What does the 'principle of indemnity' state regarding insurance policies?

The principle of indemnity is a fundamental concept in insurance that aims to ensure that the insured is compensated for their losses without profiting from the claim. This principle dictates that insurance should restore the insured to the same financial position they occupied before the loss occurred, effectively putting them back in the situation they were in prior to the event that caused the damage or loss. This approach prevents moral hazard, which could arise if individuals were encouraged to incur losses knowingly, as they might benefit financially from a claim.

The focus on restoration rather than profit is essential in maintaining fair and balanced practices in the insurance industry. It ensures that the insurance mechanism serves its purpose of providing security without creating an incentive for fraud or over-reporting of losses. Policies structured around this principle promote equity and integrity within the insurance framework.