What is the principle of indemnity in insurance?

The principle of indemnity in insurance is fundamentally about ensuring that compensation for a loss does not exceed the actual amount of the loss incurred. This concept is designed to prevent the insured from profiting from their insurance claim, thus reinforcing the notion that insurance is meant to restore the insured to their pre-loss financial position rather than allow them to gain financially from their misfortune.

Under this principle, if an individual has an insurance policy that covers a specific loss, the payout from the insurer will correspond directly to the financial loss suffered, ensuring that the policyholder does not receive a windfall as a result of the event leading to the claim. For example, if a person's property suffers damage worth $10,000, their insurance payout will be limited to that amount, provided that is the extent of the loss.

The other choices do not accurately capture the essence of the indemnity principle. For instance, promoting profit from losses would contradict the intention of insurance, and methods for calculating risk premiums deal more with assessing the likelihood of loss rather than addressing compensation after it occurs. Similarly, policyholder disclosures are more related to the responsibilities of the insured than the principle of indemnity itself.