Indemnity
Indemnity is a fundamental insurance principle stating that an insured should be restored to the same financial position they were in immediately before a loss occurred, receiving compensation equal to the actual loss without profit or gain.
Exam Tip
Indemnity = restore to PRE-LOSS position, no profit. ACV = Replacement Cost - Depreciation. Life insurance is EXCEPTION (valued policy). Subrogation supports indemnity principle.
What is the Principle of Indemnity?
The principle of indemnity is one of the core principles of insurance. It states that insurance is designed to compensate the insured for actual financial loss suffered, restoring them to the same financial position they held before the loss occurred. The insured should neither profit from nor suffer loss beyond the actual damage.
Core Concept
| Element | Description |
|---|---|
| Purpose | Restore insured to pre-loss financial position |
| Limitation | No profit from insurance claims |
| Measurement | Based on actual cash value or replacement cost |
| Goal | Make the insured "whole" again |
How Indemnity Works
| Scenario | Without Insurance | With Indemnity Principle |
|---|---|---|
| $10,000 car damaged | Owner bears full loss | Insurance pays up to $10,000 actual value |
| Partial damage | Owner pays repairs | Insurance pays actual repair cost |
| Total loss | Owner loses asset | Insurance pays actual cash value |
Indemnity vs. Valued Policies
| Aspect | Indemnity Policy | Valued Policy |
|---|---|---|
| Payment | Actual loss amount | Pre-agreed fixed amount |
| Applies to | Most property insurance | Life insurance, some marine/fine art |
| Calculation | Assessed at time of loss | Determined at policy inception |
| Profit Possible? | No | Potentially yes |
Methods of Indemnification
| Method | Description | Example |
|---|---|---|
| Cash Payment | Direct payment to insured | Check for damages |
| Repair | Insurer arranges repairs | Auto repair shop |
| Replacement | Insurer replaces property | New for old |
| Reinstatement | Insurer restores property | Rebuild structure |
Actual Cash Value (ACV)
| Component | Calculation |
|---|---|
| Formula | Replacement Cost - Depreciation = ACV |
| Example | $20,000 (new) - $8,000 (5 years depreciation) = $12,000 ACV |
| Purpose | Ensures indemnity, prevents profit |
Replacement Cost vs. ACV
| Aspect | Replacement Cost | Actual Cash Value |
|---|---|---|
| Depreciation | Not deducted | Deducted |
| Payment | Cost of new item | Value of used item |
| Premium | Higher | Lower |
| Indemnity Principle | Modified application | Strict application |
Exceptions to Indemnity
| Exception | Description |
|---|---|
| Life Insurance | Pays fixed death benefit (valued policy) |
| Health Insurance | Fixed daily benefits not tied to actual cost |
| Valued Policies | Agreed value paid regardless of actual loss |
| Replacement Cost Coverage | Pays to replace without depreciation |
Related Insurance Principles
| Principle | Connection to Indemnity |
|---|---|
| Insurable Interest | Must have financial stake in loss |
| Subrogation | Prevents double recovery |
| Contribution | Multiple policies share loss proportionally |
| Utmost Good Faith | Honest disclosure prevents fraud |
Subrogation and Indemnity
| Step | Action |
|---|---|
| 1 | Insured suffers covered loss |
| 2 | Insurer indemnifies the insured |
| 3 | Insurer gains right to recover from third party |
| 4 | Any recovery reduces insurer's loss |
Exam Alert
Indemnity = restore insured to SAME financial position as before loss. NO profit from insurance. Actual Cash Value = Replacement Cost - Depreciation. Life insurance is an EXCEPTION (valued policy, pays agreed amount). Subrogation supports indemnity by preventing double recovery.
Study This Term In
Related Terms
Actual Cash Value (ACV)
InsuranceActual Cash Value is a property valuation method that equals replacement cost minus depreciation, representing what property is worth today after accounting for wear and tear.
Replacement Cost
InsuranceReplacement cost is a property valuation method that pays the full cost to replace damaged property with new items of like kind and quality, without deducting for depreciation.
Subrogation
InsuranceSubrogation is the insurance principle that allows an insurer, after paying a claim, to assume the policyholder's legal right to recover damages from the third party responsible for the loss.
Insurable Interest
InsuranceInsurable interest is a legal requirement that the person purchasing insurance must have a financial stake in the insured person or property, ensuring they would suffer a genuine loss if the insured event occurs.