A valid agreement between a life insurance company and the applicant for insurance, represented by an instrument called the policy (from the Italian word polizza, meaning "a rolled document"), is a contract and as such, is subject to the general rules of contract law. However, in adapting these rules, which are familiar to all students of business law, to the life insurance contract, the courts have introduced substantial modifications because of certain peculiar characteristics of the life insurance contract. These characteristics�which, with one exception, are common to all types of insurance contracts�are briefly described in this chapter.

The agreement contained in a life insurance policy is aleatory in nature, rather than commutative. In a commutative agreement, each party expects to receive from the other party, in one way or the other, the approximate equivalent of what he or she undertakes to give. Thus in an agreement to purchase real estate, the buyer agrees to pay a sum of money that represents the approximate value of the property to him or her, while the seller agrees to sell the property for a price that represents its approximate value to him or her. In other words, both parties contemplate a fairly even exchange of values. The courts generally will not consider whether the value exchanged would be equal to an objective observer unless there is such a huge discrepancy that it amounts to evidence of undue influence by one party or incompetence by the other. For most purposes, the worth of a thing is the price it will bring.

In an aleatory agreement, on the other hand, both parties realize that, depending on chance, one may receive a value out of all proportion to the value that he or she gives. The essence of an aleatory agreement is the element of chance or uncertainty. The prime example of such a contract is the wagering agreement. The term may also be applied to an endeavor where the potential gain or loss is governed largely by chance. Thus, the oil industry�s exploration and drilling functions may be described as aleatory in nature. So is prospecting for gold, silver, or uranium.

In a life insurance transaction, the present value of the potential premium payments at the inception of the agreement is precisely equal, on the basis of the company�s actuarial assumptions, to the present value of the anticipated benefits payable under the contract. In this sense the life insurance transaction is not aleatory. Moreover, the sum total of insurance transactions for a company, or for the entire life insurance industry, is not aleatory because of the predictability and stability provided by the theories of probability and the law of large numbers.

It remains true, however, that a particular policyowner may pay in to the insurance company a sum of money considerably smaller than the sum promised under the contract. Indeed, the face amount of the policy may become payable after the insured has paid only one installment of the first premium. This chance of obtaining a disproportionate return from an "investment" in a life insurance policy has motivated�and continues to motivate�many unscrupulous persons to seek life insurance through fraudulent means and for illegal purposes. The remedies for breach of warranty, misrepresentation, and concealment are invoked by the companies to protect themselves and society against fraudulent attempts to procure insurance. The requirement of an insurable interest is also designed to deal with the problems created by the fact that the life insurance policy is an aleatory contract. The aleatory nature of the insurance contract accounts in large measure for the modifications of general contract law as it is applied to the field of insurance contract law.

Most contracts in the business world are bilateral in nature. This means that each party to the contract makes an enforceable promise to the other party. The consideration for such a contract is the exchange of mutual promises. Thus an order from a wholesaler to a manufacturer for a specified quantity of a particular item at a specified price, if accepted, is a bilateral contract. The manufacturer agrees (promises) to deliver the desired merchandise at an agreed-upon price, while the wholesaler agrees (promises) to accept and pay for the merchandise when delivered. Either party can sue if the other fails to perform as promised.

Under a unilateral contract, on the other hand, only one party makes an enforceable promise. A contract is created because the nonpromising party to the contract performs his or her part of the bargain before the contract comes into existence. For instance, if the wholesaler in the example above had remitted cash with his or her order, the transactions would have become unilateral in nature, inasmuch as only the manufacturer (who made a promise to deliver) had anything to perform. In general, unilateral contracts are confined to situations in which one party is unwilling to extend credit to the other or to take the other's word for future performance.

As a general rule, a life insurance policy is a unilateral contract, in that only the insurance company makes an enforceable promise thereunder. The insurer�s promise is given in exchange for performance by the policyowner of a certain act�payment of future premiums. As the consideration demanded by the company�namely, the application and the first premium or the first installment thereof�is given by the applicant, the contract goes into effect. Under the life insurance contract, the policyowner has made no promise to pay premiums subsequent to the first and is under no legal obligation to do so. If he or she does not pay additional premiums, the company will be released from its original promise to pay the face amount of the policy. Nevertheless, the policyowner incurs no legal penalties through failure to continue premium payments. On the other hand, the insurance company is obligated to accept the periodic premiums from the payer and to keep the contract in force in accordance with its original terms.

A life insurance contract may become a bilateral contract in some circumstances. For example, assume an agent of an insurer has authority to waive cash payment of the first premium. If an insurance policy is delivered by such agent in exchange for the applicant�s promissory note or for the applicant�s oral promise to pay premiums, a bilateral contract is created. In this situation the insurer�s promise is exchanged for the applicant�s promise.

Closely related to the foregoing is the fact that the life insurance policy is a conditional contract. This means that the company�s obligation under the contract is contingent on the performance of certain acts by the insured or the beneficiary. This does not, however, make the contract bilateral.

