What does the principle of indemnity guarantee in an insurance contract?

The principle of indemnity is a fundamental concept in insurance that ensures an insured party is compensated for their actual loss, but not to the extent that they profit from that loss. Choosing reimbursement for the actual amount of the loss reflects this principle accurately. Under this principle, the insurer agrees to pay for the economic loss incurred by the insured, allowing them to return to their financial position before the loss occurred without providing unnecessary financial gain.

In practical terms, this means that if a policyholder experiences a covered loss, such as damage to property, they will receive compensation that aligns with the cost to repair or replace that property, rather than a predetermined or arbitrary amount. This approach aims to prevent insurance fraud and helps maintain fairness within the insurance system by ensuring that claims are settled based on the real economic impact of the loss suffered.