Indemnity in Insurance

A google search for the word, “indemnity” gives the following:

  • security or protection against a loss or other financial burden
  • security against or exemption from legal responsibility for one’s actions
  • a sum of money paid as compensation, especially one paid by a country defeated in war as a condition of peace.

All correct.

But the first bullet is more applicable to insurance.

Indemnity is one of the key principles of insurance business. This principle states that the insurance company will, in the event of a loss, put the insured back to the same financial position he was prior to the occurrence of the loss. No more, no less – the insured is not rewarded or penalised for the loss suffered.

In insurance, the insured is compensated up to the amount of the loss incurred. He does not profit from the unfortunate event, nor suffer a penalty for taking the initiative to insure in the first place.

Let’s say, for example, you insure your car for N5 million and it’s involved in an accident. The cost of repairs is N2 million and you submit the bill to your insurance company. The extent of your loss is N2 million. The insurance company will indemnify you up to the tune of N2 million because that’s the extent of loss you have suffered. Paying you more than that will translate to making a profit from the insurance cover; which is against the principle of indemnity.

Life insurance is not a contract of indemnity for the simple reason that the insurance company cannot adequately compensate a beneficiary for the loss suffered if a breadwinner (i.e. the insured) dies. One cannot place a monetary value on a life.

So, a life insurance contract is simply an agreement to pay a certain sum of money (i.e. sum assured) in the event of death of the assured, or at the maturity of the policy. In this case, the insurance company is not indemnifying (or compensating) the beneficiary for the death of the assured. Instead, it is paying an agreed amount on the occurrence of an agreed event (i.e. death or maturity of the policy). Life and health insurance contracts are therefore known as benefit policies, not indemnity policies.