Indemnity
Definition

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What is an indemnity?

An indemnity is a feature of a business contract in which one party agrees to compensate another party for a prior or potential loss. The payment either takes the form of cash or repair or replacement of damaged property.

 

What is the role of an indemnity in insurance?

An indemnity is the foundation of most business insurance policies, including general liability, workers’ compensation, commercial auto, and commercial umbrella liability. At its core, insurance is fundamentally an indemnity arrangement. Here’s how it works:

Under the terms of the agreement (listed in the policy), the insurance buyer (the insured) agrees to pay the insurer a premium.

In return, the insurer agrees to compensate the insured for any covered losses during the policy period. Losses can range from property damage and legal expenses to automobile injuries or workplace illnesses, among others.

 

How is an indemnity paid?

An indemnity is fulfilled by making a cash payment or by repairing or replacing the damaged property. The indemnity agreement or policy specifies the payment mode.

 

Are all types of insurance based on an indemnity?

Not all insurance policies are based on an indemnity. An indemnity applies to insurance in which the payment to insureds is tied closely to a specific replacement cost, fair-market value, or reimbursement.

In cases where it’s impossible to calculate such a value, an indemnity does not apply. A prime example is life insurance, which is not an indemnity because it’s impossible to determine the value of a human life or to indemnify (or make whole) a deceased person.

 

What is the role of an indemnity in business?

In business law, indemnities are arrangements in which one party assumes responsibility for another party’s liability, a transfer which occurs through a hold harmless agreement.

The liability transfer occurs after a trigger event, such as:

  • Breach of contract
  • Committing an error or omission
  • Or some other specified action

 

When does a small business owner need an indemnity?

You need an indemnity when a contract with another party subjects you to an unacceptable level of risk.

For example, let’s say you own a technology firm, and you hire a freelance software programmer to design an application. Because you’re concerned the programmer might violate a third party’s copyright when coding your app,  you require him to indemnify you (make you whole) in case a copyright owner files a lawsuit alleging infringement.

 

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