What does the principle of indemnity in insurance entail?

The principle of indemnity in insurance focuses on the concept of restoring the insured to their pre-loss financial state following an insured event. Essentially, this means that the purpose of insurance is to compensate the policyholder for their loss without allowing them to profit or suffer financially as a result of the loss. This principle helps to maintain the balance of risk and ensures that an individual is made whole, rather than being placed in a better financial position than they were before the loss occurred.

In practice, this means that when a claim is filed and validated, the insurance company will cover the actual financial loss up to the policy limits, ensuring that the insured does not receive a windfall from their coverage. This principle of indemnity is fundamental to the functioning of insurance and helps prevent moral hazard, where individuals might take greater risks knowing they have insurance coverage that would compensate them beyond their actual loss.