Why Life Insurance is not contract of Indemnity?

Life insurance is one of the most popular and frequently purchased financial products and because of this insurer like life insurance Corporation of India and some private life insurance companies has become really big over time. The year on year growth rate is also satisfactory.

Many of us may have one or more life or general insurance products in their name but at the same time many of us do not know that the concept of insurance is governed by a few basic principles. These principles are popularly called as the seven principles of insurance which are utmost good faith, insurable interest, proximate cause, principle of indemnity, subrogation, contribution and loss minimization. Subrogation and contribution are not separate principles but considered as a corollary of the principle of indemnity. We will discuss the principle of indemnity in detail to answer the question asked in the topic along with a few others.

What is Indemnity?

Principle of indemnity suggests that the insured is compensated on a damage or loss which is covered under the policy up to the extent of loss suffered by him. This compensation by the insurance company will be such that he will be neither better nor worse than his situation just prior to the loss. As per this principle if the insurance company can get the damaged property repaired so that it functions just like before the loss occurred it is good and sufficient discharge of the insurer’s duties. This is followed as the insured cannot take undue benefit from the insurance mechanism and reduces the chances of moral hazard. It is due to this concept that prohibits fraudulent malpractices of purchasing insurance on old and dilapidated property and later claiming to get benefit out of the same. The principle of indemnity is basically implemented by charging depreciation and deducting salvage charges under an insurance contract.

Which insurance products are contract of Indemnity?

Most non-life insurance products, where the insurance is taken on a particular property for which value can be ascertained easily are contracts of indemnity. Therefore all motor own damage policy, Property insurance, Engineering insurance, Marine insurance, Liability insurance etc. are all indemnity contracts. We will take an example to understand this, say we have a car which is more than 5 years old, here we cannot obviously take insurance on the value of a brand new car. The insurer will only allow taking insurance on the depreciated value of the car which is known as insured declared value, so that policyholder cannot take undue benefit from the insurance company at the time of a claim.

Although there is a provision made as return to invoice cover where the insured can claim the full value of the car but this cover is available on payment of additional premium and it is only available to newer vehicles. In property, engineering and marine insurance as well the same concept of indemnity is applicable and the insurance will only compensated to bring him back to his position just before the loss.

In indemnity policies there will be no depreciation deducted when there is a partial loss which will be get repaired by insurer but there will be definitely a deduction of suitable depreciation and salvage charges when there is a total loss where the repair expenses are so high that it is not feasible for the insurer to do so. Normal health insurance policies covering in-patient hospitalization are also indemnity products as it basically works on the concept of reimbursing for the expenses which you spend in medical treatment and it is equal to making your loss good in no better or worse manner.

Why life insurance is not a contract of Indemnity?

Just like indemnity policies there are benefit policies where a lump sum amount will be paid on occurrence of the covered incident. Life insurance policies like term life providing death benefit, personal accident policies and health insurance policies covering specific diseases like cancer are some of the insurance products which work on this concept. Human life is not a product with a specific value where depreciation slabs can be introduced and calculations can be made to settle claims on indemnity basis.

This is the reason that life insurance contracts cannot on indemnity basis. No one can attach a value to the life of a human who is precious more than anything to relatives and near ones. But does that mean that the insurance policies like personal accident and life insurance do not adheres to the principle of indemnity.

Well, it may not do it completely but obviously does partially as the sum insured which can be opted under these policies will be linked to the income of the policyholder and will be what is considered enough to bring back the family out of financial distress in event of death of the earning member of the family.

The sum insured which can be chosen under a life or personal accident insurance policy will be generally up to 20 times the annual income of the policyholder which is an indirect way to apply and follow indemnity principle. Life insurance works of the human life value concept which is equal to present value of all future income an individual can earn for his family in lifetime. In other words it is the total value of the income in contemporary time the individual is expected to earn till retirement.


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