As in the case of other simple contracts, there must be a manifestation of mutual assent before a life insurance contract can be created. One party must make an offer to enter into an insurance transaction, and the other must accept the offer. One would naturally assume that the company, through one of its soliciting agents, makes the offer, which the prospective insured is free to accept or decline. That is not necessarily the case.

In many situations, the prospect is considered to have made the offer. As a general rule, and subject to the exceptions noted later, the prospect is considered to have made the offer whenever the application is accompanied by the first premium; the company is regarded as the offeror whenever the first premium is not paid (or at least not definitely promised) with the application. In the first situation, the prospect has indicated his or her unqualified willingness to enter into a contractual relationship with the company, even to the point of putting up the consideration. In the second situation, the prospect may refuse, without any legal penalties, to accept and pay for the contract issued by the company. The question of who is the offeror and who the offeree is important in determining the exact time at which the contract comes into existence, which may be of crucial significance. (This matter is dealt with later in this book.)

Many states now require that the policyowner be given a "10-day free look" after delivery of the policy. During that time the contract is in effect, but its continuation is subject to the policyowner�s right to cancel the policy within the 10 days and receive a full refund of his or her premiums.

The chain of events that culminates in the formation of a life insurance contract begins with a conversation between the company�s soliciting agent and a prospect for insurance, during the course of which the prospect is invited or�more accurately�urged to extend an offer to the company. Such invitations to deal have no legal consequences in the formation of the contract, although they may contain representations that will have consequences after the contract is made. If the invitation to deal comes from a broker, the representations will have no legal effect before or after formation of the contract since a broker is considered the applicant�s agent for the purpose of procuring insurance.

The applicant�s offer to the company, or an applicant�s invitation to the company to make him or her an offer, as the case might be, is communicated in the form of an application. Unless there is a specific state statute requiring that the application be in writing, it is clear that the application and the contract can be either oral or written. Written applications for life insurance policies, however, are required as a matter of company practice.

The application for a life insurance contract serves the following purposes:

The contents of the application relating to the first two functions constitute the offer in the technical sense since they fix the terms of the policy to be issued by the company as an acceptance of the offer. While the identification of the person whose life is to be insured is a necessary part of the offer, the detailed description of the risk is not actually a part of the offer. From a legal standpoint, the applicant�s representations as to his or her medical history, present physical condition, and so on are merely inducements to the insurer; they are not promises or conditions of the contract. Neither does the nonwaiver clause relate to the offer. It is intended merely to prevent the applicant from successfully contending afterwards that he or she was misled as to the agent�s apparent authority.

In the typical commercial transaction, the offer becomes a part of the contract ultimately consummated. This is not true of the offer leading to a life insurance contract unless the application is specifically made a part of the contract (a common insurance practice). It has long been established�first by court decisions and later by statutes�that once a life insurance policy is issued, the entire contract is contained in the policy. This rule, known historically as the parol evidence rule, has been stated as follows:

A typical state statute provides that "every policy of life, accident or health insurance, or contract of annuity delivered or issued for delivery in this state shall contain the entire contract between the parties." In addition, most insurance policies contain a provision to this effect, as in this example: "This policy, the attached copy of the initial application, any application for reinstatement, all subsequent applications to change the policy and any endorsements or riders are the entire contract. No statement will be used in defense of a claim unless such statement is contained in the application(s)."

Since the company places great reliance on the information contained in the application and in the event of a contested claim would undoubtedly want to introduce evidence therefrom, it customarily incorporates the application into the contract, by reference as well as by physical attachment of a copy (usually a photostat) of the application to the policy. In most of the states there are statutes requiring that a copy of the application be physically attached to the policy if the statements in the application are to be treated as representations and are to be introduced into evidence in the event of litigation. Typical statutory language provides that "no application for issuance of any life, accident or health insurance policy, or contract of annuity shall be admissible in evidence unless a true copy of such application was attached to such policy when issued."

