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Indemnity: A key underlying principle of insurance

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By Adebisi Ikuomola

Insurance by tradition provides a safety net for the survival of businesses and individuals in society. The significance of this role cannot be overemphasized. The sector’s contribution to the GDP has been on the upward trajectory across countries with different jurisdictions and regulations.

Insurance players perform their laudable roles by putting their customers in their pre-loss position in making good the losses suffered by them.

One of the underlying principles of insurance is indemnity which is a method through which insurance companies pay compensation to their customers under the insurance contract. This method of compensation may take the following forms: repair, reinstatement, replacement or by cheque payment.

However, under-insurance and restrictive policy terms may preclude the insurance customer from getting compensation for the actual loss. In a decided case of Castellain v Preston (1883), ‘a contract of insurance is necessarily a contract of indemnity (except life and personal accident insurance) and of indemnity only.’ This presupposes that the customer can only obtain full indemnity and not more than indemnity.

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In a contract of indemnity, the selection of proper sum-insured is important as this is the limit within which indemnity will be considered. As mentioned earlier, excess and other restrictive terms such as franchise and average may reduce the amount eventually received by the customer in an insurance claim.

An excess is a predetermined amount to be borne by the customer to keep the customer in check on moral hazard in having to make constant trivial claims.

A franchise is also for the same purpose but with a caveat that claims will be fully paid when the franchise amount is reached. When the claim amount does not reach the franchise, the customer does not get compensation.

Average, on the other hand, defeats under-insurance. This may be pro-rata average condition, two conditions of average and special condition of average.

Despite the above restrictive terms, there are certain types of policies that have profound impact on the principle of indemnity. These are valued and first loss insurance. Valued policies are those policies where the value of the property is agreed beforehand and which is made the sum-insured under the insurance policy.

The condition of such a policy is that if there is a total loss, then the full sum insured is to be paid even though the actual value is less than the sum insured.

Therefore, the principle of indemnity is not followed strictly as depreciation is not taken into account. In cases of partial loss under a valued policy, normal indemnity basis applies.

The first loss is another case in point, where the sum-insured is deliberately restricted to a sum lesser than the actual value given that total loss is rather impossible because of the nature of the subject matter. For example, in burglary insurance, burglars may not be able to take away all the goods, particularly, if they are heavy.

We shall x-ray other principles of insurance in subsequent editions.

Conclusively, insurance solutions remain the most single platform to change the fortunes of organizations and individuals that have lost valuable assets.

Adebisi Ikuomola, is Executive Director, Technical Anchor Insurance Company Limited


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