What Makes An Insurance Contract Different From Other Contracts?
An Insurance Policy Is a Special Type of Contract That Must Contain Elements Additional to the Elements Required Within Other Contracts. For Validity of An Insurance Policy, Meaning Contract, Insurable Interest and Utmost Good Faith Are the Additionally Required Elements.
Understanding the Foundational Elements of Contract Formation Within a Binding Insurance Policy
An insurance policy is a contract; however, an insurance policy is a unique type of contract with legal rules that differ from the formation of generic contracts. The additional rules, or contract formation principles, are quite plain and obvious when reviewed consciously; however, without a conscious awareness and a few moments of genuine thought as to the purpose for the additional rules, such may seem confusing, unnecessary, or to the skeptically minded as just a scam of the insurance industry.
The foundational elements to an insurance contract are:
- Legality of Purpose
- Insurable Interest
- Utmost Good Faith
Where one, or more, of these elements is lacking at the time that an insurance policy, meaning an insurance contract, is formed, the insurance policy is other than a legally binding contract and is therefore unenforceable by either party, the insurer or the insured, to the contract.
Elements Required Uniquely Within Insurance Contracts
The principle of insurance interest involves the requirement that a person who wishes to arrange insurance coverage must hold a legal need or reason for doing so, that is based upon a chance of loss. Without the potential to suffer a loss due to the object of the insurance, such as a car, house, life of spouse, among other things, the person is viewed as being without an insurance interest. The reason for requiring an insurable interest for validity of an insurance contract is to reduce both a risk of fraud as well as to avoid insurance being treated in a manner of speculative betting.
The requirement of insurable interest developed in response to abuses in the purchase of insurance coverage. This is mentioned within texts available from the Insurance Institute of Canada, including the Principles and Practices (C11) textbook which states:
"In England, in the early 18th Century, it was common practice to take out a life insurance policy on the life of a prominent person or insure a public building against fire as a form of gambling. Laws were passed to put an end to such contracts, and the validity of a contract became dependent upon the insured’s financial interest in the subject matter of the contract (for example, the life that was insured). This became known as insurable interest."
If an insurance policy was permitted without an insurable interest, meaning without a risk of loss to the person arranging the insurance, then there would be little, if any, incentive to that person to care for, and avoid, loss of the object being insured. Indeed, the opposite may occur whereas without a risk of loss; but, with an opportunity for gain (the insurance proceeds), fraud might be encouraged. Accordingly, only where a person stands to suffer a loss if harm comes to the object (thing or life) or legal risks (liability, etc.), may a person obtain insurance against that possibility of loss. Even more easily said, if a person stands only to gain by harm coming to a thing, life, or legal risk, then the person is almost certainly without an insurable interest.
In regards to policies involving life insurance, the Insurance Act, R.S.O. 1990, c. I.8 mandates and defines insurable interest as:
Insurable Interest, required
(2) A contract is not void for lack of insurable interest,
(a) if it is a contract of group insurance; or
(b) if the person whose life is insured has consented in writing to the insurance being placed on his or her life.
Consent of Minor
(3) Where the person whose life is insured is under the age of sixteen years, consent to insurance being placed on the person’s life may be given by one of his or her parents or by a person standing in the role of parent to him or her.
Insurable Interest, defined
179 Without restricting the meaning of “insurable interest”, a person, in this section called the “primary person”, has an insurable interest,
(a) in the case of a primary person who is a natural person, in his or her own life and in the lives of,
(i) the primary person’s child or grandchild,
(ii) the primary person’s spouse,
(iii) a person on whom the primary person is wholly or partly dependent for, or from whom the primary person is receiving, support or education,
(iv) the primary person’s employee, and
(v) a person in the duration of whose life the primary person has a pecuniary interest; and
(b) in the case of a primary person that is not a natural person, in the lives of,
(i) a director, officer or employee of the primary person, and
(ii) a person in the duration of whose life the primary person has a pecuniary interest.
Utmost Good Faith
The principle of utmost good faith requires that both parties to an insurance contract, the insurer and the insured, be fully honest and forthcoming both at the time of negotiating an insurance coverage contract as well as once the contract is in force. This mutual duty of utmost good faith was succinctly stated within the case of RBC v. Field, 2016 ONSC 5584 whereas it was said:
 I conclude as a matter of law that there is a doctrine of mutuality that imposes a duty on an insurer and an insured party to act in good faith when dealing with each other in the making or processing of a claim under a policy of insurance. This mutuality arises from the reciprocal duty of an insured to act fairly, honestly and in good faith when making a claim, and of an insurer to act fairly, honestly and in good faith when adjusting that claim.
"Utmost good faith (good faith in Quebec) denotes a standard of honesty greater than that found in other contracts; it is required of the insured and the insurer. Insureds have the duty to disclose all material facts relating to a risk. Misrepresentation includes non-disclosure and concealment. If brokers or agents have binding authority their knowledge of a risk is considered knowledge of the insurer."
Principle of Indemnity
Insurance purists will state and argue that an true insurance policy, meaning an insurance arrangement in the historical sense of the word, involves an insurance pollicy wherein agreements provide only for indemnification whereas indemnification means being put back into the same financial position that person was prior to the loss. Accordingly, a purist would view an insurance policy that provides indemnification coverage for a dwelling house and the contents within an an actual cash value basis as a true insurance policy. As an insurance policy based upon actual cash value indemnification, which is to put a person into the same financial position as existed a moment before a loss occurred, if a house and contents were actually worth $248,576.32 a split second before being totally destroyed by fire, or tornado, or any other peril included within the insurance coverage, then an pure insurance policy providing for indemnification would result in $248,576.32 being due to the insured person (minus any applicable deductibles or other loss sharing mechanisms). However, in the competitive marketplace that the insurance industry is, insurers developed non-pure forms of insurance that provide for compensation beyond indemnification. These types of insurance policies are those that include coverage on a replacement cost basis, or that contain other provisions that enable the insured person to receive more than the actual cash value of the insured object when the object is lost or destroyed in a fashion that is included within the insurance protection. Accordingly, if the house and contents worth $248,576.32 as mentioned above will cost $300,000.00 to replace, a replacement cost policy, subject to the limits being set high enough (meaning at least $300,000.00) and without considering deductibles, among other things, will provide the $300,000.00 as compensation for the cost to replace rather than merely indemnify.
An insurance policy differs from most types of contracts. For an insurance policy, being a special type of contract, to exist and be legally binding and enforceable, the special elements of contract formation as required for insurance agreements must occur.