What Is Indemnity?
An indemnity is a comprehensive form of insurance compensation for damages or loss. When indemnity is used legally, it may also refer to an exemption from liability for damages.
Indemnity is a contractual agreement between two parties. In this arrangement, one party agrees to pay for potential losses or damages caused by another party. A typical example is an insurance contract, in which the insurer or the Indemnitor agrees to compensate the other (the insured or the indemnitee) for any damages or losses in return for premiums paid by the insured to the insurer. With indemnity, the insurer indemnifies the policyholder and promises to make whole the individual or business for any covered loss.
KEY TAKEAWAYS
- An indemnity is a comprehensive form of insurance compensation for damages or loss.
- In this arrangement, one party agrees to pay for potential losses or damages caused by another party.
- A typical example is an insurance contract, in which the insurer or the Indemnitor agrees to compensate the other (the insured or the indemnitee) for any damages or losses in return for premiums paid by the insured to the insurer.
How Indemnity Works
An indemnity clause is standard in the majority of insurance agreements. However, precisely what is covered and to what extent depends on the specific agreement. Any given indemnity agreement has a period of indemnity or a particular length of time for which the payment is valid. Similarly, many contracts include a letter of indemnity, which guarantees that both parties will meet the contract stipulations (or else an indemnity must be paid).
Indemnity is common in agreements between an individual and a business (for example, an agreement to obtain car insurance). However, it can also apply on a larger scale to relationships between companies and governments or between governments of two or more countries.
IMPORTANT: Indemnity clauses can be complicated to negotiate and can lead to increased costs of services because of the increased risk of the contract.
Sometimes, governments, businesses, or an entire industry must take on the costs of more significant issues on behalf of the public, such as disease outbreaks. For example, according to Reuters, Congress authorized $1 billion to fight a bird flu epidemic that devastated the U.S. poultry industry in 2014 and 2015. The U.S. Department of Agriculture spent $600 million on virus elimination and disinfection and $200 million in indemnity payments.
Special Considerations
How Indemnity Is Paid
An indemnity may be paid in cash or by way of repairs or replacement, depending on the terms of the indemnity agreement. For example, in the case of home insurance, the homeowner pays insurance premiums to the insurance company in exchange for the assurance that the homeowner will be indemnified if the house sustains damage from fire, natural disasters, or other perils specified in the insurance agreement. If the home is damaged significantly, the insurance company will be obligated to restore the property to its original state through repairs by authorized contractors or reimbursement to the homeowner for expenditures incurred for such repairs.
Indemnity Insurance
Indemnity insurance is a way for a company (or individual) to obtain protection from indemnity claims. This insurance protects the holder from having to pay the full sum of an indemnity, even if the holder is responsible for the cause of the indemnity.
Many companies make indemnity insurance a requirement, as lawsuits are expected. Everyday examples include malpractice insurance, standard in medical fields, and errors and omissions insurance (E&O), which protects companies and employees against claims made by clients and applies to any given industry. Some companies also invest in deferred compensation indemnity insurance, which covers the money companies expect to receive in the future.
As with any other form of insurance, indemnity insurance covers the costs of an indemnity claim, including, but not limited to, court costs, fees, and settlements. The amount covered by insurance depends on the specific agreement, and the cost of the insurance depends on many factors, including the history of indemnity claims.
Property leases also include indemnity clauses. For example, in the case of a rental property, a tenant is typically responsible for damages due to negligence, fines, lawyer fees, and more, depending on the agreement.
Acts of Indemnity
An act of indemnity protects those who have acted illegally from being subject to penalties. This exemption typically applies to public officers, such as police officers or government officials, who are sometimes compelled to commit illegal acts to carry out the responsibilities of their jobs. Often, such protection is granted to a group of people who committed an unlawful act for the common good, such as the assassination of a known dictator or terrorist leader.
History of Indemnity
Although indemnity agreements have not always had a name, they are not new. Historically, indemnity agreements have ensured cooperation between individuals, businesses, and governments.
In 1825, Haiti was forced to pay France what was then called an “independence debt.” The payments were intended to cover the losses French plantation owners “suffered” after losing land and slaves. While this form of indemnity was incredibly unjust, it is one example of many historical cases showing how indemnity has been applied worldwide.
Another common form of indemnity is the reparations a winning country seeks from a losing country after a war. Depending on the amount and extent of the indemnity due, it can take years and even decades to pay off. One of the most well-known examples is the indemnity Germany paid after its role in World War I. Those reparations finally paid off in 2010, almost a century after they were implemented.
