How does 'indemnity' protect the insured?

Indemnity is a fundamental principle in insurance that aims to restore the insured to the financial position they were in before a loss occurred, without allowing them to profit from the situation. This principle is crucial in maintaining fairness in the insurance system and prevents moral hazard, where individuals might take undue risks knowing they can collect an insurance payout without consequence.

By adhering to the principle of indemnity, insurance policies are structured to compensate the insured only for the actual financial loss incurred, thus safeguarding the insured from profiting from the loss. The focus is on making the insured whole again, rather than providing an opportunity for financial gain through their insurance policy.

In this context, increasing coverage limits, ensuring full replacement value, or limiting liability to a fixed amount do not encapsulate the essence of indemnity as they may not necessarily adhere to the principle of preventing profit from a loss. Instead, they could result in surplus payouts beyond the actual loss experienced by the insured.