2.3 Principle of Indemnity

Indemnity is the rule that limits an insurance recovery to the insured's actual loss — no profit, no betterment. Every personal lines property policy enforces indemnity through valuation methods, deductibles, coinsurance, other-insurance clauses, and subrogation. Supporting doctrines exist to prevent the insured from collecting more than the loss.

Doctrines That Support Indemnity

• Insurable interest — caps recovery at the extent of the financial interest.
• Actual cash value — strips depreciation so the insured is not enriched.
• Other-insurance clauses — prevent collecting full limits from two policies on one loss.
• Subrogation — sends recovered money to the insurer, not the insured.

Property Valuation

Worked ACV example: a 15-year-old roof with a 30-year life suffers a covered loss. Replacement cost is $20,000; it is 50% depreciated, so ACV pays $10,000 minus the deductible. RCV coverage would pay the full $20,000 (often after the insured actually replaces it).

Deductibles

• Straight (flat) deductible — A fixed dollar amount subtracted from each loss.
• Percentage deductible — A percentage of the dwelling limit; common for wind/hail or hurricane in coastal and Gulf states.
• Disappearing (franchise) deductible — Shrinks as the loss grows and vanishes above a threshold.
• Waiting-period deductible — A time deductible used in time-element coverages such as loss of use.

Coinsurance

The coinsurance clause penalizes underinsurance. The formula is:

Payment = (Insurance Carried / Insurance Required) x Loss − Deductible

The required amount is the coinsurance percentage (often 80%) times the property's replacement cost.

Worked Example

Replacement cost $400,000; 80% coinsurance required = $320,000 minimum limit. The insured carries only $240,000. A $100,000 fire loss occurs with a $1,000 deductible.

Payment = ($240,000 / $320,000) x $100,000 − $1,000
Payment = 0.75 x $100,000 − $1,000 = $74,000

The insured absorbs $26,000 because of underinsurance. Note: if the insured had carried at least $320,000, the ratio would be capped at 1.0 and the loss would be paid in full (less deductible). The penalty applies only to partial losses; total losses are usually paid to the limit regardless.

Other-Insurance Clauses

When two or more policies cover the same loss, these clauses prevent the insured from collecting twice and so uphold indemnity.

• Pro rata — Each insurer pays the share of the loss equal to its limit divided by total limits. If Policy A is $100,000 and Policy B is $200,000 on a $60,000 loss, A pays $20,000 (1/3) and B pays $40,000 (2/3).
• Contribution by equal shares — Each policy pays equally until a policy exhausts its limit, then the rest split the remainder.
• Primary and excess — One policy pays first to its limit; the other responds only above that. Personal umbrella policies are excess over the underlying HO and PAP limits.

Subrogation

Subrogation is the insurer's right, after paying a claim, to step into the insured's legal shoes and recover from the third party who caused the loss. The insured may not waive subrogation after a loss or settle with the wrongdoer in a way that defeats it. Any recovery first reimburses the insurer for what it paid; surplus returns to the insured.

Abandonment

Personal lines property policies expressly prohibit abandonment. The insured cannot dump damaged property on the insurer and demand the full limit. The insurer chooses whether to repair, replace, or pay the ACV/RCV — and the salvage belongs to the insurer once it pays a total loss.

Stated Amount, Agreed Value, and the Valued-Policy Law

Most personal lines property is indemnity-based, but two exceptions matter:

• Agreed value — Insurer and insured agree in advance on the property's value and waive coinsurance. Common on scheduled fine art and antique autos.
• Valued policy — Pays a stated amount regardless of actual value at loss. Life insurance is the classic valued contract.

Some states have a valued policy law requiring the insurer to pay the full face amount of dwelling coverage in the event of a total loss by a covered peril, regardless of ACV — a deliberate exception to strict indemnity meant to discourage over-insuring and then under-paying.

How the Pieces Combine on a Claim

Walk a partial loss through in order, because the exam often chains several concepts in one stem:

1. Confirm coverage and that no exclusion applies.
2. Determine the loss amount (repair/replace cost).
3. Apply the valuation method (ACV strips depreciation; RCV does not).
4. Apply the coinsurance ratio if the insured is underinsured.
5. Subtract the deductible.
6. Apply other-insurance clauses if more than one policy responds.
7. Pursue subrogation if a third party caused the loss.

Key trap: betterment. If a new RCV roof improves the home beyond pre-loss condition, strict indemnity is technically exceeded — which is why ACV is the default and RCV is a purchased upgrade.