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Principle of indemnity

Principles of insurance · Updated 17 October 2026

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In short

The principle of indemnity says insurance should restore the insured to the financial position they were in just before a loss, no better and no worse, so no one profits from a claim.

Also called: indemnity principle, contract of indemnity, indemnity basis

What is the principle of indemnity?

The principle of indemnity is the rule that a claim payment should put the insured back where they stood financially just before the loss, and no further. The insurer pays the actual loss, measured in money, up to the sum insured and subject to the policy terms. The insured should not end up richer because the loss happened.

Most general insurance (fire, property, motor own damage, marine, engineering) and hospitalisation health policies are contracts of indemnity. Life insurance and personal accident are not, because a human life has no market value to restore. Those are benefit or valued contracts that pay a fixed amount when the insured event occurs.

How the principle of indemnity works in India

Section 3 of the Marine Insurance Act, 1963 describes marine insurance as an agreement by which the insurer "undertakes to indemnify the assured" against marine losses, and Indian courts apply the same idea across non-life insurance. IRDAI's product rules also name indemnity as one of the basic principles every product must follow, under Regulation 4 of the IRDAI (Insurance Products) Regulations, 2024.

The principle is supported by several related doctrines, each of which stops the insured from collecting more than the loss:

DoctrineWhat it does
SubrogationAfter paying, the insurer takes over the insured's right to recover from a third party who caused the loss
ContributionWhere two policies cover the same loss, the insurers share it, and the insured cannot claim twice
SalvageThe value of damaged property left after the loss is deducted from the claim
Average clauseIf the sum insured is below the true value, the claim is reduced in proportion

Bases of settlement

The IRDAI Master Circular on Protection of Policyholders' Interests, 2024 requires insurers to state the basis on which a retail general insurance loss will be settled. The options it lists are:

  • Indemnity: the loss after depreciation, under-insurance, salvage and deductible.
  • Reinstatement value: the cost of replacing or repairing, without deducting depreciation or applying under-insurance.
  • Agreed value: a stated amount fixed in the policy, without adjustment.
  • First loss: cover for an amount below the full value of the items.
  • Parametric: a fixed payout when a defined event occurs, without measuring the actual loss.

Reinstatement and agreed value are deliberate, priced departures from strict indemnity. A reinstatement value fire policy, for example, can pay the cost of new machinery where pure indemnity would pay only the depreciated value.

Example

A shop insures its stock for ₹10 lakh on an indemnity basis. A fire damages stock with a market value of ₹6 lakh, and the burnt goods can be sold as scrap for ₹50,000. The policy has a ₹10,000 deductible. The claim payable is ₹6,00,000 minus ₹50,000 salvage minus ₹10,000 deductible, which is ₹5,40,000. The shop is back where it was, less the deductible it agreed to bear, and does not collect the full ₹10 lakh sum insured.

What the principle of indemnity means for distribution

Most claim disputes in general and health insurance come from a gap between what the customer expected (the sum insured) and what indemnity actually pays (the assessed loss).

  • Sum insured is a ceiling, not a promise. Customers often believe a ₹5 lakh health cover or a ₹50 lakh fire cover will pay that amount. Advisers should explain that only the actual, admissible loss is paid.
  • Under-insurance shrinks claims. If the customer insures a building at its purchase price rather than today's rebuilding cost, the average clause can cut the payout. Asking for a current valuation at each renewal protects both the customer and the channel's reputation.
  • Depreciation surprises. In motor own damage, parts depreciation is deducted under indemnity. That is why add-ons like zero depreciation sell well, and why they need clear explanation of what they do and do not change.
  • Health: indemnity vs benefit. An indemnity health policy reimburses hospital bills; a critical illness policy pays a lump sum on diagnosis. Selling them together works because they answer different needs, and the adviser should say so plainly.
  • Commercial customers. For SMEs, brokers and agents add value by choosing between indemnity and reinstatement bases and by documenting values so that claims settle quickly.

Sources

Health insuranceIndemnity health insuranceIndemnity health insurance pays the actual medical expenses an insured person incurs on covered treatment, up to the sum insured and subject to policy limits, rather than a fixed amount.Property, commercial and specialty insuranceAverage clause and under-insuranceThe average clause is a property insurance condition that reduces a claim in proportion to under-insurance when the sum insured is lower than the property's actual value at the time of loss.Principles of insuranceSubrogationSubrogation is the insurer's right, after paying a claim, to step into the insured's shoes and recover the amount from the third party who caused the loss, up to what it paid.Principles of insuranceContributionContribution is the principle that when two or more indemnity policies cover the same loss, the insurers share the claim in proportion, and the insured cannot recover more than the actual loss.Claims and policyholder serviceSalvageSalvage is the value left in damaged insured property after a loss, such as a wrecked car or fire-damaged stock, which is deducted from the claim or taken over by the insurer after payment.Health insuranceCritical illness insuranceCritical illness insurance is a benefit based health cover that pays a fixed lump sum when the insured is diagnosed with a listed serious illness, such as a specified cancer, whatever the bills.

Cite this entry

Glotus456 Research. "Principle of indemnity." Insurance Encyclopedia (India), updated 17 October 2026. https://www.glotus456.com/research/encyclopedia/principle-of-indemnity

About this entry. Written by the Glotus456 Research team, a BFSI distribution consultancy in Gurugram working with insurers, NBFCs and FinTechs across India. It explains how things work and is general information, not legal, tax or financial advice. Rules change: check the current IRDAI regulation or circular, or the official scheme or tax source, before acting.