Property and Casualty Insurance Practice Exam

Which principle ensures that an individual does not profit from a loss in an insurance policy?

1. Principle of Indemnity

2. Principle of Insurable Interest

3. Principle of Subrogation

4. Principle of Fair Compensation

The correct answer is: Principle of Indemnity

The Principle of Indemnity is the concept that ensures individuals are compensated for their losses but do not profit from an insurance policy. This principle underscores the fundamental purpose of insurance: to restore the insured to the financial position they were in before the loss occurred, without allowing them to gain an advantage or profit from the situation. In practice, this means that when a claim is paid, it corresponds accurately to the actual loss suffered. For instance, when a home is damaged, the insurance payout will cover the cost of repairs or the value of the property lost, not more than that. This principle helps maintain the integrity of the insurance system by preventing moral hazard, where policyholders might be incentivized to make claims they do not truly deserve. Understanding the context of this principle is crucial, especially when considering other concepts related to insurance, such as insurable interest, which mandates that the policyholder must have a legitimate interest in the insured item. Similarly, subrogation relates to the insurer's right to recover the amount paid to the insured from a third party responsible for the loss, but it does not pertain directly to the notion of profiting from a loss. Lastly, the idea of fair compensation can be subjective and would not address the specific