Principles of Insurance – Indemnity and Subrogation

“Indemnity” is an important principle of Insurance and comes into play when there is a claim. Indemnity is applied only when there is insurable interest, if there is no insurable interest then indemnity is not applicable. The principle of indemnity states that the person suffering the financial loss should be compensated equal to the loss he suffered. He should be in the same financial position after the loss as he was before the loss. The insured should neither be better off nor worse off. All contracts of the motor are treated as contracts of indemnity.

Suppose an insured driver has an accident and his vehicle is damaged. The damage is to his bumper, fender, and door. Luckily the insured was not hurt in the accident. The total cost of repairing his vehicle comes to $ 10,000. In such a scenario the insured should be paid $ 10,000 to apply the principle of indemnity. But in practice, this may not happen as policies have conditions like sum-insured, inner limits, deductible or excess, and co-insurance condition, etc. However, the spirit of the principle of Indemnity should be followed while practicing insurance. The principle of Indemnity clearly states that the insured should neither be financially better off nor worse off from the accident or disease.

Let us take a look into the following two examples where the application of indemnity is not fully complied with.

Example 1 – Application of the principle of indemnity in case of co-insurance – Mr. X, got a first-month free auto insurance policy providing comprehensive insurance coverage. His policy had a compulsory deductible of $ 1,000.

Being a telecom engineer he was on a holiday with his family at one of the hill stations and whilst driving down the hill his vehicle skidded and hit the tree. The vehicle had major damage like both the front lights were damaged, the bumper was broken and there were damages to the radiator and battery. He took the vehicle for repairs. The total cost of his repairing the vehicle was $ 6,000. Due to this incident, Mr. M suffered a financial loss which he is supposed to be compensated.

As per the principle of indemnity, he should be compensated with an amount of $ 6,000. However, in this case due to the deductible amount the insured is paid the cost of repairing less the deductible, which came to $ 5,000. On the face of it, the indemnity principle is not fully complied with due to the presence of a deductible. Generally, in practice, this principle may not be applied with 100% accuracy in all types of policies but will act as a guide to the settlement of claims.

Example 2 – Application of the principle of indemnity in case of inner limit – Mr. Q had purchased a no deposit car insurance providing full motor insurance coverage. The policy also had coverage for towing his vehicle from the site of the accident to the Garage. His limit for towing extension was $ 1,000. Once he went to a very remote and far-off location on a recreational visit.

While returning he had an accident and his vehicle was totally damaged. He arranged for towing the vehicle to his hometown. The towing company charged him $1,600. When he claimed the towing bill, the Insurer paid him only $ 1,000 as per the limitation of the policy. In this case, the coverage limit condition did not allow him to be fully indemnified.

Subrogation  

It is one of the six principles, which supports the achievement of Indemnity. Suppose any third party is responsible for causing the damage to the vehicle or injury to the insured under the policy, then the insured has a right to claim from the party that was responsible for causing the loss due to accident to him, moreover, the insured can also claim from his insurance company.

This gives the benefit of two claims to the insured and he will definitely benefit from insurance. In order to avoid such a situation, wherein the insured is in a better-off position thereby violating the principle of Indemnity, the principle of subrogation is applied, which helps in the achievement of the basic principle of Indemnity.

The insurance company applies the principle of subrogation to recover the cost of the damages from the third party on behalf of their Insured. In laymen’s terms, Subrogation is nothing but assuming the legal rights of a person for which the expenses or claim has been paid. It can be termed as substitution, substituting the place of the insured.

Example – If Mr. A is driving his car on the road and Mr. B hits his car from behind as his brakes failed at the last moment. The accident had caused major damage to Mr. A’s car. The total cost of repairing the car was $ 25,000. Mr. A has a right to recover this amount from Mr. B. However, Mr. A purchased a motor insurance policy from Good2go Auto Insurance, then he has a right to file a claim.

If the insured claims the insurance company and Mr. B then he will be in a better position and he is benefiting out of Insurance. Hence the Insurance Company will settle the claim and will ask Mr. A to pay back the money he received from Mr. B. If Mr. B has not paid then the insurance company will ask Mr. A to provide a subrogation letter and will pursue the claim on behalf of A. Any amount recovered from B will go to the insurance company.

Subrogation is substituting or stepping into the shoes of the insured to pursue the rights of recovery from the third parties.