How To Understand Your Insurance Contract

Most people need certain sorts of insurance. For example, if you own a property, homeowners insurance may be required. Auto insurance insures your vehicle, whereas life insurance protects you and your loved ones in the worst-case situation.

When your insurer delivers you the policy document, study it carefully to ensure that you understand it. Your insurance advisor is always there to assist you with the complicated phrases on the insurance paperwork, but you should also understand what your contract says.

Insurance Contract Essentials

When evaluating an insurance policy, there are some features that are often included.

• Offer and Acceptance: When applying for insurance, the first thing you do is get the proposal form of a particular insurance company. After filling in the requested details, you send the form to the company (sometimes with a premium check). This is your offer. If the insurance company agrees to insure you, this is called acceptance. In some cases, your insurer may agree to accept your offer after making some changes to your proposed terms.
• Consideration: This is the premium or the future premiums that you have to pay to your insurance company. For insurers, consideration also refers to the money paid out to you should you file an insurance claim. This means that each party to the contract must provide some value to the relationship.
• Legal Capacity: You need to be legally competent to enter into an agreement with your insurer. If you are a minor or are mentally ill, for example, then you may not be qualified to make contracts. Similarly, insurers are considered to be competent if they are licensed under the prevailing regulations that govern them.
• Legal Purpose: If the purpose of your contract is to encourage illegal activities, it is invalid.

Contract Values

This portion of an insurance contract defines how much the insurance company may pay you for an eligible claim and how much you may pay the insurer for a deductible. The layout of these portions of an insurance contract is often determined by whether you have an indemnity or non-indemnity policy.

Indemnity Contracts

Most insurance contracts are indemnity agreements. Indemnity contracts apply to insurance policies in which the loss is measurable in monetary terms.

• Principle of Indemnity:  This means that insurers will pay no more than the actual loss suffered. An insurance contract’s purpose is to return you to the exact financial situation you were in immediately before the incident that resulted in an insurance claim. When your ancient Chevy Cavalier is stolen, do not expect your insurer to replace it with a brand new Mercedes-Benz. In other words, you will be compensated based on the entire amount you have insured for the car.
• Under-Insurance:  Often, in order to save money on premiums, you may insure your house for $80,000 while the actual worth is $100,000. In the event of a partial loss, your insurer will only pay $80,000, leaving you to dip into your resources to cover the remaining amount of the loss. This is known as underinsurance, and you should strive to prevent it as much as possible.
• Excess: To avoid minor claims, insurers have implemented safeguards such as excess. For example, you have auto insurance with a $5,000 excess. Unfortunately, your car was involved in an accident that resulted in a $7000 loss. Your insurer will reimburse you $7,000 because the loss exceeds the set $5,000 limit. However, if the loss exceeds $3,000, the insurance provider will not pay a penny, and you will be responsible for the loss expenses. In summary, insurers will not accept claims unless your losses surpass a minimum level specified by the insurer.
• Deductible: This is the amount you must spend out of pocket before your insurer will cover the remainder. Therefore, if the deductible is $5,000 and the total insured loss is $15,000, your insurance company will only pay $10,000. Higher deductibles result in reduced premiums, and vice versa.

Non-Indemnity Contracts

Non-indemnity contracts include life insurance and the majority of personal accident policies. You can buy a $1 million life insurance policy, but it doesn’t mean your life is worth that much. An indemnification contract is ineffective since you cannot calculate and price your life’s net worth.

Life insurance contracts often contain the following:

• Declarations page: This is often the first page of a life insurance policy and it includes the policy owner’s name, the policy type and number, issue date, effective date, premium class or rate class and any riders you’ve chosen to add on. If you purchased a term life policy, the declarations page should also specify the length of the coverage term.
• Policy terms and definitions: You may see a separate section in your life insurance contract that breaks down terms and definitions, including death benefit, premium, beneficiary and insurance age. Your insurance age may be your actual age or the nearest age assigned to you by the life insurance company.
• Coverage details: The coverage details section of a life insurance contract provides in-depth information about your policy, including how much you’ll pay for premiums, when those payments are due, penalties for missing payments and who your policy’s death benefits should be paid out to. For example, you may have just one primary beneficiary or a primary beneficiary with several contingent beneficiaries.
• Additional policy details: There may be a separate section in your life insurance contract that covers riders if you’ve chosen to add any on. Riders expand your policy’s coverage. Common life insurance riders include accelerated death benefit riders, long-term care riders and critical illness riders. These add-ons allow you to tap into your death benefit while still living if you need money to cover expenses related to a terminal illness.

When you’ve decided that you need life insurance, you should thoroughly research your options. If you do not require lifetime coverage, you may prefer term life insurance over permanent life insurance. If you think of life insurance as an investment, you might select permanent coverage.

Insurable Interest

It is your legal right to insure any property or event that could result in financial loss or legal consequences for you. This is known as insurable interest.

Assume you are living in your uncle’s house and apply for homeowners insurance because you assume you will inherit the property later. Insurers will reject your offer because you are not the owner of the property and hence do not stand to lose money in the case of a loss. Insurance does not cover the home, automobile, or machinery. Your policy covers the monetary interest in that property, automobile, or machinery.

It is also the idea of insurable interest that allows married couples to purchase life insurance policies on each other, based on the assumption that one will suffer financially if the other dies. Insurable interest exists in some business agreements, such as those between a creditor and a debtor, company partners, or employers and employees.

 Tips: In life insurance contracts, someone having an insurable interest can be your spouse, children or grandkids, a special needs adult who is also dependent, or your aging parents.

