Characteristics of Insurance Contracts

Characteristics of Insurance Contracts
••• Contract image by CraterValley Photo from

The insurance industry is one made up of legal agreements between insurance companies and their customers. These agreements come in the form of insurance policies, or contracts. Insurance contracts are different from other types of contracts you may encounter, and they have some distinguishing characteristics that define them as insurance documents.

Aleatory Contracts

Most of the time, contracts between two parties represent an agreement for certain services in exchange for an amount of money that corresponds to the services rendered, which is generally fair to both parties. Insurance contracts, by contrast, are aleatory. This term means that one party to the contract can potentially profit from the agreement much more than the other party. For example, if you never file a claim, the insurer receives all your premiums and profits from the agreement. If you file a large claim, however, you can potentially receive much more than you ever paid in premiums, so you profit greatly.

Require Good Faith

Insurance policies are based on promises. The insurer relies on your utmost good faith to report your risk characteristics truthfully, so the insurer can adequately rate your premiums, and you must trust that the insurer will fulfill its promise to pay a claim when you file one. While all contracts rely on the good faith of their parties to some degree, insurance contracts are contracts of "utmost" good faith, because there are no concrete goods or services involved. Often, an insurer is allowed to cancel a policy if it discovers that you violated your good faith requirement on the application.

Contracts of Adhesion

With many contracts, the two parties can negotiate the terms of the contract before they sign it. With insurance contracts, however, the insurer writes the contract in its entirety and you can either take it or leave it. You don't get to dictate the terms of the policy, and you must pay corresponding premiums for any changes you do request after it is in force. Because you must adhere to the insurer's contract without negotiating its terms, insurance policies are contracts of adhesion.

Executory Contracts

Generally, the parties to a contract each agree to perform some kind of action as part of the agreement. Insurance policies are executory contracts, as there is a possibility that the insurance company will legally leave its part of the contract unfulfilled. While you must always pay your premiums, the insurer only has to act if you suffer a loss. If you never have a loss, you are the only party to the contract that ever does anything.