What Is an Aleatory Contract?

An aleatory contract is an agreement for which the performance of the contract depends on events—like death, an accident, or a natural disaster—that are beyond the control of either party.

Historically related to gambling, these contracts first appeared in ancient Roman law as contracts whose fulfillment depended on chance. Typical examples included contracts related to speculative investment, gambling, insurance, and life annuities.

Many companies use aleatory contracts because they help reduce financial risk. Read on to learn more about aleatory contracts.

Aleatory contracts are legally binding agreements that state that one of the parties doesn’t have to act unless a certain event—such as death or an accident—occurs. These contracts are also characterized by an unequal consideration or exchange of value between the parties.

Since the performance of the contract depends on events that are beyond the control of either party, the benefits provided by an aleatory contract may or may not be equal to the premiums paid.

The purpose of aleatory contracts is risk assessment. Many individuals and companies enter into these contracts to protect themselves from potentially fatal events. Since they’re meant to protect insured parties from various risks, aleatory contracts vary greatly depending on the situation.

In other words, there’s no one-size-fits-all for writing aleatory contracts. Definitions of events, such as  “death” and “accident,” can vary greatly between policies. Most life insurance policies, for instance, don’t cover suicide while the policy is in force, while others allow for the payment of benefits in case of suicide if the policy is over two or three years old.

Yes, aleatory contracts are legally enforceable. Like other contracts, they feature the six essential factors of contract enforceability:

1. Offer
2. Acceptance
3. Awareness
4. Capacity
5. Legality
6. Consideration.

Although aleatory contracts’ consideration is unequal, that doesn’t mean they don’t offer consideration. Remember that consideration refers to the value that has been agreed upon, whether that’s money, an action, or a promise.

This means that services, property, and risk management are all legitimate examples of consideration. As such, aleatory contracts provide sufficient consideration because they offer protection from potential threats in exchange for premiums.

Insurance policies

As one of the most popular types of aleatory contracts, insurance policies don’t give any benefits to the policyholder until a specific event (death, an accident, or natural disaster) happens. This means that the insured party or policyholder will continue paying premiums without receiving anything in return other than coverage until the event occurs.

Once the event does happen, the insured party will receive a payout that can outweigh the sum of the payments they had previously made to the insurer.

There are five main types of insurance policies:

1. Life insurance: Life insurance protects people who are financially dependent on a particular family member. These policies give dependents, such as spouses, children, and parents, large payouts upon the death of the insured family member.
2. Homeowner insurance: This type of insurance covers damages and losses to your home and assets in the event of a disaster such as a fire.
3. Health insurance: Health insurance pays for potential surgical and medical expenses that you may incur in the future. Without health insurance coverage, you may have to pay exorbitant amounts to receive emergency care or an expensive treatment plan.
4. Long-term disability (LTD) insurance: Some people want to protect themselves in case they face an LTD in the future. LTD policies provide coverage so that you can continue your standard of living even if you can’t work anymore.
5. Automobile insurance: This type of insurance is required in most jurisdictions. Even if you’re not required to have it, you should get it. Without automobile insurance, you could lose all of your belongings if you are held liable for causing someone’s injuries.

Annuities

Annuities are contracts that give investors a steady income stream in the future. They are considered a type of insurance policy and are widely offered and distributed by financial institutions.

These contracts are mostly used for retirement purposes and help retirees tackle the risk of outliving their pension and savings. Annuities have two phases:

1. The accumulation phase:This is when investors purchase or invest in annuities with lump-sum or monthly payments.
2. The annuitization phase: This is when the financial institution starts issuing a guaranteed income stream for a period of time or for the rest of the investor’s life.

There are two main types of annuities:

1. Immediate: Immediate annuities allow you to convert a lump-sum contribution (i.e., a lottery win or settlement) into an ongoing income stream so you can immediately receive income. An immediate annuity allows you to:
   1. Pay taxes only on the earnings part of your immediate annuity payments, meaning you won’t be taxed on the initial deposit
   2. Supplement your income
2. Deferred: Deferred annuities provide investors with an income stream that begins on a date of their choice. They are great for long-term retirement planning because:
   • There are no limits on annual annuity contributions.
   • There’s a death benefit, which means that if you die before collecting the annuity, your family will get the amount you contributed. They will also receive investment earnings.
   • Income tax payments are deferred until you withdraw money.

Both types of annuities can be fixed or variable. Fixed annuities provide the investor with regular periodic payments, while variable annuities enable the investor to receive larger future payments if the annuity funds’ investments do well. However, it will provide smaller payments if the investments do poorly.

Guarantees

Guarantees are agreements issued by banks that the bank (the guarantor) will pay a specific amount to a party (beneficiary) of a contract as protection against the risk of the other party’s failure to perform.

If the other party fails to perform according to the contract, the beneficiary can demand payment from the guarantor, who can then seek payment from the other party, known as the principal.

There are many types of guarantees, including:

• Demand guarantees: Typically issued by banks, demand guarantees are a great way to manage, transfer, and price non-performance risk.
• Personal guarantees: These are agreements between business owners and lenders that state the lender will be responsible for paying back a loan if the business is unable to make payments.
• Upstream or subsidiary guarantees: An upstream or subsidiary guarantee is a financial guarantee in which the subsidiary company guarantees its parent company’s debt. Parent companies often require these guarantees when most of their assets are in their subsidiaries.

Aleatory contracts can be one of the more difficult contract types to draft and manage, as they often contain a lot more information and clauses than other types of contracts. Here are a few tips for drafting and managing them effectively:

1. Be detailed and direct

Be as detailed as possible when describing:

• What event or events trigger the contract
• How much one of the parties has to pay to secure the policy
• How the payout is calculated
• When the company won’t pay the benefit (i.e., if the insured person commits suicide within three years of the day the policy was issued)
• What happens if the paying party doesn’t pay their premiums

Avoid flowery language, use straightforward syntax, and define every term you come across. Otherwise, the readers may have a difficult time understanding how the contract works.

2. Use enterprise-grade contract management software

You should also consider using top-notch contract lifecycle management (CLM) software like Ironclad to help you draft and manage aleatory contracts. Sleek and user-friendly, Ironclad comes with all of the tools you need to turn contracts from blockers to enablers.

Our Data Repository allows you to store, find, draft, and manage aleatory contracts. Simple and powerful, it lets you bring in aleatory contracts from anywhere and enriches them with metadata. With all of your contracts in one place, you can find answers to questions within seconds and give other users as much—or as little—access to your contracts as needed.

Our software also comes with a codeless Workflow Designer that you can use to draft and approve aleatory contracts. A self-service tool that works out of the box, Workflow Designer doesn’t require long implementation times or technical expertise. Team members only need to upload an aleatory contracted template, tag fields as needed, and add approvers and signers to create and launch contract generation and approval processes.

What’s more, all of our contracts are up-to-date and have guardrails to ensure 100% contract compliance.

Aleatory contracts are agreements where a party doesn’t have to perform contractual obligations unless a specified event happens. These contracts also feature unequal consideration—for instance, an insured party will only receive coverage in return for premiums and won’t get a payout unless the specified event happens.

Common examples of these contracts include insurance policies, annuities, and guarantees.

Writing and managing aleatory contracts can be trying, particularly if you’re already up to your neck in contracts. That’s why you should consider using Ironclad. A premier digital contracting software, Ironclad will simplify and accelerate the contract management lifecycle. Our Data Repository and Workflow Designer will help you keep track of upcoming obligations, answer questions within seconds, and draft complex aleatory contracts in minutes.

Interested in experiencing the Ironclad difference? Try our free sandbox demo today.