What does the principle of indemnity in insurance entail?

The principle of indemnity in insurance is fundamentally designed to ensure that an insured individual receives compensation that restores them to their financial position prior to a loss, but does not allow them to profit from that loss. This principle helps to prevent unjust enrichment by ensuring that insurance payouts match only the documented losses incurred, thereby reflecting actual economic harm.

By adhering to this principle, insurance aims to maintain fairness and stability within the system. The compensation provided focuses on the value of the property or extent of the financial loss incurred, which reinforces the idea that insurance is a protective measure rather than a financial windfall for the insured.

This principle contrasts with options that suggest providing additional coverage beyond what is necessary or that reward the insured for good risk, which would undermine the core objective of indemnification. It is also distinct from cost-effective policies aimed at high-risk individuals, which are designed to manage risks rather than to indemnify.