The coverage under a life insurance policy becomes effective the instant the contract comes into existence. This, however, takes place only after certain conditions have been fulfilled, and those conditions can be fulfilled in more than one manner. The procedure by which a contract is brought into existence after the application�s submission depends on whether the application is regarded as an offer or only as an invitation to the company to make an offer. That, in turn, depends on the time at which and the circumstances under which the first premium is paid. In that regard it is necessary to distinguish among three different sets of circumstances. The first set of circumstances is one under which the application is submitted without payment of the first premium.

Recall that when the applicant does not tender the first premium with the application, no application has been made. The application is regarded as only an invitation to deal. The approval of the application and the issuance of the policy constitute an offer from the company to the prospective insured, which is normally communicated by delivery of the policy. The applicant manifests his or her acceptance of the company�s offer by accepting delivery of the policy and paying the first premium. This assumes that the soliciting agent does not have authority to extend credit. If the agent has authority to take a promissory note or even an oral promise of the insured in lieu of cash, an application accompanied by such a promise is an offer from the applicant to make a bilateral contract�an exchange of the applicant�s promise for the insurer�s promise.

Most companies specify in the application that the prospective insured must be in good health at the time of delivery of the policy, and some insurers condition the contract on the absence of any medical treatment during the interim between the application�s submission and the policy�s delivery. All these requirements�delivery of the policy, payment of the first premium, good health of the applicant, and absence of any interim medical treatment�are treated as conditions precedent that must be fulfilled before the contract comes into existence and the coverage becomes effective. Each of these requirements will be discussed below.

Delivery of the Policy. Delivery of the policy is a legal prerequisite to the validity of the life insurance contract only because many companies specifically make it so. Neither by statute nor by common law is the delivery of a formal policy requisite to the completion, validity, or enforceability of a contract of insurance. This is contrary to real estate law, for example, which holds that legal title to real estate is not transferred until the deed is delivered. The company could conceivably communicate its offer to the applicant in some other manner, and the applicant could manifest acceptance by notifying the company or the soliciting agent.

The controlling reason why many insurance companies make delivery of the policy a condition precedent to the formation of the contract is that it provides a way to establish the precise moment at which coverage under the contract becomes effective. Some carriers make no special provision in the application to set the date when coverage begins. Some provide that coverage begins when the policy is issued and the entire first year�s premium has been paid. Several other actions of the company�such as approval of the application by the underwriting department, issuance of the policy, or mailing the policy to the soliciting agent for delivery�might be used to mark the inception of coverage. This could lead to much confusion and litigation unless the parties agree in advance that a definite determinable event, such as delivery of the policy, marks the beginning of coverage.

Despite this attempt to achieve certainty, litigation has developed over the meaning of the word "delivery." The issue is whether the condition can be satisfied only by a manual delivery or whether constructive delivery is sufficient. If it is clearly evident from the terms of the application and the policy that actual manual delivery is expected, the requirement will be strictly enforced. If, however, the requirement is couched in terms of a simple "delivery," the general rule is that the condition can be fulfilled by constructive delivery.

Constructive delivery has been held to take place whenever a policy, properly stamped and addressed to the company�s agent, is deposited in the mail, provided no limitations are imposed on the manual delivery of the policy to the insured by the agent. There are a number of decisions, however, that hold that the requirement of delivery�and especially "actual delivery"�is itself a condition precedent that cannot be met by constructive delivery. (It should be noted that the issue of constructive delivery is not material if the other conditions�notably, payment of the first premium and the applicant�s good health�are not met.)

To a large extent delivery is a matter of the parties� intention. It is a question of who has the right to possession of the policy, rather than who has actual possession. That being true, possession of the policy by the insured is at most only prima facie evidence of its delivery. The presumption of proper delivery can be rebutted by evidence that the insured obtained possession of the policy by fraud or for the purpose of inspecting it, or in any other manner manifesting a lack of intention on the company�s part to effectuate a legal delivery of the policy. On the other hand, it has been held that if the first premium has been paid, the applicant is in good health, and the company has implicitly expressed its intention of being legally bound under the contract by delivering the policy to the agent to be unconditionally passed on to the applicant, the contract is in force. Even though the insured may die without actual possession of the policy, the company is liable for payment of the insured amount.

