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Now that we understand what makes an insurance contract valid, let's explore what makes insurance contracts unique. While all valid contracts must have the CLOC elements, insurance contracts have additional special features that set them apart from ordinary business agreements. These special characteristics reflect the unique relationship between insurers and their customers, and they directly affect how insurance policies work in practice.
An insurance contract is an aleatory contract because one party may recover more in value than has been paid. This difference in benefits occurs because they depend on uncertain future events, such as illness or death. In other words, aleatory contracts involve unequal exchanges. The value of the policy owner's potential benefit (a claim payment) is usually higher than the premium paid to the insurer. Both insurance and gambling contracts are typically considered aleatory contracts.
Think of an aleatory contract like a "what if" agreement. Here's how it works:
"Aleatory" means depending on chance. You don't know if you'll need to use the insurance, and the insurance company doesn't know if they'll need to pay. Consider these real-world examples of aleatory contracts:
Insurance policies are contracts of adhesion because they are prepared by only one party — the insurance company. When buying insurance, the applicant can't change what the policy says. The insurance company writes all the rules. The applicant can either take the policy as it is or leave it and choose something else. A policy can also be described as a contract of adhesion because it can only be modified by the insurance company.
Ambiguities or confusing language in a contract can result in differing legal interpretations and conflicts. In any contract of adhesion, the party that dictates the contract terms is responsible for ensuring that all terms are clear and free of ambiguity. The insurance company has this responsibility when it comes to its insurance policies. When policy language is unclear:
Here's why ambiguities matter: an auto policy states, "coverage excludes damage from acts of nature" without defining "acts of nature." A fallen branch damages the insured's car during a storm. The insurer claims this is an act of nature and denies coverage. The insured argues that damage from fallen branches should be covered since "acts of nature" is not clearly defined. The court would likely rule in favor of the insured because the insurer wrote the contract, and the term is ambiguous because reasonable people might interpret it differently.
The doctrine of reasonable expectations means courts look at what an average person would expect from the policy. If the policy promises something different from what it delivers, the court supports the consumer's reasonable understanding. The purpose of this doctrine is to correct the advantage gained by the party that prepared the contract. Because of this doctrine, an insurer must obtain state insurance department approval before it can use or modify a policy form.
The reasonable expectation is a legal principle that reinforces the rule that ambiguities in insurance contracts should be interpreted in favor of the policyholder. It also states that an insured is entitled to coverage under a policy that a sensible and prudent person would expect it to provide.