Formation and formalities of an insurance contract

The fundamental principle of Insurance is mathematical; its application is financial; and its interpretation is legal. For the layman to understand the Insurance principle he should be an actuary (who design and price the insurance products); to understand its application to financial problems, he need not be a financial; and to understand its legal concepts, he need not be a lawyer.

Insurance may be defined as a contract between two parties whereby one party called insurer undertakes in exchange for a fixed sum called premium to pay the other party called insured a fixed amount of money after happening of a certain event. Insurance policy is a legal contract & its formation is subject to the fulfillment of the requisites of a contract. “A Contract may be defined as an agreement between two or more parties to do or to abstain from doing an act, with an intention to create a legally binding relationship.”

The formation of the insurance contract generally commences with the making of an offer which must be accepted. In practice, the offer is made by the insured by means of completing a standard proposal form. However, in some instances, the insurer makes a standard offer to the public or a group of targeted potential clients. The parties then agree upon the material terms which are essential matters such as the amount of premium, the nature and subject matter of the risk insured, the duration of the risk, etc.

A. Elements of General Contract
1. Offer & Acceptance, 2. Consideration, 3. Legal capacity to contract or competency, 4. Consensus “ad idem”, 5. Legality of object

However, it should be noted that the absent adjustment of such terms by the proposer/insured, he/she is deemed to have accepted the standard terms of the insurance policy as provided by the insurer.
Where the insured proposes terms of insurance to the insurer, or vice versa, the insurer may accept or as often happens send a counter offer. In practice for instance, there is no binding offer of insurance until premium is in fact paid. This constitutes a counter offer which the insured may reject but the insurer may not revoke unless there is a change in circumstances.

B. Elements of Special Contract relating to Insurance

1. Life Insurance
a. Utmost Good Faith (Uberrima Fides)
b. Insurable Interest

2. General Insurance
a. Utmost Good Faith (Uberrima Fides)
b. Insurable Interest
c. Indemnity
d. Subrogation
e. Proximate Cause

In the case of Canning V. Farquhar (1886) 16 Qbd 727, where a proposal for life insurance was accepted on December 14, on the terms that no insurance was to take effect until the first premium was paid. The premium was tendered on January 9, but four days previously, the insured had fallen and suffered serious injuries from which he subsequently died. The court observed that the insurer was not bound.
It should be noted that if there is a change in the risk between the proposal and acceptance, then such should be disclosed to the insurer. Generally, the law of contract requires that he acceptance of the contract by either party should be unilateral and communicated. This principle also applies to the insurance contracts. However, there are instances where the insurance is not unilateral and therefore communication of acceptance may not be communicated but rather constituted by performance in accordance with the terms of the offer.

An example is motor third party insurance which is offered at a standard fee and sold by agents of the insurer such as at gas stations. The offer that is made by the insurer may be accepted by the potential client or not but acceptance of such offer shall be by purchasing of the certificate of insurance.

Relevant insurance Cases:
- Hercules Insurance Co Ltd V. Trivedi & Co Ltd, [1962] E.A 258
- Jupiter General Insurance Company V. Kasanda Cotton Co. [1966] Ea 252
- Jubilee Insurance Company Ltd V. Fifi Transporters Ltd Hccs No. 81/2008.

Essentials of an Insurance Contract
The essentials of any Insurance Contract are discussed as under with reference to the life Insurance only.

1. Offer & Acceptance:
In Life Insurance an offer can be made either by the Insurance Company or the applicant (proposer) & the acceptance will follow. e.g., subsequently
(a). An offer made by the Insurance company to proposer that the premium amount will be Rs.100/- per annum for the Insurance amount of Rs.1000/-. It is for the proposer to accept the offer or not.
(b). An advertisement in the newspaper about the availability of different life Insurance policies is an invitation for an offer. If a proposer makes an application then it will be offer from the applicant and the Insurance Company may or may not accept it.
(c). An offer may be considered accepted either when the Insurance Company issues the policy or the first premium is paid by the applicant.

As stated above in example (a) if the applicant pays the first premium of Rs.100/- to the Insurance Company then the contract is completed as both the parties have accepted the offer.
Similarly, if the company issues the policy in above stated example. (b) then the offer is accepted by the Insurance company & the contract is completed. In fact, in life Insurance contract the effective date of the policy is very important; when the premium is paid with the application but no conditional receipt is issued the contract is not in force until the policy is delivered to the applicant. The payment of the premium with the application constitutes the offer and the delivery of policy is its acceptance.

Further, if the premium is paid with the application & conditional receipt is issued, the effective date of the contract depends upon the provisions of the conditional receipt. There are three types of conditions as follows:

(a) The condition may be that the Insurance becomes effective as of the date of the application or medical examination whichever is later. A claim arising after this date will be paid even if the application papers have not reached the competent / Approving Authority, provided of course, that the facts on the application & the results of the medical examination are such that the company would have accepted the application had the applicant lived.