In view of the foregoing presumption, an agent must observe proper safeguards in relinquishing physical possession of a policy to an applicant before all conditions precedent have been fulfilled. The need for caution is greatly magnified if the policy, on its face, acknowledges receipt of the first premium, which is sometimes the case. The most common circumstance under which the agent may find it necessary to relinquish control over a policy without making a legal delivery is when the applicant expresses a desire to study the policy. In that event, the applicant is asked to sign a receipt acknowledging that the policy has been delivered only for examination and approval and that the first premium has not been paid. This acknowledgment is called an inspection receipt.

Payment of First Premium. It is customary for the application�and sometimes the policy itself�to stipulate that the first premium must be paid before coverage becomes effective. Payment of the full amount in cash is usually specified, and unless the company agrees to extend credit, any payment smaller than the full premium will fail to satisfy the requirement. The agent is usually not authorized to extend credit on behalf of the company, but he or she may pay the premium for the insured and seek reimbursement on a personal basis. If an agent is authorized to accept an applicant�s promissory note in payment of the first premium, the applicant�s tendering such a note will satisfy the condition precedent, but failure of the insured to pay the note at maturity may cause the policy to lapse.

Payment by check may be taken as absolute or conditional payment, depending on the parties� intention. If the check is accepted in absolute payment of the first premium, bank�s failure to honor the check would not affect the validity of the policy but merely give the insurance company the right to sue the applicant for the amount of the check. On the other hand, if the check is accepted only as conditional payment, nonpayment of the check would cause the contract to fail. Most companies stipulate that checks are accepted subject to being honored by the bank, which is the common-law rule in the absence of evidence that the check was accepted as absolute payment.

Good Health of Applicant. The delivery-in-good-health clause is a by-product of the process by which risks are underwritten in life insurance. In most lines of property and casualty insurance, the local agent is given the authority to underwrite the risk and bind the coverage. There need be no lag between the inspection of the risk and the binding of the coverage. In life insurance, however, all underwriting information is forwarded to the home office, and the right to bind the risk rests solely with the executive officers of the company. Under such a system, which seems to be the only feasible one, there is an inevitable time lag between the submission of the application and the assumption of the risk by the insurer. In some cases, where the investigation of the applicant or the insured is very comprehensive and the collection of medical data involves correspondence with attending physicians and requests for supplemental diagnostic procedures, the lag might be as long as several weeks. Obviously the company would like to be protected against a deterioration of the applicant�s health during the time it is considering the application. The way that insurance companies have chosen to accomplish this objective is the delivery-in-good-health clause.

While the exact wording of the good-health clause varies from company to company, the gist of the clause is that the policy will not take effect unless, upon the date of delivery, the applicant is alive and in good health. Some clauses provide that unless the first premium is paid with the application, the applicant must be alive and in good health upon payment of the first premium. This clause has the effect of making the applicant�s good health a condition precedent to the effectiveness of the contract. Under the laws of some states, including Pennsylvania, if the applicant underwent a medical examination at the request of the insurer, the good-health requirement can be invoked only with respect to changes in the applicant�s health occurring after the medical examination.

The fact that the good-health requirement is a condition precedent and has been enforced by the majority of courts has great significance in protecting life insurance companies against fraud. Even so, the protection of the good-health clause must be sought by the insurer during the policy�s period of contestability. Once that period has expired, the good-health clause is void.

In attempting to rescind a contract on the grounds of misrepresentation or concealment, insurance companies are frequently required to prove that the applicant deliberately misrepresented the facts of the case. In fact, most states have enacted legislation that stipulates that no misrepresentation will void a policy unless the misrepresentation was made with an actual intent to deceive or unless it would increase the risk. To prove intent to defraud is always difficult and is frequently impossible. With the good-health clause, however, insurance companies can avoid that difficulty since intent is not involved. The clause is concerned with the existence of a condition and not with what may or may not have been known to the applicant. If the company can prove to the court�s satisfaction that the applicant was not, in fact, in good health at the date of delivery of the policy, it can avoid liability under the contract. In practice, however, companies generally raise the issue only when they suspect that the applicant did not act in good faith or when there has been a material deterioration in the applicant�s health in the interval between the date of the medical examination and the date of delivery of the policy.

