What is the principle of indemnity in insurance?

The principle of indemnity in insurance is fundamentally about ensuring that the insured is restored to their prior financial condition following a loss, without the ability to profit from that loss. This principle is designed to prevent insurance from becoming a source of financial gain for the insured, which could lead to fraudulent claims or moral hazard where individuals might take unnecessary risks knowing they would be compensated beyond their actual loss.

When an insured event occurs, such as damage to property or loss of income, the insurance company assesses the situation and compensates the policyholder for the direct financial losses incurred, thereby reinstating their position as if the event had never happened. This is intrinsic to the way insurance policy values and claims are structured, ensuring fairness and integrity across the insurance system.

Other options do not encompass the key elements of indemnity as they either pertain to different aspects of insurance management or payment expectations rather than the central focus of restoring financial equivalence after a loss.