What does the principle of indemnity ensure in an insurance contract?

The principle of indemnity is a fundamental concept in insurance that ensures that a policyholder is compensated for a loss in a way that restores their financial position before the loss occurred, without allowing them to profit from the insurance claim. This means that if a covered event causes damage or loss, the insurer will provide an amount that is equivalent to the value of the loss, bringing the policyholder back to their pre-loss state, rather than providing extra financial gain.

This principle is crucial because it prevents moral hazard, where insured individuals might take risks knowing they would be compensated for losses. The goal is fairness in risk management by making sure that the claim process does not lead to overcompensation or encourage insurance fraud. By adhering to this principle, insurance maintains its role of providing support during unfortunate events while discouraging profit from losses.

The other choices either suggest an arrangement that could lead to profit (such as guaranteed payout or overcompensation) or misrepresent the insurer's role. Therefore, the correct understanding revolves around restoration to a previous financial condition, ensuring that the policyholder experiences no more than what they lost.