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9.3: Requirements of a Contract

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    • Anonymous
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    Learning Objectives

    In this section we elaborate on general requirements of contracts:

    • Offer, acceptance, and consideration
    • Competent parties
    • Legal purpose
    • Legal form

    When an agent sells an insurance policy, he or she is selling a contract. A contract is an agreement enforceable by law. For any such agreement to be legally enforceable, it must meet the following minimum requirements:

    • There must be an offer and an acceptance
    • There must be consideration
    • The parties to the contract must be competent
    • Its purpose must be legal
    • The contract must be in legal form

    Offer and Acceptance

    Offer and acceptance is the process of two parties entering into a contract; an agreement is reached only after offer and acceptance between the contracting parties. If the party to whom the offer was made requests a change in terms, a counteroffer is made, which releases the first offerer from the terms of the original offer. In the making of insurance contracts, the buyer usually offers to buy and the insurer accepts or rejects the offer. When you call an insurance agent for insurance on your new automobile and the agent provides coverage, there is an offer to buy and the agent has accepted the offer on behalf of his or her company. As stated previously, this acceptance is called a binder. The offer may be verbal, as in this case, or it may be in the form of a written application. This process differs for life and health insurance.


    A contract also requires the exchange of consideration. Consideration is the price each party demands for agreeing to carry out his or her part of the contract. The value of the consideration is usually unimportant, but lack of consideration will cause the contract to be regarded as a gift and therefore unenforceable. In many cases, insurance contracts stipulate that the consideration is both in the form of premium and certain conditions specified in the policy. Such conditions may include maintenance of a certain level of risk, timely notice of loss, and periodic reports to insurers of exposure values. Conditions will be explained in detail in parts III and IV of the text in the descriptions of insurance contracts. Consideration, therefore, does not necessarily imply dollars.

    Competent Parties

    Another essential element for a contract is that the parties to the contract must be competent parties, or of undiminished mental capacity. Most people are competent to contract, but there are exceptions. Mentally ill or intoxicated persons are not recognized as competent. Minors may enter into contracts, but such contracts may be voided (or terminated). Upon reaching majority (age eighteen in some states, age twenty-one in others), the young person may ratify or reject the contract. If ratified, the contract would then have the same status as one originally entered into by competent parties.

    A minor who enters into an insurance contract, therefore, may void it during infancy or when he or she reaches majority. Ratification of a policy at the age of majority can be accomplished (by oral or written communication) either explicitly or implicitly (by continuing the policy). Some states have laws giving minors the power to enter into binding life insurance contracts on their own lives as young as age fourteen.

    Legal Purpose

    A contract must have a legal purpose—that is, it must not be for the performance of an activity prohibited by law. If it does not, enforcing the contract would be contrary to public policy. A contract by a government employee to sell secret information to an agent of an enemy country, for example, would not have a legal purpose and would be unenforceable. For the same reason, a contract of insurance to cover losses caused by the insured’s own arson would be illegal and contrary to public policy, and thus unenforceable.

    Legal Form

    Contracts may be either oral or written; they must, however, follow a specific legal form, or appropriate language. Legal form may vary from state to state. As noted, some insurance contracts are—at least initially—oral. Most states do not have laws directly prohibiting oral contracts of insurance. They do, however, require that some contract forms (the written version of standardized insurance policy provisions and attachments) be approved by the state before being offered for sale.

    Moreover, the nature and general content of some policies are specified by law. Most states require that certain provisions be included in life and health insurance contracts. Thus, although some contracts may be oral, insurance contracts must—for the most part—be in writing, and they must conform to the requirements of the states in which they are sold.

    Key Takeaways

    In this section, you studied the following:

    • Contracts feature an offer, acceptance, and consideration; an insured must offer to buy and consider the premiums/policy conditions, and the agent must accept the offer (provide coverage) in order for an insurance contract to be enacted
    • Parties to a contract must be competent; mentally ill and intoxicated persons are not competent to contract
    • A contract must be for a legal purpose only
    • Contracts may be oral or written, but they must follow legal form

    Discussion Questions

    1. What are the requirements of a contract? Provide an example.
    2. A talented high school senior is entered into the National Basketball Association Draft, selected by a team, and ultimately signs a play contract. Why might this contract be disputed as unenforceable?
    3. Following construction of a storage shed on his property, a homeowner refuses to pay the builder the full amount agreed upon orally for performance of this service. Can the builder sue the homeowner and collect damages for breach of contract? Why or why not?

    This page titled 9.3: Requirements of a Contract is shared under a CC BY-NC-SA 3.0 license and was authored, remixed, and/or curated by Anonymous.