What Is Indemnity Insurance?

by Teo Spengler ; Updated September 26, 2017

Everybody has monthly bills to pay, but nobody likes having to find the money to cover unexpected financial obligations or liabilities. In fact, people go to great lengths to avoid such unexpected financial losses. Indemnity insurance is one of the methods available to protect yourself.

When you purchase indemnity insurance, you are contracting with an insurance company to protect, or indemnify, you. That means in exchange for your insurance premiums, the company agrees to pay for certain losses you may suffer in the future. Essentially, the company agrees to make you financially whole in the event of an unexpected loss.

Definition of Indemnity

Indemnify is a legal concept. Under the law, it means that a person or entity compensates another person or entity for part or all of a loss or financial obligation. If a company contracts to indemnify someone against future financial losses, that agreement is called an indemnity contract.

Here are a few examples of indemnity contracts:

  • Automobile indemnity coverage is part of most standard automobile insurance policies. It means that the company agrees to cover any losses, including property damage, that the insured suffers from a vehicle accident.
  • Contractor indemnity is when a subcontractor works with a contractor, and the contractor is on the hook to the property owner for financial damage caused by the subcontractor's faulty work. If the subcontractor agrees to reimburse the contractor for any losses he causes, this is known as an indemnity agreement.

Principle of Indemnity

Under the principle of indemnity, the person to be indemnified receives back only enough money to make her whole. She can never profit from an indemnity contract or receive a windfall of cash that is not part of the specific debt or liability she is covered for. For example, if the insured damages her car in an accident, under an automobile indemnity policy she can recover up to 100 percent of the amount of the damage suffered, but she cannot recover more than is necessary to restore her to the same financial position she enjoyed before the accident.

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Advantages of Indemnity Insurance

The obvious advantage of indemnity insurance is that a person is insulated against a specific type of financial loss. For a known sum -- the cost of the insurance premiums -- you can protect yourself from unknown losses. This is useful to both individuals and businesses that need to plan fixed expenses as part of a budget.

Exceptions to the Principle of Indemnity

Modern laws have created a number of exceptions to the general principle of indemnity. In these exceptions, the company generally agrees to pay a sum certain in the event a specified loss occurs. For example, in a personal accident and life insurance policy, the insurer may agree to pay the policy amount if the insured dies in a covered accident. The company does not address the question of restoration or profit. Likewise, sometimes ship owners often contract with marine insurance companies to cover a total loss of the ship and/or its cargo at a fixed sum, such as one million dollars. The company then does not assess the actual amount of loss, but simply pays the contracted amount if the ship is lost.

About the Author

From Alaska to California, from France's Basque Country to Mexico's Pacific Coast, Teo Spengler has dug the soil, planted seeds and helped trees, flowers and veggies thrive. World traveler, professional writer and consummate gardener, Spengler earned a BA from U.C. Santa Cruz, a law degree from Berkeley's Boalt Hall, and an MA and MFA from San Francisco State. She currently divides her life between San Francisco and southwestern France.

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