As might be expected, the courts have frequently been called upon to define the meaning of the terms "good health" and "sound health." The courts have ruled that "good health," as used in the context of the clause under discussion, is a relative term, meaning not absolute freedom from physical infirmity but only such a condition of body and mind that one may discharge the ordinary duties of life without serious strain upon the vital powers. The term does not mean perfect health, but a state of health free from any disease or ailment that seriously affects a person�s general physical soundness. Good health is not impaired by a mere temporary indisposition, which does not tend to weaken or undermine the constitution. One of the most comprehensive definitions was supplied by a Kansas court:

There has been a tendency on the part of some courts to narrow the application of the clause to cases where a change in the applicant�s health occurs between the time of the medical examination and delivery of the policy to the applicant. This line of decisions is exemplified by a Pennsylvania case, in which the court stated that the good-health clause has no application to a disease the applicant may have had at the time of the medical examination unless fraud or misrepresentation can be proved, since presumably the applicant�s physical condition was satisfactory to the company; otherwise, the policy would not have been issued. According to the court, "The legal scope of that provision is restricted to mean only that the applicant did not contract any new disease impairing his health, nor suffer any material change in his physical condition between the time of such examination and the date of the policy. . . ."

This interpretation of the good-health clause is certainly at variance with the common understanding of the term good health and with the legal definition cited earlier, but it is consistent with the apparent purpose of the clause. As a matter of fact, companies have usually invoked the clause as a defense against a claim only where there has been a change in the applicant�s health, or where there has been fraud or misrepresentation in the application. Moreover, the burden of proving that the applicant was not in good health at the time of delivery of the policy is usually on the insurance company, although a minority of courts have held that the insured or the beneficiary must prove compliance with the clause.

Medical Treatment after Submission of Application. Some policies issued today contain a clause that provides that the life insurance policy will not take effect if the applicant has received medical or hospital treatment between the time that the application was signed and the date of delivery of the policy. Like the good-health clause, this clause is designed to deal with a change in the applicant�s physical condition during the time the application is being processed. It is intended to be a condition precedent, and the courts generally treat it as such. In other words, if during the contestable period, the company can prove that the applicant received medical or hospital treatment between the date of the application and delivery of the policy and failed to disclose that fact to the company, the company can avoid liability under the contract. If the medical treatment is disclosed at the time the policy is delivered, the company, after consideration of the ailment, may conclude that the applicant�s insurability is not impaired and waive the clause. The courts are very zealous in seeking a waiver of the clause manifested in the conduct of life insurance companies or their agents.

Justification of Conditions Precedent. When the premium is not paid with the application, all conditions precedent must be fulfilled before the contract becomes effective. In general this means that the policy must be delivered by the agent while the applicant is alive and in good health, and the full amount of the first premium must be paid in cash or by a valid check at the moment of delivery. Delivery of the policy and payment of the first premium are supposed to be simultaneous transactions.

Recognizing the advantages to both the applicant and the company of having the coverage attach at the date of application, insurance companies have devised a procedure to accomplish this objective. This procedure, involving the use of a conditional receipt, is described in the following section.

The applicant can avoid the legal consequences of conditions precedent by remitting the first premium with the application for insurance. Companies generally acknowledge receipt of the premium with a document called a condi-tional receipt, which binds the coverage without reference to delivery of the policy. There are several forms of conditional receipt in general use today, but the two basic types are the insurability type and the approval type. The insurability type is the most common by a large margin. The approval type is no longer widely used because it offers far less protection to the applicant than the insurability type.

Insurability Type. The insurability type of receipt (see figure 3-1) makes the coverage effective at the time of the application, provided the applicant is found to be insurable in accordance with the general underwriting rules of the company. Some receipts make coverage effective on the date of the application or the medical examination, whichever is later.

