The principle of indemnity in insurance emphasizes that on the happening of a loss, the insured shall be put back into the same financial position as he used to occupy immediately before the loss. In other words, the insured shall get neither more nor less than the actual amount of loss sustained. This, of course, is always subject to the limit of the sum insured and also subject to certain terms and conditions of the policy.
Therefore, to put the principle of indemnity in insurance business in a much better way: on the happening of a loss, the insurers will try to put back the insured into the same financial position as the insured used to occupy immediately before the happening of the loss, only if the insurance is properly arranged on full value insurance.
Under insurance and restrictive terms of the policy may preclude the insured from getting actual loss. On the other hand, even if the sum-insured is more than the actual value of the property or subject-matter, this would not entitle the insured to get more than the actual loss.
This principle of indemnity in insurance business is indeed very important to keep the business of insurance in track and to keep it free from wagering. This also checks the moral hazard of a man and at the same time allows him to get the actual amount of loss and certainly not more than that. Consider a proposition wherein through over-insurance somebody is allowed to take more than the actual amount of loss. In that case it can be said with definite certainty that there will always be a temptation to create an insured event deliberately for the sole purpose of making a profit out of a loss.
A contract of insurance is necessarily and purely a contract of indemnity (except for life insurance and personal accident insurance). This means that in case of a loss the insured shall be fully indemnified, but shall never be more than fully indemnified. That is the fundamental principle of insurance.
