What is the principle of indemnity in insurance?

The principle of indemnity is a fundamental concept in insurance that ensures a policyholder is restored to the financial position they were in prior to the loss, without the opportunity to profit from that loss. This principle maintains that insurance is intended to provide compensation for actual losses incurred rather than serve as a source of profit.

When a loss occurs, the insurance payout should equal the value of the loss experienced by the insured. This means that if a person incurs a loss due to damage or destruction of property, their compensation should cover the cost of repairs or replacement up to the policy limits. By adhering to this principle, insurance companies help prevent moral hazard, where policyholders might take unnecessary risks or fail to take care of their property, knowing they could receive more than they lost.

In this context, the choice correctly emphasizes that the insured cannot profit from a loss, ensuring fairness and integrity in the insurance system. This ultimately reinforces the purpose of insurance as a mechanism for managing risk rather than a means of financial gain.