What does it mean when an insurance policy is described as "indemnity"?

When an insurance policy is described as "indemnity," it is fundamentally aimed at compensating the insured for losses incurred, without allowing them to profit from the loss. The principle of indemnity ensures that the insured is restored to their financial position prior to the loss, but does not allow them to gain a financial advantage from the situation. This principle is essential to maintaining fairness and preventing moral hazard, whereby an individual might otherwise take undue risks knowing they could profit from a claim.

The focus on compensation rather than profit is crucial because it reinforces the purpose of insurance as a risk management tool, not a profit-generating mechanism. Indemnity policies distinguish between losses that can be quantified and compensated, versus opportunities that could arise from potential profit due to insurance payouts. This ensures that the insured receives a fair settlement for their actual loss rather than an inflated or advantageous amount.

This understanding of indemnity is embedded in the core of many insurance policies, guiding how claims are filed and evaluated. It reflects the ethical framework of insurance, ensuring that recovery from losses is fair and proportional to the actual damages suffered.