What is the Principle of Indemnity in Insurance?

In the world of insurance the word “indemnity” is used in a variety of ways and this can sometimes cause confusion with clients however all should be aware of the principle of indemnity and its importance to most general insurance contracts but what is the principle of indemnity in insurance and why is is vital to the understanding of most general insurance policies?

What is indemnity in general insurance policies?

The principle of indemnity under a general insurance policy provides for the policyholder to be placed in the same financial position after a loss as they enjoyed immediately prior to the loss.

This is at the core of most general insurance policies and is enshrines the principle that a policyholder should not be placed in an improved position following a claim as this might lead to engineered or fraudulent claims.

How is indemnity provided under a policy?

The insurance company has a number of ways of providing an indemnity to a policyholder in the event of a claim;

  • Payment of Cash
  • Repair
  • Replacement
  • Reinstatement

The final option of reinstatement is only available to the insurance company if the policy specifically includes this option.

How “New for Old” cover modifies the principle of indemnity

Many policies, especially home insurance policies, provide for contents to be insured on a new for old basis and this is effect modifies the strict principle of indemnity as the policy will respond to claims without making a deduction for wear and tear, or the age, of the property lost and whilst the value of the property immediately prior to the loss may be significantly lower than its replacement cost the insured is in effect in a better position than they enjoyed prior to the loss. Extending this example it is possible that the replacement value of the property may in fact be even higher than it’s original cost thereby even further extending the principle of indemnity.

 
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