A condition is always inserted in a contract for the benefit of the promisor (the insurer) and hence is disadvantageous to the promisee (the policyowner). The following is a simple example of a conditional unilateral contract: Able promises to pay Baker $10 if she washes Able�s car. The promised payment of the money is conditioned upon the performance of the act.

Conditions are not confined to unilateral contracts; a party to a bilateral contract can condition his or her promise in any manner acceptable to the other party. The following is an example of a conditional bilateral contract: Able promises to deliver 10 red rocking chairs, and Baker promises to accept them and pay Able $100 each if they are delivered prior to May 1st.

Conditions are classified as either precedent or subsequent. A condition precedent must be satisfied before legal rights and duties are created or continued, whereas a condition subsequent must be fulfilled in order to prevent the extinguishment of rights and duties already created in the contract. Whether a condition is precedent or subsequent depends on the intention of the parties to the contract. When the intention is not clear, the courts� tendency is to classify a condition as precedent in order to avoid a forfeiture.

The legal significance of a condition is quite different from and less burdensome than that of a promise. Failure to perform a contractual promise subjects the promisor to liability for damages to the promisee. Failure to perform or fulfill a condition does not subject the person involved (the promisee) to liability for damages but merely deprives him or her of a right or privilege that he or she otherwise would have had or might have acquired. It releases the promisor from his or her obligation to perform.

The promise of a life insurance company is conditioned on the timely payment of premiums. Payment of these premiums is considered to be a condition precedent to the continuance of the contract under its original terms. If this condition is not fulfilled, the company is relieved of its basic promise but remains obligated to honor various subsidiary promises contained in the surrender provisions and the reinstatement clause.

The company�s promise to pay the face amount of the policy is always conditioned on the insured�s forbearance from committing suicide during a specified period (usually one or two years) after the policy�s issue and may be conditioned on the insured�s death from causes not associated with war or aviation. Finally, the insurance company has no liability until satisfactory proof of death has been submitted by the beneficiary or the insured�s personal representative.

A life insurance policy is also a contract of adhesion. This means that the terms of the contract are not arrived at by mutual negotiation between the parties, as would be the case with a bargaining contract. The policy, a complex and technical instrument, is prepared by the company and, with minor exceptions, must be accepted by the applicant in the form offered to him or her. The prospective insured may or may not contract with the company, but in no sense is the applicant in a position to bargain about the terms of the contract. The applicant must reject the contract entirely or "adhere" to it. Any bargaining that precedes the issuance of a life insurance contract has to do only with whether or not the contract is to be issued, the plan and amount of insurance, and to some degree the terms of the settlement agreement, although the settlement agreement itself is actually drafted by the insurance company.

The adhesive nature of the life insurance contract is highly significant from a legal standpoint. This importance derives from the basic rule of contract construction that a contract is to be construed or interpreted most strongly against the party who drafted the agreement. The avowed purpose of this rule is to neutralize any advantage that might have been gained by the party that prepared the contract. This means that if there is an ambiguity in a life insurance policy, the provision in question will be given the interpretation most favorable to the insured or his or her beneficiary. A rather prevalent view in insurance circles is that the courts, in their zeal to protect the insured, often find ambiguities in contracts where none exist.

Some who readily admit the soundness of this rule of construction in general and of its application to life insurance policies prior to the turn of the century question its continued application to policies currently being issued, considering the large number of provisions that are required by state statutes to be incorporated in such policies. Although these statutes do not prescribe the exact language to be used, many states require that the language of all policy provisions, including those voluntarily included, be approved by the state insurance department before sale of the policy form to the public. Such a requirement has the purpose, among others, of preventing the use of any deceptive or misleading language or of any provisions that would be unfair to policyowners. These factors have produced a relaxation of the strict rule of construction in some courts, but generally, all ambiguous provisions of the policy continue to be construed against the insurer.

Contracts issued by property and casualty insurance companies are usually contracts of indemnity. This means that the insured can collect only the amount of his or her loss, irrespective of the face of the policy�except, of course, that the recovery cannot exceed the face of the policy. Moreover, upon payment by an insurer of a loss caused by the negligence of a third party, as in the case of an automobile accident, the insurer acquires the insured�s right of action against the negligent third party up to the amount of its loss payment and any expenses incurred in enforcing its rights. This is known as the doctrine of subrogation. While a provision giving effect to this doctrine is included in virtually every property and casualty insurance policy, the doctrine applies even in the absence of a policy provision.

A life insurance policy therefore is not a contract of indemnity, but one to pay a stated sum. This is presumably based on the assumption that because the value of a person�s life to that person is without limit, no sum payable upon his or her death will be in excess of the loss suffered. Thus even though the insured has reached an age or a circumstance where he or she no longer has an economic value, upon his or her death the insurance company will still have to pay the sum agreed upon. The practical significance of this principle is that the insurance company, after paying the face amount of the policy, is not subrogated to the right of action of the decedent�s estate when his or her death was caused by the negligence of a third party.