A valid insurance contract is a legally binding document between you, or your business, and your insurance company. The many clauses in your contract clarify the terms, specify the risks, and describe the limits and period of coverage.

Insurance contracts vary depending on your specific needs, the coverage, and the level of protection. There are, however, many key elements found across insurance contracts and we will define each of them briefly.

The Key Elements

Offer and Acceptance

An insurance contract begins with an application. You work with an agent or broker and provide the necessary information via their application form. If your offer meets the insurance company’s criteria, the company may accept it. You might have to pay your first premium before they will accept it, as is the case when you apply for property or liability insurance.

Most of the time, the insurance agent can accept the offer for the company they represent. They issue a temporary contract, or binder, which activates your coverage immediately. After the company reviews your application, they issue a formal, detailed policy.

If an agent cannot bind the insurance company, your application goes to the insurance company and you do not have coverage until acceptance. This might require making your first payment of your premium, such as when you apply for life insurance. Some companies also require a medical examination and will only activate coverage on the date you pass the exam.

Legal Consideration

Consideration is the agreed value between you and your insurance company. For you, it means you agree to abide by the contract and pay premiums. For the insurance company, it means they’ll pay if you submit a claim for a covered loss.

Competent Parties

Only legally competent parties can enter into an insurance contract. This means you must be of legal age of majority, of sound mind, and not disqualified from the contract by law. The insurance company, on its end, must have a license to sell in your state and they must act according to the regulations that govern them.

Free Consent

Both parties must enter the contract without coercion, undue influence, fraud, misrepresentation, or mistake.

Legal Purpose

A legal and enforceable insurance contract must comply with the law of the land and public policy. Agreements for illegal purposes are not legally binding.

Insurable Interest

You have an insurable interest when you benefit from the existence of whatever you insure. That is, if the insured event occurs, you’ll suffer a financial loss.

Those who will not suffer a financial loss from an event do not have an insurable interest and cannot purchase an insurance policy to cover that event.

Utmost Good Faith

Utmost good faith applies to all insurance. It means both parties in the contract must disclose all the material facts without misrepresentation, non-disclosure, or fraud.

Material Facts

Material facts are the factors affecting risk. They provide the insurance company with the information they need to decide whether they should accept risk and, if so, on what terms.

For life insurance, the material facts include age, occupation, health, and income. For property insurance, they include building construction, building use, age, and property location (find out How Insurance Companies Calculate Your Home Insurance Premiums).

Full and True Disclosure

Full and true disclosure means parties should not conceal, misrepresent, or mistakenly or fraudulently report material facts. False statements, partial truths, or omissions are not permitted.

Duty of Both the Parties

Both parties have a duty to report material facts accurately. Since you’re the one filling out the application form, you’ll disclose most of the information, but the insurance company complies with industry regulations and is legally accountable for their actions.

Principle of Indemnity

Most insurance contracts are indemnity (compensation) contracts. If a loss occurs, the insurance company reimburses you so that you’re in the same position as you were before the event occurred.

You cannot, however, over-insure and make a profit from the loss. The insurance company only pays the actual cash value and you must prove you suffered a monetary loss. This principle discourages fraudulent activities and helps to maintain reasonable premium levels.

Doctrine of Subrogation

The doctrine of subrogation is the right of the insurance company to legally pursue a third party that caused your insurance loss. Take, for instance, a situation in which a driver runs a red light, hits your car, and totals it (learn The First Steps You Need to Take After Wrecking Your Car). In this case, your insurance company will pay you for the expenses related to the accident and then will seek reimbursement from the other driver’s insurance company. In other words, they step in to recover any amount they paid for your loss.


Warranties are the conditions and promises in the insurance contract. They describe what will happen and the necessary conditions to trigger action.


Countless conditions can affect a policy. Some healthcare policies, for example, require yearly medical exams and access to medical records. Most policies also describe territorial restrictions and premium details. If you fail to satisfy the conditions, you breach your contract and the insurance company is not obligated to pay.

Breaches of contract can include failing to notify the insurer of any loss, failing to provide a required inventory, or failing to submit the required proof of a medical condition. Also, if you fail to pay your premium or there’s evidence of fraud, your insurance provider can cancel your policy.

Fortunately, most parties discharge an insurance contract at the end of its term. They switch providers, find a superior rate, or do not need coverage anymore.


Limitations specify items such as the maximum amount that the insurance company will pay, restricted coverage under certain circumstances, or your time frame for filing a claim. For instance, if your health insurance policy has a $2 million limit, then your insurance company will only pay up to that limit, regardless of your total medical costs. They may also require you to submit your expenses within a year.

Limitations can also include restricted coverage, such as prohibiting coverage if you are diagnosed with a pre-existing condition within six months of your policy start date. After six months, the coverage kicks in and covers your costs. Most policies also include restrictions that come into effect if you have more than one policy.


Exclusions are exceptions to the general statements in your policy. For instance, an automobile liability policy typically covers bodily injury or property damage when the insured are legally responsible for an accident. However, your policy may exclude coverage if you intentionally caused the accident or if you’re hiring yourself out as a paid driver.

Other common exclusions in insurance contracts include epidemics, natural disasters, war, strikes, suicide, and acts performed with the intention of triggering a claim.

Proximate Cause

Proximate cause refers to the way the loss or damage actually occurred and whether it is a result of an insured peril. If insurance covers the cause of the event, the insurer will compensate for the loss.

Return of Premium

Ordinarily, insurance companies do not refund premiums. However, your contract may describe particular circumstances when this is appropriate, such as death, overpayment, or over-insurance (find out whether you're in one of the 3 Groups Who Benefit from Return of Premium Life Insurance).


Insurance contracts are carefully worded and usually standardized. They clarify coverage and they satisfy legal requirements. You usually can’t negotiate an insurance contract, although your business may be able to do so through a broker. You can. however, request an addition or amendment to the basic policy (rider) to fulfill your needs.

Your agent or broker can explain any unclear areas to you and advise you on the best course of action. Review your contract carefully before you sign, because it is a complex and legally binding document. Understanding the requirements and limitations of your insurance contract is vital to protecting your interests.

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