the insured person and the insurance company are clear as to the terms that have been agreed between them, a policy is issued. The policy contains all the details of cover, period of cover, exceptions, conditions, the premium and other relevant information. The policy is not the contract of insurance in itself; rather, it is evidence of the contract.

The contract of insurance comes into effect once the insurance company has accepted the insurance proposal, terms have been agreed and the premium has been paid or agreed to be paid. Thus, the contract exists irrespective of the existence of an actual policy document. The absence or loss of the policy does not invalidate the contract, but the policy is useful as proof in the event of a dispute over the terms agreed. We will examine the structure and contents of the policy in detail in Part 2 of this chapter.

The role of insurance agents in insurance contracts

In the eyes of the law, anyone who acts on behalf of another person is an ‘agent’. If we allow someone to act for us, we probably have to accept responsibility for whatever is done by them on our behalf within the terms of the arrangement. This is true in insurance, and whenever there is the involvement of an intermediary, legal relationships are set up.

We saw in chapter 1 that there are different types of intermediaries involved in the insurance industry and that the term ‘agent’ is applied to a licensed intermediary hired by an insurance company to sell that company’s products on its behalf. In doing so the intermediary becomes the legal ‘agent’ and is deemed to be acting on behalf of the ‘principal’ (in this case, the insurance company). They are authorised by the principal to bring the principal into a contractual relationship with a third party (in this case the proposer/

person wanting to take out insurance).

Anand Khemka
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