A Guide to Principle of Indemnity in Insurance!

The word indemnity means protection. In financial terms, it means reimbursement of the actual loss suffered by the insured. The principle of indemnity in insurance defines that it won’t compensate more than you deserve. It is the policy that puts you in the same place where you were before the loss happened. Generally, medical insurance is not put under the indemnity. Because it is uncountable. It is used in non-medical insurance like property insurance, car insurance, etc. It is a policy to bring back the insured person to the same financial position where he was before the loss

How does the principle of indemnity work?

Let us discuss how indemnity works in case of auto insurance and home insurance.

#1.Vehicle Insurance:

Suppose you own a car. You have car insurance that covers accidental damages. You have been using it for three years. So there is a depreciation in the value of your car. Now you met with an accident. The insurance company is not going to reimburse you for the money for a new car. It will be a loss for the insurance company. The company will consider the depreciation in the car value before paying you. So you will receive less money than the original cost of the car as you have used it for years. Thus the company is not paying you more than you deserve. It pays you enough so that you can recover from your loss. This is the working principle of indemnity in insurance.


#2. Homeowner’s insurance:

The same process is applicable in case of property insurances like homeowners’ insurance and furniture insurance. If your house is damaged and your furniture is destroyed in fire, cyclone, or flood the insurance company is going to pay you the actual cash value for the damages. This is done because the roof of your house, the furniture that you are using have a depreciation factor involved. These items will depreciate over time. So at the time of reimbursement, the insurance company will pay you the actual value of the asset deducting the depreciation.


How does indemnity pay you?

It pays you in cash or by repairs or replacement. Let us take an example. You have insured your house through homeowners’ insurance. The insurance company reimburses you in case there is fire damage or damages due to natural disasters. The insurance company can repair your house by authorized contractors. It can also reimburse the money that you have spent to repair your house.  By contract, they are obligatory to restore your house to the original state.


Why is the indemnity insurance important in Business?

Sometimes indemnity is used in large scales like between government and businesses or between governments of two or more countries. Indemnity is widely used in agreements. The policy provides financial security in case there is negligence, mistakes, unexpected mishaps, or some kind of unavoidable situations that could hamper the business. This type of insurance is done to secure your business against lawsuits. It helps the insured from paying the full amount in settlement. It covers you from the legal expenses you would face during a lawsuit filed against you.

There is indemnity insurance used only in business. They are

#1. Professional liability insurance:

This type of insurance is highly needed for a business. If a customer loses money as you failed to deliver he is going to file a lawsuit. So professional liability insurance is a must for your business. This type of insurance usually covers your legal expenses and settles your dispute with the customer. AIG is a good company giving out this policy.

#2. Errors and Omissions insurance:

It is a type of insurance that covers the companies and their workers against claims that are done due to negligence in work or inadequate work. It covers your court costs and settlement specified in the contract.

#3. Directors or Officers insurance:

This type of insurance covers individuals from personal losses if they are sued for their actions. Director has the power to run an organization. For their wrong decision if the company suffers a loss the stakeholders will file a case against him or the company. So to protect them from this kind of situation D&O insurance comes to work.  It pays for the losses and the legal expenses.

Type of clauses in the principle of indemnity

#1. First party indemnity: In this type of case both the company and the supplier indemnifies each other if there is a breach of contract.

#2. Third-party indemnity: In this case, the company indemnifies the supplier in case the third party faces a loss.

#3.Limited indemnity: The Company indemnifies the supplier other than the supplier’s fault.

#4. Reverse indemnity: When the company indemnifies the supplier due to its fault.

#5. Financing indemnity: The Company indemnifies the supplier if a third party fails to honor the financial obligation to the supplier.

Final Words

The sole purpose of the principle of indemnity is to compensate the insured from the financial losses that occurred due to some event. It helps them to recover their actual loss so that they can start over again. You cannot gain from an insurance company as it is not a source of profit. The payment cannot exceed the total value of the asset. It only compensates for the actual loss.

You should read all the clauses the insurance company is going to provide you. Ask your insurance advisor for more help if you are not able to understand any clause. It is always wise to consult with your advisor before you purchase any policy. There are many types of insurance company available in the market who offers different types of schemes. So shop around and take a quotation. Take the best policy that shoots you.

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