Principle of Indemnity

Insurance has 7 primary principles that the insurer, as well as the assured, should abide by. They are:

• Indemnity
• Utmost good faith
• Subrogation
• Contribution
• Loss minimization
• Proximate cause
• Insurable interest

We will be focusing on the Principle of Indemnity through the article. By the time this article ends you will have a thorough understanding of indemnity, its features, and its benefits. Further, you will also get clarity on the concept through an example. Let us begin!

What is the Principle of indemnity in insurance?

The principle of indemnity states that the assured will be put back into the same financial position that he enjoyed before his incident. The insurance company will only reimburse the assured to that extent, and not beyond. The assured cannot make a profit out of the insurance policy in any event.

The assured will be reimbursed to the extent of the damage caused, nothing more. The insurance company will only indemnify the assured to the extent of the damage, even though the policy value is greater than the damage caused.
Let us bring further clarity to this concept with an easy-to-understand example.

Example of Principle of Indemnity

Let us say Mr. Dheeraj has taken a health insurance policy with a cover of 10 lakhs. Let us assume that Mr. Dheeraj has suffered a minor accident and is admitted to the hospital for treatment.

The total hospitalization expenses amount to Rs 2 Lakhs. Mr. Dheeraj will only be compensated by the insurance company up to Rs 2 Lakhs, and nothing beyond that.

Thus even though Mr. Dheeraj had a cover of 10 lakhs, he was only eligible to receive Rs 2 Lakhs (As that was the actual expense of his hospitalization).

Features of Principle of Indemnity

• There is a minimum of 2 parties. i.e an indemnifier and a promisee.
• Indemnifier indemnifies the promisee against their losses.
• The indemnity contract must be valid under the Indian Contract Act, 1872.
• Promisee has the rights to take the indemnifier to court if he fails to make good on his promise.

The Principle of Indemnity Does Not Apply to Which Insurance?

The principle of indemnity does not apply to life insurance and certain types of marine insurance policies. Let us understand why this principle does not apply to life insurance.

Human life cannot be quantified. Thus the loss of this life does not have a definite value attached to it. This is why life insurance policies are fixed benefit policies. i.e The insurance company will pay the pre-decided amount to the nominee in the event of the policyholder’s demise.

The settlement amount is fixed and mentioned on the policy document. This makes a life insurance contract a contingent contract and not an indemnity contract.