There are certain types of insurance most people need to have. For example, if you own a home then homeowner’s insurance may be standard. Auto insurance covers your vehicle while life insurance protects you and your loved ones in a worst-case scenario.
When your insurer gives you the policy document, it’s important to read through it carefully to make sure you understand it. Your insurance advisor is always there for you to help you with the tricky terms in the insurance forms, but you should also know for yourself what your contract says. In this article, we’ll make reading your insurance contract easy, so you understand their basic principles and how they are put to use in daily life.
Insurance Contract Essentials
When reviewing an insurance contract, there are certain things included that are typically universal.
- Offer and Acceptance. When applying for insurance, the first thing you do is get the proposal form of a particular insurance company. After filling in the requested details, you send the form to the company (sometimes with a premium check). This is your offer. If the insurance company agrees to insure you, this is called acceptance. In some cases, your insurer may agree to accept your offer after making some changes to your proposed terms.
- Consideration. This is the premium or the future premiums that you have to pay to your insurance company. For insurers, consideration also refers to the money paid out to you should you file an insurance claim. This means that each party to the contract must provide some value to the relationship.
- Legal Capacity. You need to be legally competent to enter into an agreement with your insurer. If you are a minor or are mentally ill, for example, then you may not be qualified to make contracts. Similarly, insurers are considered to be competent if they are licensed under the prevailing regulations that govern them.
- Legal Purpose. If the purpose of your contract is to encourage illegal activities, it is invalid.
Contract Values
This section of an insurance contract specifies what the insurance company may pay out to you for an eligible claim, as well as what you may pay to the insurer for a deductible. How these sections of an insurance contract are structured often depends on whether you have an indemnity or non-indemnity policy.
Indemnity Contracts
Most insurance contracts are indemnity contracts. Indemnity contracts apply to insurances where the loss suffered can be measured in terms of money.
- Principle of Indemnity. This states that insurers pay no more than the actual loss suffered. The purpose of an insurance contract is to leave you in the same financial position you were in immediately prior to the incident leading to an insurance claim. When your old Chevy Cavalier is stolen, you can’t expect your insurer to replace it with a brand new Mercedes-Benz. In other words, you will be remunerated according to the total sum you have assured for the car.
(To read more on indemnity contracts, see “Shopping for Car Insurance” and “How Does the 80% Rule for Home Insurance Work?“)
There are some additional factors of your insurance contract that create situations in which the full value of an insured asset is not remunerated.
- Under-Insurance. Often, in order to save on premiums, you may insure your house at $80,000 when the total value of the house actually comes to $100,000. At the time of partial loss, your insurer will pay only a proportion of $80,000 while you have to dig into your savings to cover the remaining portion of the loss. This is called under-insurance, and you should try to avoid it as much as possible.
- Excess. To avoid trivial claims, the insurers have introduced provisions like excess. For example, you have auto insurance with the applicable excess of $5,000. Unfortunately, your car had an accident with the loss amounting to $7,000. Your insurer will pay you the $7,000 because the loss has exceeded the specified limit of $5,000. But, if the loss comes to $3,000 then the insurance company will not pay a single penny and you have to bear the loss expenses yourself. In short, the insurers will not entertain claims unless and until your losses exceed a minimum amount set by the insurer.
- Deductible. This is the amount you pay in out-of-pocket expenses before your insurer covers the remaining expense. Therefore, if the deductible is $5,000 and the total insured loss comes to $15,000, your insurance company will only pay $10,000. The higher the deductible, the lower the premium and vice versa.
Non-Indemnity Contracts
Life insurance contracts and most personal accident insurance contracts are non-indemnity contracts. You may purchase a life insurance policy of $1 million, but that does not imply that your life’s value is equal to this dollar amount. Because you can’t calculate your life’s net worth and fix a price on it, an indemnity contract does not apply.
A life insurance contract typically includes the following:
- Declarations page: This is often the first page of a life insurance policy and it includes the policy owner’s name, the policy type and number, issue date, effective date, premium class or rate class and any riders you’ve chosen to add on. If you purchased a term life policy, the declarations page should also specify the length of the coverage term.
- Policy terms and definitions: You may see a separate section in your life insurance contract that breaks down terms and definitions, including death benefit, premium, beneficiary and insurance age. Your insurance age may be your actual age or the nearest age assigned to you by the life insurance company.
- Coverage details: The coverage details section of a life insurance contract provides in-depth information about your policy, including how much you’ll pay for premiums, when those payments are due, penalties for missing payments and who your policy’s death benefits should be paid out to. For example, you may have just one primary beneficiary or a primary beneficiary with several contingent beneficiaries.
- Additional policy details: There may be a separate section in your life insurance contract that covers riders if you’ve chosen to add any on. Riders expand your policy’s coverage. Common life insurance riders include accelerated death benefit riders, long-term care riders and critical illness riders. These add-ons allow you to tap into your death benefit while still living if you need money to cover expenses related to a terminal illness.
When you’ve determined that life insurance is something you need, it’s important to compare the options carefully. For example, you may lean toward term life insurance versus permanent life insurance if you don’t need lifetime coverage. Or you may prefer permanent coverage if you’re treating life insurance like an investment.
In either scenario, it’s important to shop around to find the best life insurance companies.