(b) The second type of conditional receipt used by a company is the approval form, which provides coverage beginning with the date the application is approved by the company. This form does not offer the insured protection for the period from the date of the application until it is approved by the company.

(c) A third type of receipt is the unconditional binding receipt. According to this receipt the company binds the Insurance from the date of the application until the policy is issued or the application is rejected. The companies using this type of receipt place a time limit usually from 30 to 60 days. This binding receipt is beneficial to the prospects because he becomes insured from the time the application is filed. This form of receipt is not widely used.

The offer or proposal and its acceptance may be verbal or in writing but in Insurance contracts these are in writing. In General Insurance the Insured offers to purchase an insurance from the Insurer and this offer is in the form of a proposal form and the Insurer after studying the proposal can either reject the proposal or accept it. In case he accepts he issues a cover note or a letter of acceptance. In the latter event the acceptance letter becomes a counter offer or proposal, which is accepted on payment of premium by the insured.

2. Consideration:
There is no validity of a contract if there is no consideration, which is the act or promise offered by one party and accepted by the other as the price of his promise. In Insurance contracts the consideration is the premium that the Insured pays to the Insurer as the price of the promise that the Insurer has made that he shall indemnify the insured. Hence premium payment is the consideration on part of the insured and the promise to Indemnify is the consideration on part of the Insurer.

In text Questions
1. When is the insurance contract considered to be completed?
2. What is consideration in any insurance contract?

3. Legal Capacity/ Competency to Contract:
For a contract to be binding on all parties, the parties intricate must have the legal capacity to enter into a contract. With respect to the insurer, if the company is formed as per laws of the country & authorized to solicit insurance then the insurer is proficient of entering into an agreement.
With respect to the insured, the person should be of legal age i.e. 18 years and of sound mind.
If a contract is made with an underage the application may be held unenforceable if the minor decides to repudiate it at a later date. In Insurance contract the insurer is bound by the contract as long as the underage wishes to continue it. If the minor repudiates his contract, the law will allow him a refund of all premium paid.
Insanity or mental incompetence precludes the making of a valid Insurance contract.

4. Consensus “ad idem” (Meeting of the mind):
The understanding between the insurer & insured individual should be of same thinking or mind. The causes for taking the Insurance policy should be explicable to both the parties. Both parties to the insurance contract should be of the same mind and there must be consent arising out of common intent. Both parties should be clear about what the other is saying. The Insurer should know what the insured wants and the insured should know what the insurer is offering and both should be agreed on this. For example, if an Insured seeking a fire policy is issued a burglary policy there is no consent arising out of common intention.

5. Legality of Object:
To be a valid contract, it must be for a legal purpose & not conflicting with public policy. Insurance is legal business therefore it cannot be illegal on the part of the insurer. An individual can take the life Insurance of his own life or his/her family associates. If an individual takes a policy on the life of an anonymous person, it will not be a valid contract as it will amount to wagering.
Another example is that the contract will not be legal if it has anything to do with stolen property or if it is in respect of any unlawful activity. Hence Insurance of stolen goods or the Insurance of smuggling operation shall not stand scrutiny in the court of law and such contracts will be void.

Summary
In addition to the above features which are common to commercial contracts as well as contracts of Insurance, Insurance contracts are subject to certain special principles evolved under common law in UK. These principles are known as the fundamental principles of the law of Insurance.

Terminal Questions:
1. Explain the various features of any commercial contract.

Objective Type Questions

1. Choose the correct option
a. In an insurance contract an insurer makes an offer and the prospect accepts it.
b. In an insurance contract a prospect makes an offer and an insurer accepts it.
c. In an insurance contract an offer and acceptance is not a requirement.
d. In an insurance contract no principles of contact are applicable.

2. The consideration for the insurer under an insurance contract is a______ (premium/ sum insured)
3. The consideration for an insured under an insurance contract is a_____ (compensation/ premium).

4. Choose the correct options
Statement A: The minor can enter in to an insurance contract.
Statement B: The person with unsound mind cannot enter into an insurance contract.
a. Both statements are correct
b. Both statements are wrong
c. Statement A is correct
d. Statement B is correct

5. Choose the correct options
Statement A: Insurance is lawful business.
Statement B: The insurance is not a gambling.
a. Both statements are correct
b. Both statements are wrong
c. Statement A is correct
d. Statement B is correct

Answers to In-text Questions
1. On accepting the proposal by the insurance company the insurance contract is completed.
2. Premium paid by the person to the insurance company and any compensation paid by the insurance company.

Answers to Objective Type Questions
1. b     2. Premium     3. Compensation     4. d         5. a