Insurance Basics & Contract Law
Insurance Basics & Contract Law
Core concepts every L&H candidate must know: risk, insurable interest, and the legal elements and special characteristics of an insurance contract.
Risk & How Insurance Works
Insurance covers only PURE risk (loss or no loss, no chance of gain) — speculative risk is not insurable. A PERIL is the cause of loss (fire, illness); a HAZARD is a condition that increases the chance or severity of loss. The LAW OF LARGE NUMBERS lets insurers predict losses accurately as the number of similar exposure units grows, and ADVERSE SELECTION (higher-risk people seeking coverage more) is controlled through underwriting.
Insurable Interest
For LIFE insurance, insurable interest must exist at the time of APPLICATION but need not exist at death. For PROPERTY insurance, it must exist at the time of LOSS. Everyone has unlimited insurable interest in their own life; others (spouses, business partners, creditors) must show a genuine financial or love-and-affection interest.
Contract Elements & Characteristics
A valid contract needs agreement (offer & acceptance), consideration, competent parties, and legal purpose. Insurance contracts are ALEATORY (unequal exchange of value), UNILATERAL (only the insurer makes an enforceable promise), CONDITIONAL, and contracts of ADHESION (drafted by the insurer, so ambiguities favor the insured). Applicant statements are REPRESENTATIONS (believed true), not warranties.
📖 Key Terms
- Pure vs. speculative risk
- Pure = loss or no loss (insurable); speculative = a chance of gain (not insurable).
- Insurable interest
- A genuine financial or love-and-affection stake; for life it must exist at application, not at death.
- Indemnity
- Restoring the insured to their pre-loss financial condition without profiting.
- Adverse selection
- The tendency of higher-risk people to seek or keep insurance more than better risks.
- Representation vs. warranty
- A representation is believed true to the best of one's knowledge; a warranty is guaranteed literally true.
💡 Exam Tips
- ▸Only pure risk (loss or no loss) is insurable; speculative risk is not.
- ▸Life insurable interest must exist at application, not at death; property at the time of loss.
- ▸Insurance contracts are aleatory, unilateral, conditional, and contracts of adhesion.
- ▸Application answers are representations — a material misstatement can void the policy within the contestable period.