Principle of Indemnity, Definition, Functions, Application

• Financial Restoration : The main aim is to restore the insured to their financial state prior to the loss.
• No Financial Gain : The insured cannot profit from the insurance policy; compensation is strictly based on the actual loss incurred.
• Insurable Interest : The insured must have a legitimate insurable interest in the item covered by the insurance for this principle to be applicable.
• Compensation Limits : Compensation is capped at either the actual loss amount or the policy limits, whichever is lower.
• Depreciation Consideration : In property insurance, depreciation may be factored in to determine the property's actual value at the time of the loss.

Also Read: Different Forms of Business Organizations

Exceptions to the Principle of Indemnity

Here are the exceptions to the Principle of Indemnity:

• Life Insurance : Life insurance does not adhere to the principle of indemnity, as the insurer pays a fixed amount (the face value) upon the insured's death, regardless of any actual financial loss.
• Personal Accident Insurance : Similar to life insurance, personal accident insurance may provide a set sum for specific injuries or events, thus deviating from the strict application of the principle of indemnity.
• Valued Policies : Certain insurance policies, known as valued policies, specify a predetermined compensation amount that does not depend on the actual loss, making them exceptions to the principle.
• New-for-Old Policies : In some cases, particularly in marine insurance, "new-for-old" clauses allow for the replacement of damaged or lost items with new equivalents without factoring in depreciation.

Application of the Principle of Indemnity

Here are the applications of the Principle of Indemnity:

• Property Insurance : This principle is used to compensate the insured for actual financial losses from property damage or loss, taking into account repair costs and depreciation.
• Liability Insurance : Although liability insurance does not strictly follow this principle, it still compensates the insured for actual financial losses arising from covered liability claims.
• Health Insurance : This principle applies in health insurance by reimbursing the insured for actual medical expenses incurred, up to the limits specified in the policy.
• Motor Insurance : After an accident, motor insurance employs this principle by compensating the insured for either the repair costs or the actual cash value of the damaged vehicle.

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