According to the principle of indemnity, how is compensation determined?

The principle of indemnity is a fundamental concept in insurance that ensures individuals are compensated for their losses without making a profit from the loss situation. The selected answer, which states that compensation is determined in proportion to the incurred losses, aligns directly with this principle.

When a loss occurs, the insurer evaluates the actual financial impact on the insured. This assessment includes determining the extent of the damage or loss incurred. The idea is to restore the insured to the financial position they were in immediately before the loss occurred, meaning that compensation must accurately reflect the actual damages or losses sustained.

Calculating compensation in proportion to incurred losses prevents over-compensation and ensures that the insured is not benefiting financially from the loss situation. This principle thereby maintains fairness and discourages moral hazard, where an insured might deliberately incur losses to receive a payout. Overall, the principle of indemnity emphasizes fairness in insurance adjustments specifically reflecting real financial losses.