Legal Definitions - indemnity principle

The indemnity principle is a fundamental concept in insurance law. It states that an insurance policy should aim to restore the insured person or entity to the financial position they were in immediately before a covered loss occurred, without allowing them to profit from that loss. In simpler terms, insurance is designed to make you "whole" again, but not better off than you were before the incident.

Here are some examples to illustrate this principle:

• Automobile Insurance: Imagine a person owns a seven-year-old sedan with a current market value of $8,000. They have comprehensive auto insurance. If the car is involved in an accident and declared a total loss, the insurance company, adhering to the indemnity principle, would pay out $8,000 (minus any applicable deductible). The insurer would not pay the original purchase price of the car, which might have been $25,000 seven years ago, nor would they pay for a brand new equivalent model. The payment reflects the actual value of the car at the time of the loss, ensuring the owner is compensated for their loss but does not gain financially from the accident.

• Homeowner's Insurance (Actual Cash Value): Consider a homeowner whose 15-year-old washing machine is destroyed by a burst pipe, a covered peril under their homeowner's policy. If their policy pays out based on "actual cash value" (ACV), the indemnity principle would mean the insurer pays for the cost of a new washing machine, *minus* depreciation for the 15 years of use the old machine had. The aim is to provide funds to replace the function of the old machine, not to give the homeowner a brand new appliance without accounting for the prior wear and tear, which would effectively put them in a better financial position than before the loss.

• Business Property Insurance: A small retail store experiences a fire that damages its inventory. The store has business property insurance. The indemnity principle dictates that the insurance payout for the damaged goods would be based on their wholesale cost or the actual cash value at the time of the fire, not the potential retail selling price. For example, if a shirt cost the store $15 to purchase and would have sold for $30, the payout would be $15. This ensures the business is compensated for the actual cost of the lost inventory, preventing it from receiving funds that would represent a profit margin it had not yet earned.