How does the principle of indemnity function in insurance?

The principle of indemnity in insurance is designed to ensure that the insured is compensated for their loss without allowing them to profit from it. This principle reflects the fundamental aim of insurance, which is to put the insured back in the same financial position they occupied before the loss occurred.

When a claim is made, the insurer evaluates the situation and pays out an amount that corresponds to the actual loss. This ensures that the insured receives fair compensation for their damages but does not receive any extra value beyond what was lost. By adhering to this principle, the insurance system maintains its integrity and prevents moral hazards, where the insured might otherwise be incentivized to cause losses intentionally or exaggerate claims.

Profit maximization for insurers, encouraging claims, or minimizing claims handling time are not aligned with the core objective of the indemnity principle, which is focused on equitable compensation for losses and protecting the insurer from undue financial strain.