Contract Formation and Characteristics

The Four Elements of a Valid Legal Contract

A valid legal contract requires agreement, consideration, competent parties, and legal purpose. A contract needs agreement, consideration, competent parties, and legal purpose, but a capacity defect may make a contract voidable rather than automatically unenforceable. A contract that lacks legal purpose is considered void from the beginning.

Agreement consists of an offer made by one party and an acceptance by the other party. In life insurance, the applicant typically makes the offer by submitting a completed application along with the initial premium payment. When an applicant submits an application without the initial premium, the insurer may treat it as a request for coverage and make an offer by issuing a policy, but the application and insurer's procedures determine how offer and acceptance occur. When an application is submitted without premium, policy issuance may be the insurer's offer, depending on the application and insurer's procedures. When the insurer approves an application as submitted with premium, issuing the policy generally constitutes acceptance, subject to any applicable conditions for coverage to take effect. If the insurer instead issues a policy with modified terms or higher premium ratings, that issued policy is a counteroffer rather than an acceptance. A counteroffer replaces the original offer and generally requires the applicant's acceptance before coverage takes effect under the changed terms, subject to any temporary coverage already in force.

Consideration is the exchange of something of value between the parties to a contract. In life insurance, the applicant's consideration consists of the representations made on the application and the payment of the initial premium. The insurer's consideration is the promise to pay policy benefits upon the occurrence of a covered event.

The remaining two elements ensure that the parties and the agreement itself are legally sound. Competent parties means an individual generally must have the legal capacity and mental ability to understand the contract. Intoxication may affect capacity if it prevents that understanding, and state law sets the minimum age at which a person has the legal capacity to enter into an insurance contract. An insurance contract entered into by a person who lacks legal competence may be void or voidable. Legal purpose requires that a contract must not be created for an illegal act or contrary to public policy. For a life insurance contract to have a legal purpose, it must be lawful and generally must involve an insurable interest when coverage begins.