Indemnification
Definition
The act of compensating someone for harm or loss, restoring them to their pre-loss financial position. In insurance, it refers to the principle that policyholders should be made whole but not profit from a loss.
Example
A contractor accidentally damages a client's property worth $50,000. The contractor's general liability policy indemnifies the client by paying the $50,000 repair cost, restoring the client to their pre-loss position without allowing them to profit.
In Practice
The principle of indemnification prevents moral hazard and ensures insurance serves its intended purpose of risk transfer rather than profit generation. Actual cash value and replacement cost are both methods of indemnification, differing in how they calculate the loss amount. Some policies include 'betterment' clauses that account for improvements when replacing old items with new ones.