Principle of Indemnity

What indemnity means

An indemnity contract is designed to restore the insured to the financial position they were in immediately before the loss, no more and no less. The insured should not profit from a loss.

Indemnity is a core principle of property, motor, marine, liability and reimbursement-type health insurance. It does not govern benefit-type covers. Life insurance, personal accident death or disability benefits and fixed-benefit health plans pay a pre-agreed amount, because a human life or limb cannot be assigned a monetary value in the way a machine can.

Measuring the loss

Indemnity needs a measure of what was actually lost. For property this is usually the market value at the time of the loss. Depreciation is applied to arrive at that current value, so that the claim reflects the actual financial loss and not the original or an inflated price.

In motor insurance the measure is the Insured's Declared Value (IDV): the manufacturer's listed price less depreciation for age. In a total loss the insurer pays up to the IDV, subject to the policy excess and any salvage adjustment, and not the original purchase price.

A surveyor, licensed by IRDAI, is appointed to assess the loss independently: the cause, the extent of damage and the fair amount of the claim. A licensed surveyor is mandatory for losses above ₹50,000 in motor insurance and ₹1 lakh in other general insurance classes.

Under-insurance and the average clause

The average clause links indemnity to adequate insurance. It is triggered when the sum insured is less than the actual value of the property. The insured is then treated as bearing a share of every loss, and the claim is reduced in proportion: claim = loss × sum insured ÷ value at risk.

This is the rule of the classic Standard Fire and Special Perils policy. IRDAI's standard products, in force since 1 April 2021, relax it: Bharat Griha Raksha waives under-insurance, and Bharat Sookshma Udyam Suraksha and Bharat Laghu Udyam Suraksha ignore a shortfall of up to 15%.

Agreed relaxations and supporting principles

Reinstatement value cover, often called new for old, pays the cost of replacing damaged property with new property of the same kind, without deducting depreciation. It is an agreed relaxation of strict indemnity. Payment is usually made on actual reinstatement and is limited to the sum insured.

The principle of contribution supports indemnity. A person with two fire policies on the same property cannot collect the loss twice: the total paid cannot exceed the actual loss, and the insurers share it in proportion.

Rules at a glance

Key points

• Indemnity restores the insured to the pre-loss financial position, no more and no less.
• Life insurance and other benefit-type covers pay a pre-agreed amount and are not contracts of indemnity.
• Depreciation is applied to find the current market value of what was lost.
• The average clause reduces a claim in proportion when the sum insured is below the value at risk.
• Reinstatement value cover pays replacement cost without depreciation, usually only on actual reinstatement.

Common misunderstandings

• A loss smaller than the sum insured is not always paid in full: under the average clause, under-insurance reduces even a partial loss.
• Depreciation is not a penalty: it brings the claim to the value the property actually had at the time of loss.
• A second policy does not double the claim: the total paid across insurers cannot exceed the actual loss.

Questions people ask