Which statement best describes the principle of indemnity?

The principle of indemnity is foundational in insurance and relates directly to the concept that insurance aims to restore the insured to their financial position before a loss occurred, without allowing them to profit from the claim. This principle ensures that insurance serves its purpose of protection against losses rather than functioning as a means for individuals or businesses to gain financially from unfortunate events.

When a policyholder suffers a loss due to an insured peril, the insurance payout is designed to cover the actual loss incurred, not to exceed that amount. This prevents the insured from receiving a windfall or financial gain beyond the original value of what was lost, adhering strictly to the principle of indemnity. By this principle, the compensation provided reflects the loss suffered, effectively placing the insured back where they were prior to the incident, ensuring fairness and maintaining the integrity of the insurance system.

The other statements, while they may reflect some aspects of insurance, do not accurately encapsulate the principle of indemnity in the same manner. For instance, the idea that insurance should create profit or limit liability does not align with the core purpose of restoring financial balance following a loss.