PSI Ohio Insurance Practice Exam

Which of the following best describes the principle of indemnity in insurance?

1. Compensation must equal the loss, not profit the insured.

2. The insurer pays a fixed amount regardless of the loss.

3. Insured can claim amounts for both direct and indirect losses.

4. The principle does not apply to life insurance.

The correct answer is: Compensation must equal the loss, not profit the insured.

The principle of indemnity in insurance is centered on the idea that an insured person should be compensated for their loss, but not in a way that allows them to profit from that loss. This principle is fundamental to the functioning of insurance, ensuring fairness and preventing moral hazard—the risk that the insured will take more risks because they are protected. When an insured entity suffers a loss, the goal of the indemnity is to restore them to their financial position prior to the loss, not to provide an opportunity for gain. This serves to maintain the integrity of the insurance system by ensuring that claims do not exceed the actual loss suffered. This principle does not apply similarly in all areas of insurance; for instance, in life insurance, the payouts are predetermined and do not directly correlate to any specific loss, which aligns with the nature of the insurance product. Hence, understanding that indemnity is about equating compensation with loss, rather than profit, is crucial for the principles governing most insurance policies.