What does the indemnity principle aim to prevent?

The indemnity principle aims to prevent overinsurance by ensuring that an insured individual does not profit from a loss. This principle is fundamental in insurance as it mandates that compensation paid to an insured party in the event of a claim should only cover the actual loss suffered and not exceed the value of the insured asset or risk.

This means that when a policyholder experiences a loss, the insurance payout is designed to restore them to their previous financial position without providing any additional financial gain. For instance, if someone has a house insured for $300,000 and suffers a loss that costs $200,000 to repair, the indemnity principle ensures they only receive compensation up to that $200,000, not the full insured amount. This helps maintain the integrity of the insurance system by preventing individuals from taking out insurance policies for more than the value of the asset and then claiming total losses to profit from the situation.