Coverage under such a clause, however, is not automatic. The applicant is considered to have made an offer to the insurer. The insurer, by issuing the conditional receipt, accepts the offer, subject to a condition�the condition that the applicant is found to be insurable. If the home office finds the applicant to have been insurable in accordance with its general underwriting rules on the date of the application or medical examination, the coverage attaches retroactively to the date cited. If the company finds that the applicant was not insurable at the time he or she submitted the application, the coverage never attaches under the policy applied for and the premium is refunded. For the coverage to be binding as of the date of application, the risk must be acceptable to the company under its underwriting rules on the plan and for the amount applied for and the premium rate on the application. If the risk is acceptable, but only on a plan or at a premium rate different from that on the application, the company is construed to have made a counteroffer that must be accepted by the applicant before the coverage can become effective.

If the applicant is found to have been insurable at the date of application, coverage attaches retroactively even though, in the meantime, the applicant may have died or suffered a deterioration in health. Companies are frequently called upon to consider the application of a person known to have died since applying for insurance, and they are careful not to permit knowledge of that fact to influence their underwriting decision. The same code of ethics is followed in reviewing the prepaid applications of persons who have subsequently suffered heart attacks or other physical impairments. If the applicant is to receive the fullest benefit of the conditional receipt, it is absolutely essential that the company apply general underwriting standards, rather than standards tailored to fit the individual case.

Approval Type. The approval type of receipt (see figure 3-2) states that the coverage is effective from the completion of the application, provided the company approves the application. The receipt usually makes no reference to the criteria that will be applied in the company�s consideration of the application. Under the present state of the law, however, it is clear that the company must act reasonably and apply its customary underwriting standards.

Under the approval type of receipt, the company is not at risk if the applicant dies before the application is acted upon. Nevertheless judicial opinion is divided as to whether the insurer should be held liable for payment of the policy�s face amount if the applicant dies before the company acts on the application.

There is a judicial trend, noticeable with respect to both the insurability and approval types of receipts, to find an ambiguity and to hold that there is coverage from the date of the receipt until approval or declination of the application. In recognition of this trend, a minority (but a growing minority) of insurers use a form of conditional receipt that places the company unconditionally at risk from the date of application, usually for a limited face amount and period of time, such as 60 days. The insurance remains in full effect unless and until the application is declined. Under this form of receipt, the applicant enjoys coverage for a brief period even when he or she is definitely an uninsurable risk.

Properly construed, the conditional receipt arrangement offers real benefits to both the insured and the insurer and is widely used. It protects the applicant against loss of insurability while the application is being processed, and it protects the company against a declination of the policy by the applicant after it has been issued�at considerable expense. The arrangement is feasible, since all applicants using the plan pay their premiums in advance, and the company is not exposed to adverse selection. Moreover, the arrangement does not involve any relaxation of underwriting standards.

The majority of courts interpret conditional receipts strictly in accordance with the language used by the insurer. Nevertheless, even these courts have a clear preference to find that coverage does exist, and to do so they are sometimes creative in discovering an ambiguity that can be construed in favor of the applicant. The minority of courts take a much more liberal view in favor of the applicant. They tend to ignore the language of the conditional receipt and find that coverage exists because the applicant, having paid the premium, would have reasonably expected it to exist. A decreasing number of courts seem to be willing to go so far as to rewrite the terms of the conditional receipt.

However, some insurers expect that some courts will find temporary coverage effective regardless of the conditions stipulated in the receipt. In some jurisdictions, to eliminate the possibility of unintended temporary coverage, a few insurers have stopped accepting a premium payment with the application.

The first premium is rarely remitted with the application without a conditional receipt being issued to the applicant. Under such circumstances, coverage does not attach until the application has been approved and the policy has been delivered. The applicant is considered to have made an offer that can be withdrawn at any time before acceptance by the company. Acceptance is manifested by delivery of the policy.

As with policies whose premiums are not paid in advance, delivery can take the form of an actual physical transfer of the policy from the agent to the applicant or transmission through the mail in such manner as to constitute constructive delivery. However, if the application requires that the policy be delivered to the applicant while he or she is in good health, mailing the policy to the agent for delivery to the applicant is not likely to be regarded as constructive delivery since a condition has been imposed on its release. Mailing the policy directly to the applicant, regarded as a waiver of the delivery requirement, would be treated as a waiver of the good-health requirement only if the insurer had knowledge of a breach of the condition. The contract would become effective the instant the policy is placed in the mails, even if the insured never receives it.

