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Definition and Nature of Contracts of Insurance
Source: Insurance, Banking & Negotiable Instruments Law Teaching Material
A contract of insurance is a contract whereby one party undertakes, in return for a consideration called a premium, to pay to the other party a sum of money on the happening of a certain event (death or attainment of a certain age, or injury) or to indemnify the other party against a financial loss arising from the loss or damage to property or from incurring civil liability.
The party which promises to pay a certain amount of money to, or to indemnify, the other party is called the insurer (sometimes called the assurer- in cases of insurance of persons and the under writer in cases of marine insurance and the party to whom such protection is given is called the inured (or the assured). The document containing the terms and conditions of the contract of insurance is called the policy, and the insured is therefore, also referred to as a policyholder.
A contract of insurance is a type of contingent or conditional contract. As the name indicates, a contingent or conditional contract is a contract to do or not to do something, if some event, collateral to such contract, does or does not happen. In other words, it is a contract in which the performance of the obligation arising there from by the parties or one of them is dependent upon the condition or contingency agreed upon by them. Accordingly, as the obligation of the insurer/assurer to pay compensation or the agreed amount to the insured or the beneficiary is dependent upon materialization of the risk or risks specified in the policy. Thus, for instance, if X Insurance Company agrees to pay Birr 100,000 in exchange for B paying Birr 2500 as premium, if B’s house is destroyed by fire; there will be contingent contract, the performance of which depends upon the happening of an uncertain event, i.e. the destruction of the house by fire.
Although a contract of insurance resembles, to a certain extent, a wagering or gambling agreement whereby the insurer bets with the insured that his house will not be burnt and giving him the odds of its value, it is a legal and enforceable contract with important economic and social purposes.
Note: Wagering or gambling agreements are considered void in almost all legal systems. For instance, Art 713(2) of the Commercial Code of Ethiopia provides that games and gambling shall not give rise to valid claims for payment unless they are related to activities enumerated under Art 714, such as stock exchange speculations, sporting activities and lottery or betting authorized by the government.
A contract of insurance differs from a contract of wagering or gambling for the following reasons: 1. The object or purpose of an insurance contract is to protect the insured against economic losses resulting from a certain unforeseen future event, while the object of a wagering or gambling agreement is to gamble for money and money alone.
2. In an insurance contract, the insured has an insurable interest in the life or property sought to be insured. In a wagering or gambling agreement, neither party has any pecuniary or insurable interest in the subject matter of the agreement except the resulting gain or loss. This is the main distinguishing feature of a valid contingent contract as compared to a wagering agreement.
3. A contract of insurance (except life, accident and sickness insurances) is based on the principle of indemnity. However, in a wagering agreement there is no question of indemnity, as it does not cover any risk.
4. A contract of insurance is based on scientific calculation of risks and the amount of premium is ascertained after taking into account the various factors affecting the risk. In a wager, there is no question of any calculation what so ever, it being a mere gamble.
Finally, let us see how a contract of insurance is defined under the insurance law of Ethiopia. Art 654 of the Commercial Code of Ethiopia defines insurance as follows:
Insurance (policy) is a contract whereby a person, called the insurer, undertakes, against payment of one or more premiums, to pay to a person, called the beneficiary, a sum of money where a specified risk materializes.
According to this definition, insurance is a contract between two or more persons in which one person called the insurer, agrees to pay the agreed amount of money or compensation to another person, called the insured, or the beneficiary where the insured property is lost or destroyed ( in cases of property insurance), or where the insured person incurs civil liability (in cases of liability insurance) or where the insured person dies or suffers bodily injury or falls ill (in case of insurance of persons). The insurer undertakes this obligation for consideration, called premium payable by the insured person.
Sub Art(2) of the same article provides that a contract of insurance may be concluded in relation to “damages” covering risks affecting property or arising out of the insured person’s civil liability. These types of insurance are generally referred to as indemnity insurances, in which the insurer’s obligation is to pay compensation, which is always equal to damage. Similarly, sub Art(3) provides that a contract of insurance may also be made in respect of human person’s life, body or health in which the insurers obligation is to pay the amount agreed upon (the sum insured). This is a type of insurance in which the principle of indemnity or compensation is not applicable since human life or body does not have a market value, hence the name Nonindemnity insurance.
Thus, a contract of insurance, as a contingent contract is a perfectly valid contract, and the general principles of the law of contract apply equally to such a contract. Hence, to be valid, it must fulfill the following requirements: (i) there must be an agreement between the parties (ii) the agreement must be supported by consideration, (iii) the parties must be capable of contracting (must have capacity), (iv) the consent of the parties to the agreement must be free from defects, and (v) the object must be legal or the object must not be illegal and immoral.