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Distinguishing Characteristics of Insurance

Source: Insurance, Banking & Negotiable Instruments Law Teaching Material

Insurance contracts are subject to the same basic law that governs all types of contracts. 

However, a special body of law has developed around legal problems associated with insurance.  

Insurance contracts have the following distinct legal characteristics that make them different from other contracts. 

An insurance contract is aleatory rather than commutative. Aleatory contracts have a chance element and an uneven exchange. Under an aleatory contract, the performance of at least one of the parties is dependent on chance. An aleatory contract also involves an uneven exchange: one of the parties promises to do much more than the other party. Depending on chance, one party may receive a value out of proportion to the value that is given. For example, assume that Semira pays a premium of Birr 500 for birr 100,000 of homeowners‘ insurance on her home. If her home is totally destroyed by fire shortly thereafter, she would collect an amount that greatly exceeds the premium paid. On the other hand, a homeowner may faithfully pay premiums for many years and never suffer a loss. 

In contrast, other commercial contracts are commutative. A commutative contract is one in which the values exchanged by both parties are theoretically even. For example, the purchaser of a real estate normally pays a price that is viewed to be equal to the value of the property. 

Although the essence of an aleatory contract is chance, or the occurrence of some fortuitous event, an insurance contract is not a gambling contract. Gambling creates a new speculative risk that did not exist before the transaction. Insurance, however, is a technique for handling an already existing pure risk. Thus, although both gambling and insurance are aleatory in nature, an insurance contract is not a gambling contract because no new risk is created. 

An insurance contract is a unilateral contract. A unilateral contract is a contract in which only one party makes a legally enforceable promise. In this case, only the insurer makes a legally enforceable promise to pay a claim or provide other services to the insured. The term ―unilateral‖ means that courts will enforce the contract in one direction only: against one of the parties; in this case, the insurer after the insured has paid the premium for coverage, the insured‘s part of the agreement has been fulfilled. Under these circumstances, the only party whose promises are still outstanding is the insurer. Although the insured must continue to pay the premium to receive payment for a loss he or she cannot be legally forced to do so /compare Art 666/4/ of the Commercial Code/. However, if the premiums are paid, the insurer must accept them and must continue to provide the protection promised under the contract. 

In contrast, most commercial contracts are bilateral in nature. Each party makes a legally enforceable promise to the other party. If one party fails to perform, the other party can insist on performance or can sue for damages because of the breach of contract. 

An insurance contract is a conditional contract. This means the insurer‘s obligation to pay a claim depends on whether or not the beneficiary has complied with all policy conditions. If the insured does not adhere to the conditions of the contract, payment is not made even though an insured peril causes a loss. Conditions are provisions inserted in the policy that qualify or place limitations on the insurer‘s promise to perform. 

The conditions section imposes certain duties on the insured if he or she wishes to be compensated for a loss. The insurer is not obligated to pay a claim if the policy conditions are not met. Typical conditions include payment of premium, providing adequate proof of loss, and giving immediate notice to the insurer of a loss. For example, under a homeowner‘s policy, the insured must give immediate notice of loss. If the insured delays for an unreasonable period in reporting the loss, the company can refuse to pay the claim because a policy condition has been violated. 

In property insurance, insurance is a personal contract, which means the contract is between the insured and the insurer. Strictly speaking, a property insurance contract does not insure property, but insures the owner of property against loss. The owner of the insured property is indemnified if the property is damaged or destroyed. Since the contract is personal, the applicant for insurance must be acceptable to the insurer and must meet certain underwriting standards regarding character, morals, and credit. 

Since a property insurance contract is a personal contract, it normally cannot be assigned to another party without the insurer‘s consent. If property is sold to another person, the new owner may not be acceptable to the insurer. Thus, the insurer‘s consent is normally required before a property insurance policy can be validly assigned to another party. Since the general rule states that one cannot be forced to contract against one‘s will, the right of the insured to assign the policy is dependent on the consent of the insurance company. Otherwise, the company could not be legally bound in a contract with an individual to whom it would never have issued a policy originally, and one in which the nature of the risk is altered substantially. For example, let us say that an automobile owner decided to sell his or her car to a 17-year-old boy. If it were possible to assign the insurance policy to the boy without the consent of the insurance company, the company would then be forced to deal with a person with whom it would not have dealt. The assigned policy will be legally binding only with the written consent of the insurance company. / Compare the provisions of Arts 672, 673, 660 of the Commercial Code/ 

In contrast, a life insurance policy can be freely assigned to anyone without the insurer‘s consent because the assignment does not usually alter the risk and increase the probability of death. 

Compare Arts 696-698 of the Commercial Code. 

The insurance contract is said to be a contract of adhesion, i.e., whose terms and conditions are not the result of negotiations between the parties, and one party has to agree to the terms and conditions prepared by the other. In such types of contracts, ambiguities or uncertainties in the wording of the agreement will be construed against the drafter- the insurer. If the policy is ambiguous, the insured gets the benefit of the doubt. This principle is due to the fact that the insurer had the advantage of writing the terms of the contract to suit its particular purposes and the insured has no opportunity to bargain over conditions, stipulations, and exclusions. Therefore, the courts place the insurer under a duty to make the terms of a contract clear to all parties. In the absence of doubt as to meaning, the courts will enforce the contract as it is.  

The general rule that ambiguities in insurance contracts shall be construed against the insurer is reinforced by the principle of reasonable expectations. The principle of reasonable expectations states that an insured is entitled to coverage under a policy that he or she reasonably expects it to provide, and that to be effective, exclusions or qualifications must be conspicuous, plain, and clear. 

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