While it's a word most people have seen, especially with insurance companies, few understand how the principle of indemnity drives insurance - and your claim payment.
Put simply, indemnity is bringing a person or other entity back to the same financial condition he/she/it was in prior to a loss. For example, a person whose car is stolen would be considered to be indemnified once he or she has been paid enough to purchase another car of the same age, type and condition as the one that was stolen.
Indemnity is the principle that underlies all insurance policies; it is the basis for all aspects of the insurance industry, and especially the way claims are settled.
One of the main ideas of indemnity is that the party being indemnified should not profit from a loss. In other words, the financial situation after the loss should be exactly what it was before the loss. If the stolen car was five years old, the owner should not be paid what it would cost to buy a brand new car. This would put that person in a better condition than before the theft, which is not indemnity.
In some situations, like the case of the stolen car, the amount of the financial loss is relatively clear; therefore, it’s not too hard to fully indemnify the victim. But what about cases where it’s not so clear, or when there is no practical way to achieve exact equality?
Insurance policies, common and statutory laws, and general principles of insurance provide a number of ways to deal with these situations.
In property claims, one of the most common methods is Actual Cash Value (ACV). Again, an example. Suppose a strong windstorm damages the 10-year-old roof of a house severely enough that the whole roof needs to be replaced. You cannot go out and buy a 10-year-old roof. And even if you could, good luck finding someone to install it at labor rates from 10 years ago.
But if the insurer pays to install a new roof, the homeowner is better off than if the house still had the older roof. Actual Cash Value provides a solution by allowing the insurer to pay that portion of the repair cost that corresponds to the remaining value of the roof.
In other words, the adjuster will calculate the Replacement Cost Value (RCV) of the roof, and reduce that figure by the depreciation (loss in value due to age, wear and tear, etc) that the roof has incurred over time. The result is the ACV.
Many property insurers provide endorsements that allow the homeowner to recoup the depreciation once the repairs have been completed, but the basic policy coverage is based on ACV.
Casualty claims provide other challenges. A person who sustains a severely broken leg in a car accident has some costs, like medical bills and lost income, that can be calculated fairly easily. But what about potential future disability? What if further medical treatment is required 10 or 20 years down the road? What about the pain and trauma immediately after the accident? Does that have financial value?
Again, there are legal and contractual provisions and principles that help establish how much money an injured person is entitled to receive. Ultimately, as with the property situations noted above, the principle of indemnity provides the underlying basis for calculating these values.
