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10.1 Entering into the Contract
In this section we elaborate on the following:
- The preliminary steps of entering into an insurance contract
- The roles assumed by applications and binders in the offer and acceptance process
You may recall from Chapter 9 "Fundamental Doctrines Affecting Insurance Contracts" that every contract requires an offer and an acceptance. This is also true for insurance. The offer and acceptance occur through the application process.
Although more insurance is sold rather than bought, the insured is still required to make an applicationAn offer to buy insurance, which is an offer to buy insurance. The function of the agent is to induce a potential insured to make an offer. As a practical matter, the agent also fills out the application and then asks for a signature after careful study of the application. The application identifies the insured in more or less detail, depending on the type of insurance. It also provides information about the exposure involved.
For example, in an application for an automobile policy, you would identify yourself; describe the automobile to be insured; and indicate the use of the automobile, where it will be garaged, who will drive it, and other facts that help the insurer assess the degree of risk you represent as a policyholder. Some applications for automobile insurance also require considerable information about your driving and claim experience, as well as information about others who may use the car. In many cases, such as life insurance, the written application becomes part of the policy. Occasionally, before an oral or written property/casualty application is processed into a policy, a temporary contract, or binder, may be issued.
As discussed in Chapter 9 "Fundamental Doctrines Affecting Insurance Contracts", property/casualty insurance coverage may be provided while the application is being processed. This is done through the use of a binder, which is a temporary contract to provide coverage until the policy is issued by the agent or the company.
In property/casualty insurance, an agent who has binding authority can create a contract between the insurance company and the insured. Two factors influence the granting of such authority. First, some companies prefer to have underwriting decisions made by specialists in the underwriting department, so they do not grant binding authority to the agent. Second, some policies are cancelable; others are not. The underwriting errors of an agent with binding authority may be corrected by cancellation if the policy is cancelable. Even with cancelable policies, the insurer is responsible under a binder for losses that occur prior to cancellation. If it is not cancelable, the insurer is obligated for the term of the contract.
The binder may be written or oral. For example, if you telephone an agent and ask to have your house insured, the agent will ask for the necessary information, give a brief statement about the contract—the coverage and the premium cost—and then probably say, “You are covered.” At this point, you have made an oral application and the agent has accepted your offer by creating an oral binder. The agent may mail or e-mail a written binder to you to serve as evidence of the contract until the policy is received. The written binder shows who is insured, for what perils, the amount of the insurance, and the company with which coverage is placed.
In most states, an oral binder is as legal as a written one, but in case of a dispute it may be difficult to prove its terms. Suppose your house burns after the oral binder has been made but before the policy has been issued, and the agent denies the existence of the contract. How can you prove there was a contract? Or suppose the agent orally binds the coverage, a fire occurs, and the agent dies before the policy is issued. Unless there is evidence in writing, how can you prove the existence of a contract? Suppose the agent does not die and does not deny the existence of the contract, but has no evidence in writing. If the agent represents only one company, he or she may assert that the company was bound and the insured can collect for the loss. But what if the agent represents more than one company? Which one is bound? Typically, the courts will seek a method to allocate liability according to the agent’s common method of distributing business. Or if that is not determinable, relevant losses might be apportioned among the companies equally. Most agents, however, keep records of their communication with insureds, including who is to provide coverage.
Conditional and Binding Receipts
Conditional and binding receipts in life insurance are somewhat similar to the binders in property/casualty insurance but contain important differences. If you pay the first premium for a life insurance policy at the time you sign the application, the agent typically will give you either a conditional receipt or a binding receipt. The conditional receiptPolicy that does not bind the coverage of life insurance at the time it is issued, but it does put the coverage into effect retroactive to the time of application if one meets all the requirements for insurability as of the date of the application. does not bind the coverage of life insurance at the time it is issued, but it does put the coverage into effect retroactive to the time of application if one meets all the requirements for insurability as of the date of the application. A claim for benefits because of death prior to issuance of the policy generally will be honored, but only if you were insurable when you applied. Some conditional receipts, however, require the insured to be in good health when the policy is delivered.
In contrast, a claim for the death benefit under a binding receiptPolicy that will be paid if death occurs while one’s application for life insurance is being processed, even if the deceased is found not to be insurable. will be paid if death occurs while one’s application for life insurance is being processed even if the deceased is found not to be insurable. Thus, the binding receipt provides interim coverage while your application is being processed, whether or not you are insurable. This circumstance parallels the protection provided by a binder in property/casualty insurance.In a few states, the conditional receipt is construed to be the same as the binding receipt. See William F. Meyer, Life and Health Insurance Law: A Summary, 2nd ed. (Cincinnati: International Claim Association, 1990), 196–217.
In this section you studied that the act of entering into an insurance contract, like all contracts, requires offer and acceptance between two parties:
- The insurance application serves as the insured’s offer to buy insurance.
- An agent may accept an application through oral or written binder in property/casualty insurance and through conditional receipt or a binding receipt in life/health insurance
- What is the difference between a conditional receipt and a binding receipt?
- You apply for homeowners insurance and are issued a written binder. Before your application has been finalized, your house burns down in an accidental fire. Are you covered for this loss? What about in the case of an oral binder?
- Dave was just at his insurance agent’s office applying for health insurance. On his way home from the agent’s office, Dave had a serious accident that kept him hospitalized for two weeks. Would the health insurance policy Dave just applied for provide coverage for this hospital expense?