An aleatory contract is a contract in which parties involved in the agreement are not required to perform any action until and unless a triggering event mentioned in it takes place. In an aleatory contract, a triggering event is required for the contract to come into effect. This event will be specified in the contract. It can be something that cannot be controlled by either of the parties mentioned in the contract, including death or a natural event.
A classic example of an aleatory contract is a life insurance policy. Here, the insurer does not have to pay the insured any money until the trigger event (death) happens. An annuity is another form of an aleatory contract in which an investor pays premiums up to a certain point and then the insurance company is mandated to give payouts to the investor at regular intervals.
Insurance policies usually make use of aleatory contracts. In fact, they form the basis of many insurance policies. For instance, in the case of property insurance, the policy will state that the insurer will have to pay the insured amount only if the property is destroyed by a natural disaster like a fire or an earthquake. Aleatory contracts are purchased because they reduce the risk borne by the buyer.
Understanding aleatory contracts
In the field of insurance, an aleatory contract means that the payouts arranged for the insured are unevenly balanced. The insured person keeps paying the premiums till the trigger event happens. If the event does not happen, the insurer will not have to pay anything. But if the trigger event happens, the payout will be much higher than the sum of the premiums paid by the insured. Historically, aleatory contracts have been linked with gambling and have even been mentioned in Roman law in relation to contracts that depend on unsure events.
How do aleatory contracts work?
Assessing risk is one of the main aspects of aleatory contracts. A classic example of an aleatory contract is a life insurance policy. Here, the insurer does not have to pay the insured any money until the trigger event (death) happens. The payout happens only in the case of the death of the insured.
The uncertain event here is death since no one can predict when someone will die of natural causes. But the certain part is that if the insured does happen to die, the beneficiary of the life insurance will receive a payout that is many times the multiple of the total premiums paid by the insurer.
Another mandatory factor in a life insurance payout is that the insured must have paid all the premiums that were due till the time of their death. If the premium payments were not regular, the insurer is not obligated to pay the beneficiary anything.
Aleatory contracts and annuities
An annuity is another form of an aleatory contract in which the parties to the contract accept a certain level of risk. This is an agreement between an insurance company and an investor. Here, the investor makes a series of premium payments to the insurance company up to a certain point, for example, retirement. Upon reaching this point, the insurance company is legally required to give the annuity holder payouts periodically.
The annuity holder stands to gain from this in the form of regular income payments from the insurance company resulting in a happy retired life. On the other hand, if the investor withdraws the money early, they may lose the premiums they have paid. There are various types of annuity contracts each with its own set of rules for early withdrawal penalties, the structure of the payouts, fee schedules, etc.