Principle of Subrogation

Subrogation allows an insurer to sue a third party who caused a loss to the insured and pursue all available options to recover some of the money it paid to the insured as a result of the loss. For example, if you are wounded in a traffic accident caused by another party’s reckless driving, your insurer will compensate you. However, your insurance company may sue the reckless driver in an attempt to recover the money.

The Doctrine of Good Faith

All insurance arrangements are founded on the principle of uberrima fides, or greatest good faith. This philosophy emphasizes the existence of mutual faith between the insured and the insurer. In layman’s words, while applying for insurance, it is your responsibility to provide the insurer with accurate and complete information. Similarly, the insurer cannot withhold information regarding the insurance coverage being sold.

• Duty of Disclosure: You are legally obliged to reveal all information that would influence the insurer’s decision to enter into the insurance contract. Factors that increase the risks—previous losses and claims under other policies, insurance coverage that has been declined to you in the past, the existence of other insurance contracts, full facts and descriptions regarding the property or the event to be insured—must be disclosed. These facts are called material facts. Depending on these material facts, your insurer will decide whether to insure you as well as what premium to charge. For instance, in life insurance, your smoking habit is an important material fact for the insurer. As a result, your insurance company may decide to charge a significantly higher premium as a result of your smoking habits.
• Representations and Warranty: In most kinds of insurances, you have to sign a declaration at the end of the application form, which states that the given answers to the questions in the application form and other personal statements and questionnaires are true and complete. Therefore, when applying for fire insurance, for example, you should make sure that the information that you provide regarding the type of construction of your building or the nature of its use is technically correct.

Depending on their nature, these statements can be either representations or warranties.

• Representations: These are the written assertions you make on your application form that describe the proposed risk to the insurance provider. For example, on a life insurance application form, information regarding your age, family background, occupation, and so on should be completely accurate. Breach of representation arises only when you provide inaccurate information (such as your age) in critical statements. However, depending on the type of deception that happens, the contract may be void or not.
• Warranties: in insurance contracts differ from those in standard commercial contracts. They are imposed by the insurer to ensure that the risk is consistent throughout the term and does not escalate. For example, with auto insurance, if you lend your automobile to a friend who does not have a license and that friend is involved in an accident, your insurer may consider it a breach of warranty because it was not notified of the change. As a result, your claim may be rejected.

As previously said, insurance works on the idea of mutual trust. It is your obligation to provide all essential information to your insurance. Normally, a breach of the norm of utmost good faith occurs when you fail to disclose these vital facts, whether intentionally or accidently. There are two types of nondisclosure:

• Innocent non-disclosure relates to failing to supply the information you didn’t know about
• Deliberate non-disclosure means providing incorrect material information intentionally

For example, imagine you were ignorant that your grandfather died of cancer and hence did not reveal this important fact on the family history questionnaire while applying for life insurance; this is an innocent non-disclosure. However, if you knew about this substantial fact and purposefully concealed it from the insurer, you are guilty of fraudulent non-disclosure.

When you provide false information with the purpose to deceive, your insurance contract is voided.

• If this deliberate breach was discovered at the time of the claim, your insurance company will not pay the claim.
• If the insurer considers the breach as innocent but significant to the risk, it may choose to punish you by collecting additional premiums.
• In case of an innocent breach that is irrelevant to the risk, the insurer may decide to ignore the breach as if it had never occurred.

Other Policy Aspects

The doctrine of adhesion. The doctrine of adhesion argues that you must accept the full insurance contract, including all terms and conditions, without negotiation. Because the insured has no ability to amend the terms, any ambiguities in the contract will be interpreted in their favor.

The principle of waiver and estoppel. A waiver is the voluntary abandonment of a known right. Estoppel forbids a person from asserting their rights because they have demonstrated a lack of interest in safeguarding their rights. Assume that you failed to disclose some facts on the insurance proposal form.

Your insurer does not request that information while issuing the insurance coverage. This is a waiver. In the future, if a claim emerges, your insurer cannot challenge the contract on the grounds of non-disclosure. This is an estoppel. As a result, your insurer will be responsible for paying the claim.

Endorsements are typically used to amend the conditions of insurance contracts. They could also be used to include certain conditions in the policy. Co-insurance is the sharing of insurance between two or more insurance companies in an agreed-upon proportion.

For example, insuring a major shopping mall has a considerable risk. As a result, the insurance firm may decide to involve two or more insurers to share the risk. Coinsurance may also exist between you and your insurance provider.

This clause is extremely common in medical insurance, in which you and the insurance company agree to split the covered expenditures in the ratio of 20:80. As a result, during the claim, your insurer will pay 80% of the covered loss, and you will pay the remaining 20%.

Reinsurance occurs when your insurer “sells” a portion of your coverage to another insurance firm. Assume you are a well-known rock star and want your voice to be insured for $50 million.

The Insurance Company A accepts your offer. However, Insurance Company A is unable to keep the entire risk, so it transfers a portion of it—say, $40 million—to Insurance Company B. If you lose your singing voice, insurer A will pay you $50 million ($10 million + $40 million), but insurer B will contribute the reinsured amount ($40 million) to insurer. This method is referred to as reinsurance. General insurers use reinsurance far more than life insurers.

The Bottom Line

When applying for insurance, you will discover a wide range of insurance products on the market. If you have an insurance advisor or broker, they can search around to make sure you’re getting enough coverage for your money. Even so, a basic understanding of insurance contracts can help ensure that your advisor’s suggestions are accurate.

Furthermore, your claim may be canceled because you failed to provide specific information requested by your insurance carrier. In this scenario, a lack of information and negligence might be very costly. Instead of signing your insurer’s policy without first reading the fine print, go over its features. If you comprehend what you’re reading, you may be confident that the insurance plan you’re purchasing will protect you when you need it the most.