Final answer:
An insurance contract with ambiguous terms is resolved in favor of the insured due to the nature of insurance as a contract of adhesion. Insurance relies on imperfect information and risk-sharing, with premiums balancing out compensation, though it may lead to moral hazard.
Step-by-step explanation:
An insurance contract which may contain a "gray area" or an ambiguity is typically resolved in favor of the insured because insurance is a contract of adhesion. This type of contract is characterized by imperfect information and is designed in such a way that the insurance company, which offers the pre-drafted agreement, holds more power in the transaction. However, should there be any unclear terms or ambiguities, they are often interpreted in the way that favors the insured party as they had little to no say in the contract's terms.
Insurance functions as a risk-sharing mechanism, where individuals pay premiums to be compensated in the event of an unpleasant occurrence. The inherent principle is that the amount collected in premiums on average should not be less than what is paid out on average. Nonetheless, because of the moral hazard, insured parties may take fewer precautions against risks since they are protected from some of their consequences.