What is an aleatory contract?
How can a contract be linked to a future uncertain event?
Is an insurance contract an aleatory contract?
In this article, we will break down the notion of “aleatory contract” so you know all there is to know about it!
We will look at what is an aleatory contract, we’ll define the term aleatory and consider the legal definition of an aleatory agreement, we’ll look at how they are structured, assess an aleatory insurance contract, compare it to annuities and commutative contracts, look at examples and more!
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What is an aleatory contract
An aleatory contract is a type of contract where the parties’ obligation is linked to a future and uncertain event.
In other words, the contracting parties promise to execute certain obligations or perform certain things upon the happening of a specific triggering event.
Typically, we see aleatory contracts in:
- Gambling contract
- Wagering contract
- Speculative investments
- Insurance contract
- Life annuities
In these types of aleatory contracts, the parties’ rights and obligations are materialized when an event is agreed to happen effectively in the future.
Aleatory agreements are prevalent in the insurance sector.
In fact, insurance policies are generally aleatory in nature (generally known as aleatory insurance).
The insured is required to pay a certain amount of money as a premium whereas the insurer does not have any obligation to make any payments until an uncertain event occurs in the future.
Business interruption insurance is an aleatory insurance contract.
The insured can only expect to receive payment when and if there’s a qualified event leading to its business being interrupted.
An aleatory insurance (essentially an aleatory contract) is a very useful instrument to hedge against the risk of financial loss due to something happening in the future.
If you purchased an automobile and wanted to reduce the risk of financial loss due to theft, you will then need an aleatory insurance agreement where you insure yourself against the possibility of car theft.
The insurance company will pay a certain amount of money in the event the car is stolen (the uncertain event triggering the insurance company’s obligation).
Aleatory contract definition
In this section, we’ll define aleatory contract.
To define aleatory contract, we’ll need to answer the question: what does aleatory mean?
According to the Merriam-Webster dictionary, the term aleatory means:
Depending on an uncertain event or contingency as to both profit and loss
In other words, the term aleatory means something that is uncertain, unpredictable or conditional upon something.
Now, what is aleatory contract?
According to the USLegal, an aleatory contract is defined as:
An aleatory contract is a contract whose execution or performance is contingent upon the occurrence of a particular event or contingency or an uncertain (random) event beyond the control of either party.
In different terms, an aleatory contract is a legally binding agreement where the parties commit to performing certain acts or obligations in the event of an uncertain future outcome or event.
Aleatory contract insurance
One of the most important types of aleatory contracts is aleatory insurance contracts.
What is the aleatory contract insurance definition?
Why are insurance policies called aleatory contracts?
In an aleatory insurance contract, the insured must make premium payments to the insurance company in exchange for the insurance company’s promise that they will make a payment to the policy beneficiary when an agreed event occurs in the future.
According to IRMI, an aleatory insurance contract is defined as:
An agreement concerned with an uncertain event that provides for unequal transfer of value between the parties. Insurance policies are aleatory contracts because an insured can pay premiums for many years without sustaining a covered loss.
The insured’s obligation to make a premium payment is typically much less in value than the amount the insured “promises” to pay should a triggering event happen.
This insurance contract is beneficial for the insured as he or she is getting protection against a defined “risk” by making small premium payments (in relation to the possible payout from the insurance company).
The triggering event could be fire, theft, business interruptions, natural disaster or any other event defined in the insurance policy.
Also, the possible or potential payout in the event the aleatory insurance policy is triggered will more than outweigh all the premiums paid by the insured.
The aleatory nature of an insurance contract is also beneficial to the insurance company as it can collect a set amount of premium on a regular basis and will only have to make payment should the triggering event take place.
If the event never happens, the insurance company keeps all the premiums.
If the event does happen, the insurance company will have to pay the promised coverage.
Insurance companies will typically perform a thorough risk assessment, market analysis, actuarial studies to ensure they properly calculate their risk and rewards.
They expect to make a profit by betting on the fact that they could collect more insurance premiums from their pool of insured than having to make payments.
Aleatory contract vs commutative contract
What is the difference between an aleatory contract and a commutative contract?
The most notable difference between these two types of contracts has to do with the parties’ correlative obligation.
In an aleatory contract such as an insurance policy, one party has to make small payments (premiums) to be financially protected (coverage) against a defined risk or should an event occur.
The insured’s obligation to pay premiums is much smaller than the obligation of the insurance provider to make a payout when the policy is triggered.
On the other hand, in a commutative contract, the consideration of one party is the same as the consideration of the other party.
In other words, the parties give and take the same thing or something of equivalent value.
For instance, a sales contract is a commutative contract as the amount of money paid by one party is equivalent to the market value of the goods delivered by the other.
Aleatory contract vs annuity contract
Another type of contract that can be qualified as an aleatory contract are annuities.
An annuity is a sum of money paid on a regular basis.
An annuity agreement or annuity contract is a type of investment where the investor makes required payments to the annuity provider who promises to pay the investor a sum of money on a regular basis at some point in time.
In many cases, annuity payments are made when the investor reaches a certain age, such as retirement age.
When the investor reaches the age of retirement, the annuity can go on for as long as the annuitant is alive.
The more the annuitant lives a long life, the more the annuity provider will have to make payments.
However, an annuitant may lose premiums if he or she withdraws the investment before the annuity milestone is achieved.
Aleatory contract example
An example of an aleatory contract is life insurance.
In the context of a life insurance policy, the insured will purchase a life insurance policy and agree to make premium payments in exchange to receive a financial payout in the event of the policyholder’s death.
In a life insurance policy, the policyholder will not get any insurance payments or coverage until he or she passes away.
This is an example of an aleatory contract as the insured event is death itself.
It’s not possible to predict in advance when a person will die although we know, with certainty, it will happen one day.
The fact that death is an uncontrollable and unpredictable event, we say it is an aleatory event.
As a result, an insurance policy covering an aleatory event is a good example of an aleatory agreement.
So what does an aleatory contract mean?
An aleatory contract is based on what kind of exchange?
An aleatory contract is an agreement where the obligations are the parties are linked to and dependent on the occurrence of an uncertain future event.
For example, wagering agreements and gambling typically trigger an important payment obligation by one party if something happens in the future linked to chance or an event (such as a sports team winning a game).
Insurance policies can also be considered as aleatory agreements as the insured can expect a large payout (outweighing all the premiums paid) if something were to happen in the future.
For example, car insurance protecting you against damages to the car, fire or theft is an aleatory contract.
If the uncertain event of a fire, damage or theft occurs in the future, the insurance company will make a payment.
In exchange for this promise, you must make regular premium payments to get the coverage or benefits if the uncertain event does happen.
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