Indemnity

Reviewed by Stefan Tirschler

Noun

in·dem·ni·ty | ɪnˈdɛmnətɪ

Definition: Protection against future losses or financial burdens.

If Steven suffers an insured loss, his insurance provider will provide indemnity.

What is indemnity?

Indemnity is common in legal contracts, especially contracts of insurance. Indemnity is a promise from one party to another: Party A agrees to reimburse Party B financially when Party B suffers a monetary loss.

Indemnity can also refer to the reimbursement itself.

To indemnify someone is to repay them, or make them whole, following a loss. Indemnification is the primary function of insurance: the insurance company indemnifies the insured when the insured suffers a loss.

Many types of contracts include indemnification clauses. To keep things straightforward, we’re only going to worry about indemnification as it relates to insurance.

What does it mean to indemnify someone?

As mentioned above, the essential point of insurance is an agreement between an insured and an insurer:

  • The insured agrees to pay the insurer a premium
  • The insurer agrees to indemnify the insured in the event of a covered loss

To indemnify an insured, the insurance company either pays them the cash value of the loss or pays to repair or replace their damaged property. In either case, the insurer is bringing the insured back to the same financial state they were in right before the loss occurred.

That’s indemnification. Here’s an example of an insurer indemnifying an insured:

Example

A powerful windstorm last night did considerable damage to Cole’s house. The storm tore shingles and siding from his house and felled a tree on his shed. The total cost to repair all the damage will be $12,000. Even though he hasn’t paid for the repairs yet, Cole has suffered $12,000 in damage. He makes a claim with his insurance company, and an adjuster promptly determines that his policy will cover the loss.

To indemnify Cole for his $12,000 loss, the insurance company decides to pay to repair his house and shed. Cole doesn’t need to pay anything (except his deductible), and all Cole’s damaged property has been restored to the state it was in before the windstorm. Thus, Cole’s insurer has indemnified him.

When they indemnify an insured, the insurance company decides if they are going to repair or replace the damaged property. If the insured doesn’t want to repair or replace their stuff, they can ask for cash instead. Cash settlements, however, are usually at cash value rather than replacement value.

That means the cash settlement is often a smaller amount of money than the replacement would have been, but it still counts as full indemnification.

There are two main limitations on indemnification:

  1. The insured usually must pay a deductible before the insurer pays the rest of the loss.
  2. There is typically a maximum dollar amount the insurer will pay, regardless of the actual cost of the damage.

Deductibles are typical in all home insurance policies, as are limits of coverage. The amounts for each of these vary from policy to policy. Check your policy wordings to see what your limits are. You’ll find that information right near the beginning of your policy documents.

One exception to the standard policy limits, found on many home insurance policies, is guaranteed replacement cost. This vital coverage means that the insurance company agrees to indemnify the insured for the full cost of repairing or rebuilding their home, even if the cost is more than the policy limit.

The important points

  • Indemnity is a promise from one party to another to cover the losses of that party.
  • Indemnification is the main point of insurance contracts.
  • Insurance policies usually limit the amount the insurer will pay to indemnify the insured.
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