Principle of Indemnity in Insurance
A claim puts you back where you were before the loss. Not worse, and not better.
Indemnity means the insurer puts you back in the same financial position you were in just before the loss. Not worse, so the cover is worth having; not better, so nobody gains from a fire or an accident. If your ten-year-old sofa worth ₹15,000 burns, indemnity pays around ₹15,000, not the ₹60,000 price of a new one.
The rule removes the incentive to cause or inflate a loss. It is the parent of two other principles, subrogation and contribution, both of which exist to stop the insured collecting more than the loss.
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How Indemnity Is Provided
The insurer usually has the choice. Know all four.
- 1
Cash payment
The most common method: the assessed loss is paid in money.
- 2
Repair
Typical in motor insurance: the insurer pays a network garage to repair the car.
- 3
Replacement
The insurer replaces the lost item with an equivalent, common for glass and some contents.
- 4
Reinstatement
The insurer restores a damaged building or machine to its former condition itself.
Under-Insurance and the Condition of Average
If you insure an asset for less than its value, you are paying for a smaller risk than the one you carry, so you bear part of every loss yourself. IRDAI's master circular on general insurance defines under-insurance as the amount of loss borne by the policyholder when the sum insured is less than the actual value of the asset, and requires the policy to state whether average applies and how much under-insurance is waived.
The formula: claim = loss × (sum insured ÷ value at risk). Example: a Pune shop's stock is worth ₹50 lakh but insured for ₹40 lakh. A fire damages stock worth ₹10 lakh. The claim is ₹10 lakh × 40/50 = ₹8 lakh, before any excess. The owner bears ₹2 lakh because they insured only 80% of the value.
Policies That Modify or Do Not Follow Indemnity
IRDAI lists the bases of settlement a general insurance policy can use. Several deliberately depart from strict indemnity.
| Basis or policy | How it departs from indemnity |
|---|---|
| Reinstatement value (new for old) | Pays the cost of reinstating without deducting depreciation or under-insurance |
| Agreed value | Pays the value agreed when the policy was issued, without adjustment or average. Used for antiques, art, vintage cars and in marine |
| First loss | Cover for an amount below the full value, used where a total loss is unlikely (burglary of a large warehouse) |
| Parametric | Pays a stated sum when a defined event occurs (rainfall below a trigger), without measuring the actual loss |
| Life and personal accident | Pay a fixed sum: a life or a limb has no market value to indemnify |
| Benefit-based health | Pay a fixed amount on diagnosis or hospitalisation; IRDAI lets the policyholder claim from all insurers under all such policies |
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The Classic Case: Castellain v Preston (1883)
A seller insured a house, agreed to sell it, and it was damaged by fire before completion. The insurer paid; the buyer then paid the full price anyway. The court held the insurer could recover its payment from the seller, who would otherwise have been paid twice. Brett LJ's judgment is the classic statement that a fire policy is a contract of indemnity only, and it is cited for subrogation too.
How IC-01 Tests This
Expect the four methods of providing indemnity, an average calculation, and "which of these is not a contract of indemnity" (answer: life or personal accident). The trap is applying average to a policy written on agreed value, or treating reinstatement value cover as strict indemnity.
FAQs
What is the principle of indemnity with example?expand_more
Insurance restores you to your financial position just before the loss, no better. If a five-year-old laptop worth ₹30,000 is stolen, indemnity pays about ₹30,000 after depreciation, not the price of a new laptop, unless the policy is written on a new-for-old basis.
Does the principle of indemnity apply to life insurance?expand_more
No. Life insurance pays a fixed sum assured because a human life cannot be valued in money. The same applies to personal accident benefits.
What is the condition of average in insurance?expand_more
A clause that reduces a claim in proportion to under-insurance. Claim = loss × sum insured ÷ actual value. Insure 80% of the value and you are paid 80% of each loss.
What are the methods of providing indemnity?expand_more
Cash payment, repair, replacement and reinstatement. The policy usually gives the insurer the choice.
Next steps
- Subrogationarrow_forward
- Contributionarrow_forward
- Sum Assured vs Insuredarrow_forward
- Principles of Insurancearrow_forward
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