What is the principle of indemnity in insurance?

The principle of indemnity is foundational in insurance, emphasizing that an insured person should be restored to the financial position they occupied prior to a loss. This means that the purpose of insurance is not to enable policyholders to profit from their losses, but rather to cover the actual loss incurred.

When a claim is made, the insurance payout is intended to equal the financial loss suffered, ensuring that the insured is compensated fairly without experiencing a windfall or being left worse off than before the loss occurred. This principle helps maintain the integrity of insurance, preventing moral hazard where individuals might take excessive risks because they stand to gain from a loss situation.

Understanding this principle is critical for anyone involved in insurance, as it shapes policy design, claim adjustments, and the overall relationship between insurers and policyholders. The other choices refer to concepts that do not encapsulate the principle of indemnity, such as caps on premiums, obligatory coverage levels, or methodologies for future cost assessments.