What is the principle of indemnity?

The principle of indemnity is a fundamental concept in insurance that seeks to ensure that an insured party is compensated only for their actual loss, without allowing them to profit from the insurance claim. This principle maintains that the objective of insurance is to restore the insured to their financial position prior to the loss occurring, rather than providing them with a financial gain.

By compensating only to the extent of actual loss, this principle helps to prevent moral hazard, where individuals might take risks or engage in reckless behavior if they knew they could gain financially from a loss. It also promotes fairness among policyholders, as it ensures that no one is better off after experiencing a loss, maintaining the equilibrium that insurance is meant to provide.

In summary, the emphasis on compensating for actual losses reinforces the role of insurance as a risk management tool rather than a means of generating profit, solidifying the importance of the principle of indemnity in the insurance industry.