A life insurance company owes a moral duty (and in a minority of the states a legal duty) to the insuring public to consider all applications within a reasonable period and to render prompt decisions on the insurability of those seeking insurance. These two questions may arise in case of an unreasonable delay by the company in determining the insurability of an applicant:

It seems clear that no presumption of acceptance should be allowed when the application is not accompanied by the first premium. In that event, no offer has been made to the company, and the company�s silence could hardly be construed as acceptance of a nonexistent offer. A different situation exists, however, when the applicant remits the first premium with the application and thus makes a valid offer to the company.

As a general rule, silence is not construed as acceptance of an offer. To the contrary, after a reasonable time, the offeror can assume that the offer has been rejected and that he or she is free to deal with another party. If this were not the rule, people with goods to sell could flood the country with offers that the recipients would be obliged to reject so that they would not to become obligated to buy the goods. The writing of rejections could become an intolerable burden. A majority of courts have applied this general rule to the insurer�s silence and have held that no matter how long the company delays, its silence will not bind it to a contract of insurance.

A few courts have made a distinction between unsolicited offers, the usual kind, and those made in response to the activities of agents who are paid to solicit offers, as is the case in life insurance. These courts have held that the insurer�s unreasonable delay in rejecting an application constitutes an acceptance that completes the contract.

While in most states, delay in consideration of an application does not make an insurer liable under contract, some courts have recognized a liability of the company in tort�that is, a civil liability arising from other than a contract. Although they are distinctly in the minority (and it is believed that this is no longer an important trend in the law), these courts have held that since the company is operating under a franchise from the state, it is under duty to act promptly and with due care on all applications received by it. They argue that the state issues a charter or license in order that the public may have access to an important form of protection that, in the public interest, should be made available to all who can qualify for it. These courts believe that after the company solicits the application and obtains it along with the applicant�s consideration, the company is bound to furnish the insurance that the state has authorized or to decline to do so within a reasonable time. An Iowa court ruled, "Otherwise the applicant is unduly delayed in obtaining insurance he desires and for which the law has afforded the opportunity, and which the insurer impliedly has promised if conditions are satisfactory." Failure to live up to this obligation makes the insurer liable to the applicant for damages.

If an applicant who was insurable at the time of application dies before the insurance company�in disregard of its duty to act promptly�has approved the risk, many courts would hold that the applicant�s estate could recover the amount of insurance applied for. It would seem that if the insurer is adjudged guilty of a tort, the beneficiary would be the logical person to receive damages. With a few exceptions, however, the courts hold that the beneficiary is not a party at interest until coverage becomes effective and thus cannot recover. (The question of tort liability is not likely to arise under a conditional receipt since the conditional receipt forms in general use provide for retroactive coverage.)

The foregoing discussion was concerned with determining the date on which coverage under a life insurance contract becomes effective. This date is usually referred to as the effective date of the policy. It may or may not be the same date as that on the face of the policy, which is significant for other reasons. The date on the policy governs the status of various policy provisions after the contract has gone into effect, and it is sometimes referred to as the operative date of the policy.

The policy may bear the date on which it was issued, the date on which the coverage becomes effective, or the date on which it was applied for. The most common practice is to date the policy as of the date of issue unless there is a conditional receipt. In this event the policy will bear the date of the application or the medical examination, whichever is later.

Occasionally a policy carries a date earlier than the date of application. This is known as backdating (or antedating) the policy and is done only at the request of or with the consent of the applicant, usually to produce a lower insurance age and hence a lower premium. The practice is not generally regarded to be in conflict with antirebating laws, but several states prohibit it when an age change is involved. Other states have attempted to control the practice by forbidding the issue of a policy that bears a date more than 6 months earlier than the date of the application, a limitation that many companies have voluntarily adopted.

The practice of backdating policies�which, from a legal standpoint, refers to the use of any date earlier than the effective date of the policy�raises these three important questions: