Principle of Indemnity in Insurance

As a rule all insurance contracts expect personal insurance are contracts of indemnity.

According to this principle, the insurer undertakes to put the insured, in the event of loss, in the same position that he occupied immediately before the happening of the event insured against.

In certain form of insurance, the principle of indemnity is modified to apply. For example, in marine or fire insurance, sometimes, certain profit margin which would have earned in absence of the event, is also included in the loss.

In true sense of the indemnity, the insured is not entitled to make a profit of his loss.

Uses of the Principle of Indemnity

(i) To discourse over insurance

To discourse over insurance the principle of indemnity it is an essential feature of an insurance contract, in absence whereof this industry would have the hue of gambling and the insured would tend to effect over-insurance and then intentionally cause a loss to occur so that a financial gain could be achieved.

So, to avoid this intentional loss, only the actual loss becomes payable and not the assured sum (which is higher in over-insurance).

If the property is under-insured, i.e., the insured amount is less than the actual value of the property insured, the insured is generally regarded his own insurer for the amount if under insurance and in case of loss one shall share the loss himself.

(ii) To avoid an Anti-social Act

If the assured is allowed to gain more than the actual loss, which is against the principle of indemnity, he will be tempted to gain by destruction of his own property after getting insured against a risk.

He will be under constant temptation to destroy the property. Thus, the whole society will be doing only anti-social act, i.e., the persons would be interested in gaining after destruction of the property.

So, the principle of indemnity has been applied where only the cash-value of his loss and nothing more than this, though he might have insured for a greater amount, will be compensated.

(iii) To maintain the Premium at Low-level

If the principle of indemnity is not applied, larger amount will be paid for a smaller loss and this will increase the cost of insurance and the premium of insurance will have to be raised.

If premium is raise two things may happen – first, persons may not be inclined to insure and second, unscrupulous persons would get insurance to destroy the property to gain from such act.

Both things would defeat the purpose of insurance. So, principle of indemnity is here to help them because such temptation is eliminated when only actual loss and not more than the actual financial loss is compensated provided there is insurance up to that amount.

Conditions for Indemnity Principle

The following conditions should be fulfilled in full application of principle of indemnity.

(i) The insured has to prove that he will suffer loss on the insured matter at the time of happening the event and the loss is actual monetary loss.

(ii) The amount of compensation will be the amount of insurance. Indemnification cannot be more than the amount insured.

(iii) If the insured gets more amount than the actual loss, the insurer has right to get the extra amount back.

(iv) If the insured gets some amount from third party after being fully indemnified by insurer, the insurer will have right to receive all the amount paid by the third party.

(v) The principle of indemnity does not apply to personal insurance because the amount of loss is not easily calculable there.